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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 SEPTEMBER 30, 2003, 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
(I.R.S. Employer Identification No.)
4 TAFT COURT, ROCKVILLE, MARYLAND
(Address of principal executive offices)
20850
(Zip code)
(301) 762-8205
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [ ]
The number of shares outstanding of each of the issuer's classes of common stock
was 47,760,422 shares of common stock, par value $.01, outstanding as of
September 30, 2003.
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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)
September 30, December 31,
2003 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 9,187 $ 7,144
Investment securities 645,737 486,740
Accounts receivable, net of allowance of $7,811 and $7,068 122,647 118,050
Prepaid expenses, advances and other 41,907 37,104
Deferred income taxes 8,234 3,419
----------- -----------
Total current assets 827,712 652,457
Property and equipment, net of accumulated
depreciation of $76,689 and $70,123 81,321 82,683
Statutory deposits 21,743 21,541
Other assets 9,226 8,951
Deferred income taxes 10,085 7,396
----------- -----------
Total assets $ 950,087 $ 773,028
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ - $ 3,219
Accounts payable 73,233 62,434
Claims payable, net 340,255 297,304
Income taxes payable 14,691 12,751
Deferred premium revenue 39,106 33,901
Unearned revenue 17,247 14,592
Deferred income taxes 4,835 2,262
----------- -----------
Total liabilities 489,367 426,463
----------- -----------
Stockholders' equity
Common stock, $.01 par, 100,000,000 shares authorized; 67,772,502 issued and
47,760,422 outstanding at September 30, 2003; 65,772,502 issued
and 46,987,122 outstanding at December 31, 2002 677 657
Additional paid-in capital 673,144 466,154
Stock compensation trust (common stock held in trust) 8,304,552 shares
outstanding at September 30, 2003;
8,311,590 shares outstanding at December 31, 2002 (427,103) (269,296)
Treasury stock, 20,012,080 shares at September 30, 2003;
18,785,380 shares at December 31, 2002 (332,163) (276,205)
Accumulated other comprehensive income 10,798 9,279
Retained earnings 535,367 415,976
----------- -----------
Total stockholders' equity 460,720 346,565
----------- -----------
Total liabilities and stockholders' equity $ 950,087 $ 773,028
=========== ===========
Note: The balance sheet at December 31, 2002 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
September 30, September 30,
2003 2002
------------ ------------
Revenue
Health premium $ 652,588 $ 577,900
Fee and other 5,849 5,210
Life and short-term disability premium 2,215 2,297
Home health services 4,867 6,146
Investment 4,502 3,914
----------- -----------
Total revenue 670,021 595,467
----------- -----------
Expense
Medical 524,794 492,402
Life and short-term disability claims 1,019 1,114
Home health patient services 4,992 5,798
Administrative (including interest expense of $261 and $142) 68,743 62,516
----------- -----------
Total expense 599,548 561,830
----------- -----------
Income before income taxes 70,473 33,637
Income tax expense (24,319) (11,114)
----------- -----------
Net income $ 46,154 $ 22,523
=========== ===========
Basic earnings per common share $ 1.16 $ .57
=========== ===========
Diluted earnings per common share $ 1.10 $ .54
=========== ===========
See accompanying notes to these financial statements.
4
MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands except share amounts)
(Unaudited)
Nine Months Ended
September 30, September 30,
2003 2002
------------ ------------
Revenue
Health premium $ 1,953,546 $ 1,670,525
Fee and other 17,714 16,500
Life and short-term disability premium 6,989 6,699
Home health services 16,608 16,366
Investment 12,686 10,803
----------- -----------
Total revenue 2,007,543 1,720,893
----------- -----------
Expense
Medical 1,600,703 1,428,167
Life and short-term disability claims 3,021 2,865
Home health patient services 16,319 16,535
Administrative (including interest expense of $857 and $459) 205,819 184,751
----------- -----------
Total expense 1,825,862 1,632,318
----------- -----------
Income before income taxes 181,681 88,575
Income tax expense (62,290) (28,776)
----------- -----------
Net income $ 119,391 $ 59,799
=========== ===========
Basic earnings per common share $ 3.05 $ 1.53
=========== ===========
Diluted earnings per common share $ 2.88 $ 1.43
=========== ===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months
Ended
September 30, 2003
-----------
Cash flows provided by operating activities:
Net income $ 119,391
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 8,877
Provision for bad debts 743
Credit for deferred income taxes (5,749)
Loss on sale and disposal of assets 19
Stock option tax benefit 22,995
Increase in accounts receivable (5,340)
Increase in prepaid expenses, advances, and other (4,803)
Increase in accounts payable 10,799
Increase in income taxes payable 1,940
Increase in claims payable, net 42,951
Increase in deferred premium revenue 5,205
Increase in unearned revenue 2,655
-----------
Total adjustments 80,292
-----------
Net cash provided by operating activities 199,683
Cash flows used in investing activities:
Purchases of investment securities (679,621)
Sales of investment securities 522,758
Purchases of property and equipment (7,486)
Purchase of statutory deposits (4,452)
Maturity of statutory deposits 4,452
Purchases of other assets (367)
Proceeds from sale of assets 45
-----------
Net cash used in investing activities (164,671)
Cash flows used in financing activities:
Decrease in short-term borrowings (3,219)
Exercise of stock options 26,208
Purchase of treasury stock (55,958)
-----------
Net cash used in financing activities (32,969)
-----------
Net increase in cash and cash equivalents 2,043
Cash and cash equivalents at beginning of period 7,144
-----------
Cash and cash equivalents at end of period $ 9,187
===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months
Ended
September 30, 2002
------------
Cash flows provided by operating activities:
Net income $ 59,799
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 8,251
Provision for bad debts 445
Credit for deferred income taxes (13,433)
Loss on sale and disposal of fixed assets 24
Stock option tax benefit 17,269
Increase in accounts receivable (18,353)
Increase in prepaid expenses, advances, and other (11,851)
Increase in accounts payable 9,612
Increase in income taxes payable 5,518
Increase in claims payable 109,890
Decrease in deferred premium revenue (1,854)
Increase in unearned revenue 13,519
-----------
Total adjustments 119,037
-----------
Net cash provided by operating activities 178,836
Cash flows used in investing activities:
Purchases of investment securities (574,349)
Sales of investment securities 445,221
Purchases of property and equipment (10,425)
Purchases of statutory deposits (1,681)
Maturities of statutory deposits 100
Purchases of other assets (122)
Proceeds from sale of assets 174
-----------
Net cash used in investing activities (141,082)
Cash flows used in financing activities:
Decrease in short-term borrowings (413)
Exercise of stock options 28,664
Purchase of treasury stock (61,471)
-----------
Net cash used in financing activities (33,220)
-----------
Net increase in cash and cash equivalents 4,534
Cash and cash equivalents at beginning of period 4,510
-----------
Cash and cash equivalents at end of period $ 9,044
===========
See accompanying notes to these financial statements.
7
MID ATLANTIC MEDICAL SERVICES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
INTRODUCTION
Mid Atlantic Medical Services, Inc. is a holding company whose subsidiaries are
active in managed health care and other life and health insurance related
activities. MAMSI's principal markets currently include Maryland, Virginia, the
District of Columbia, Delaware, West Virginia, North Carolina and Pennsylvania.
MAMSI and its subsidiaries (collectively referred to as "MAMSI" or the
"Company") offer a broad range of health care coverage and related ancillary
products and deliver these services through health maintenance organizations
("HMOs"), a preferred provider organization ("PPO"), and a life and health
insurance company. MAMSI also owns a home health care company, a home infusion
services company, a hospice company, a coordination of benefits identification
and collections company and maintains a partnership interest 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. Alliance Recovery Services, LLC provides
coordination of benefits identification and collection services to third party
administrators and insurance companies.
NOTE 1 - FINANCIAL STATEMENTS
The consolidated condensed balance sheet of the Company as of September 30,
2003, the consolidated condensed statements of income for the three and nine
months ended September 30, 2003 and 2002, and the consolidated statements of
cash flows for the nine months ended September 30, 2003 and 2002 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, 2002 audited consolidated financial statements included in its
annual report on Form 10-K for the year ended December 31, 2002 ("2002 Form
10-K"). The results of operations for the three and nine month periods ended
September 30, 2003 are not necessarily indicative of the operating results for
the full year.
The Company has entered into certain long-term 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 over the contract period as a reduction
of medical expense. Because of the complexity of the Company's product offerings
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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. The Company is in
the process of settling the 2001 and 2002 risk sharing arrangements with its
former Pharmacy Benefits Manager ("PBM"). There is also a risk sharing
arrangement with the Company's current PBM for 2003. As of September 30, 2003,
the Company has recorded what it believes to be a reasonable estimate of the
results of these risk-share arrangements.
NOTE 2 - COMMON STOCK
The following table sets forth the computation of basic and diluted earnings per
share (in thousands except share amounts):
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Numerator:
Net income $ 46,154 $ 22,523 $ 119,391 $ 59,799
Denominator:
Denominator for basic earnings per share
- weighted average shares 39,670,327 39,318,030 39,154,160 39,201,813
Dilutive securities - employee stock options 2,159,192 2,330,796 2,254,903 2,624,594
Denominator for diluted earnings per share
- adjusted weighted average shares 41,829,519 41,648,826 41,409,063 41,826,407
Options to purchase approximately 8,700 shares of common stock at various prices
were outstanding at September 30, 2003, 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.
SFAS No. 130, Reporting Comprehensive Income, establishes standards for the
reporting and display of comprehensive income and its components. SFAS No. 130
requires, among other things, that unrealized gains and losses on
available-for-sale securities be included in other comprehensive income. The
following statement presents comprehensive income (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net income $ 46,154 $ 22,523 $ 119,391 $ 59,799
Other comprehensive income:
Unrealized (loss) gain on
available-for-sale securities (1,151) 3,240 1,519 7,248
------------ ------------ ------------ ------------
Comprehensive income $ 45,003 $ 25,763 $ 120,910 $ 67,047
============ ============ ============ ============
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.
9
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 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 a minimum of 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. OPM has not yet audited 2000-2002.
NOTE 4 - CLAIMS PAYABLE
The following table shows the components of claims payable at September 30, 2003
and 2002 (in thousands):
September 30, September 30,
2003 2002
------------ ------------
Reserve for incurred but
not reported claims $ 267,586 $ 270,337
Claims received, not yet
paid and other items 72,669 51,563
----------- -----------
Total claims payable $ 340,255 $ 321,900
=========== ===========
The following tables show the components of the change in claims payable for the
nine months ended September 30, 2003 and 2002 for each period's Dates of Service
("DOS") (in thousands except for percentages):
For the Nine Months Ended
September 30, 2003: Life & 2002 &
Medical STD Total 2003 DOS Prior DOS
----------------------------------------- -------------------------
Beginning of the year $ 295,721 $ 1,583 $ 297,304 $ - $ 297,304
Components of medical expense:
Estimated cost incurred 1,660,641 3,021 1,663,662 1,663,662 -
Estimated redundancy (59,938) - (59,938) - (59,938)
---------- -------- ---------- ---------- ---------
1,600,703 3,021 1,603,724 1,663,662 (59,938)
Payments for medical expense (1,557,535) (3,238) (1,560,773) (1,327,957) (232,816)
---------- -------- ---------- ---------- ---------
End of the period $ 338,889 $ 1,366 $ 340,255 $ 335,705 $ 4,550
========== ======== ========== ========== =========
Prior period redundancy as a percentage
of current period medical expense 3.74%
10
For the Nine Months Ended
September 30, 2002: Life & 2001 &
Medical STD Total 2002 DOS Prior DOS
----------------------------------------- -------------------------
Beginning of the year $ 238,814 $ 1,310 $ 240,124 $ - $ 240,124
Components of medical expense:
Estimated cost incurred 1,461,303 2,865 1,464,168 1,464,168 -
Estimated redundancy (33,136) - (33,136) - (33,136)
---------- -------- ---------- ---------- ---------
1,428,167 2,835 1,431,032 1,464,168 (33,136)
Payments for medical expense (1,346,421) (2,835) (1,349,256) (1,149,825) (199,431)
---------- -------- ---------- ---------- ---------
End of the period $ 320,560 $ 1,340 $ 321,900 $ 314,343 $ 7,557
========== ======== ========== ========== =========
Prior period redundancy as a percentage
of current period medical expense 2.32%
The Company does not track the redundancy/(deficiency) related to its life and
short-term disability business. Any actual redundancy/(deficiency) would be
immaterial to the tables above and the Company's financial statements.
NOTE 5 - 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. 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 2002 Form
10-K.
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------
Revenues:
Commercial risk $ 652,588 $ 577,900 $ 1,953,546 $ 1,670,525
Preferred provider organizations 5,849 5,210 17,714 16,500
All other 7,082 8,443 23,597 23,065
----------- ----------- ----------- -----------
$ 665,519 $ 591,553 $ 1,994,857 $ 1,710,090
=========== =========== =========== ===========
Income before taxes:
Commercial risk $ 63,915 $ 28,223 $ 162,170 $ 73,601
Preferred provider organizations 2,457 2,605 7,441 8,251
All other (266) (988) (236) (3,756)
----------- ----------- ----------- -----------
$ 66,106 $ 29,840 $ 169,375 $ 78,096
=========== =========== =========== ===========
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Reconciliations of segment data to the Company's consolidated data is as
follows:
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------
Total profit from reportable segments $ 66,372 $ 30,828 $ 169,611 $ 81,852
Other loss (266) (988) (236) (3,756)
Unallocated amounts:
Investment income, net 4,367 3,797 12,306 10,479
----------- ----------- ----------- -----------
Income before taxes $ 70,473 $ 33,637 $ 181,681 $ 88,575
=========== =========== =========== ===========
NOTE 6 - STOCK-BASED COMPENSATION
In accordance with Statement of Financial Accounting Standards No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure ("SFAS No.
148"), the effect on net income and net income per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, Accounting for
Stock- Based Compensation ("SFAS No. 123") to stock-based employee compensation
is as follows:
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------
Net income, as reported $ 46,154 $ 22,523 $ 119,391 $ 59,799
Deduct: Net stock-based employee
compensation expense determined
under fair value based method (3,162) (2,612) (9,061) (7,149)
----------- ----------- ----------- -----------
Pro forma net income $ 42,992 $ 19,911 $ 110,330 $ 52,650
=========== =========== =========== ===========
Earnings per share:
Basic - as reported $ 1.16 $ .57 $ 3.05 $ 1.53
Basic - pro forma $ 1.08 $ .51 $ 2.82 $ 1.34
Diluted - as reported $ 1.10 $ .54 $ 2.88 $ 1.43
Diluted - pro forma $ 1.03 $ .48 $ 2.66 $ 1.26
The effect of applying SFAS No. 123 on the three and nine month periods ended
September 30, 2003 and 2002 pro forma net income and pro forma net income per
share as stated above, is not necessarily representative of the effects on
reported net income for future years, due to, among other things, (1) the
vesting period of stock options and (2) the fair value of additional stock
options in future years.
NOTE 7 - SUBSEQUENT EVENT
On October 27, 2003, MAMSI and UnitedHealth Group Incorporated ("UnitedHealth
Group") announced that they had entered into an agreement and plan of merger
pursuant to which MAMSI will merge with and into a wholly-owned subsidiary of
UnitedHealth Group. If the merger is completed, each outstanding share of MAMSI
common stock will be converted into the right to receive 0.82 shares of
UnitedHealth Group common stock and $18.00 in cash. MAMSI currently anticipates
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that the merger will be completed in the first quarter of 2004, however it is
possible that delays could require that the merger be completed at a later time.
Because the merger is subject to closing conditions, including the approval of
MAMSI stockholders and the approval of regulatory agencies that have broad
discretion in administering regulations, MAMSI cannot predict the exact timing
of the completion of the merger. The agreement is subject to a termination fee
of approximately $116.4 million to be paid by MAMSI if the agreement is
terminated due to the Company taking certain actions. For more information
regarding the proposed merger, please refer to MAMSI's Form 8-K/A filed with the
Securities and Exchange Commission on October 27, 2003.
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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 with inherent risks and
uncertainties, affecting 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 of a weak economy on the Company.
3. The effect on the Company due to the 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 have the potential for increased costs, and/or increased regulation of
rates which might have the potential to decrease revenue.
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 ultimate accuracy of the Company's estimate of the liability for
incurred but not reported claims.
- 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.
8. The possibility that the Company is unable to complete the proposed merger
with UnitedHealth Group and is subject to a termination fee of $116.4 million.
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.
14
CRITICAL ACCOUNTING POLICIES
MAMSI, through its 100% owned subsidiary companies, is predominately in the
business of selling various forms of health insurance. Through the third quarter
of 2003, approximately 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 premiums 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, as of
September 30, 2003, MAMSI has no debt outstanding.
The buildings that the Company owns are either used in its operations or are
currently leased to other entities and 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 within 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. Various factors such as timing of the receipt of claims,
seasonal utilization, and underlying cost inflation affect the ultimate
development of claims expense. To the extent that we over or under estimate our
IBNR at the end of any reporting period, the adjustment is included in the
future period's results. The table below indicates how much we believe we have
over- estimated our December 31, 2002 and 2001 IBNR liability for the nine
months ended and expresses it as a percentage of the respective year to date
medical expense:
15
Nine Months Over As a % of
Ended Estimated Medical Expense
-------------- ----------- ---------------
September 2003 $59,938,000 3.74%
September 2002 $33,136,000 2.32%
If medical expense was annualized for 2003, the over-estimation as a percentage
of medical expense would be 2.8% for 2003. The over-estimation for 2002 as a
percentage of actual medical expense for 2002 would be 1.7%. This annualized
medical expense is not necessarily indicative of the medical expense for the
full year.
Another important accounting policy relates to our risk sharing contracts.
Certain of the Company's larger 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
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 is in the process of settling the 2001 and 2002
risk sharing arrangements with its former PBM. There is also a risk sharing
arrangement with the Company's current PBM for 2003. As of September 30, 2003,
the Company has recorded what it believes to be a reasonable estimate of the
results of these risk-share arrangements.
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
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.
16
For the Federal Employees' Health Benefits Program business, the Company does
not record an allowance for doubtful accounts as the Federal Government is
obligated to pay what it believes it owes. Rather, the Company utilizes a direct
write-off methodology. In the third quarter of 2003, the Company recorded a
provision, rather than an allowance, of approximately $8.5 million related to
premium amounts due from the Federal Employees' Health Benefits Program. The
Company is in the process of analyzing why certain Federal payroll offices are
remitting amounts less than they are billed.
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 2002
Consolidated net income of the Company was $46,154,000 and $22,523,000 for the
third quarters of 2003 and 2002, respectively. Diluted earnings per share were
$1.10 and $.54 in the third quarters of 2003 and 2002, 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 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 September 30, 2003 increased
approximately $74.7 million or 12.9 percent over the three months ended
September 30, 2002. A 1.1 percent increase in net average HMO and indemnity
enrollment resulted in an increase of approximately $6.1 million in health
premium revenue, while a 11.7 percent increase in average monthly premium per
enrollee, combined for all products, resulted in a $68.6 million increase in
health premium revenue. In addition, health premium revenue for the third
quarter of 2003 was reduced by an $8.5 million provision related to the
Company's Federal Employees' Health Benefits Program business. Management
believes that commercial health premiums should continue to increase during the
remainder of 2003 and in 2004, as new and renewing groups are charged higher
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 commercial 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 2003 and are expected to increase in 2004
approximately 11.0%, net of buy downs. 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.
17
The Company's home health operations contributed approximately $4.9 million in
revenue in the third quarter of 2003 as compared with $6.1 million in the third
quarter of 2002, reflecting a decrease in services provided to non-affiliated
companies and a reclassification of revenues between income statement
categories, having no net income effect.
Fee and other revenue increased to $5.8 million for the quarter ended September
30, 2003 from $5.2 million for the quarter ended September 30, 2002, primarily
due to an increase in rental income from Company-owned facilities.
Life and short-term disability products contributed $2.2 million in revenue in
the third quarter of 2003 as compared with $2.3 million for the third quarter of
2002.
Investment income increased from $3.9 million for the third quarter of 2002 to
$4.5 million for the third quarter of 2003 due to higher levels of invested
balances.
The medical care ratio decreased from 85.2% for the third quarter of 2002 to
80.4% for the third quarter of 2003. On a per member per month basis, medical
expenses increased 5.5%. 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 specialized
subrogation areas and claims review for dual health coverage, lower than
expected utilization of medical services due to hurricane Isabel, which caused
power outages in the Company's service area, preventing members from seeking
non-emergency care, and also increased premiums per member. The medical expense
trend is anticipated to be between 10.0% and 11.0% for 2004. 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.
The administrative expense ratio decreased from 10.5 percent for the third
quarter of 2002 to 10.3 percent for the same period in 2003. The decrease in the
administrative expense ratio is principally due to increases in premium rates
and membership, management's efforts to control costs as the business volume
increases and technology and productivity gains which have allowed headcount to
remain stable. Management believes that the administrative expense ratio will be
approximately 10.0% to 10.3% for 2004. 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 and
increased administrative activity related to business volume and to price
increases from the Company's vendors.
The net margin rate increased from 3.8 percent in the third quarter of 2002 to
6.9 percent in the current quarter. This increase is consistent with the factors
previously described.
THE NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2002
The Company's consolidated net income for the nine months ended September 30,
2003 increased to $119,391,000 from $59,799,000 for the nine months ended
September 30, 2002. Diluted earnings per share on net income increased from
$1.43 in the first nine months of 2002 to $2.88 for the same period in 2003. 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 nine months ended September 30, 2003 increased
approximately $283.0 million or 16.9 percent over the nine months ended
September 30, 2002. A 3.9 percent increase in net average HMO and indemnity
18
enrollment resulted in an increase in health premium revenue of approximately
$65.4 million, while a 12.5 percent increase in average monthly premium per
enrollee, combined for all products, resulted in a $217.6 million increase in
health premium revenue.
The Company's home health operations contributed approximately $16.6 million in
revenue in the first nine months of 2003 as compared with $16.4 million in the
first nine months of 2002, reflecting of a slight increase in services provided
to non- affiliated companies.
Fee and other revenue increased to $17.7 million for the nine months ended
September 30, 2003 from $16.5 million for the nine months ended September 30,
2002 primarily due to an increase in rental income from Company-owned
facilities.
Revenue from life and short-term disability products contributed $7.0 million in
revenue for the first nine months of 2003 as compared to $6.7 million in the
first nine months of 2002.
Investment income increased from $10.8 million in the first nine months of 2002
to $12.7 million in the first nine months of 2003 primarily due to higher
investment balances partially offset by lower rates.
The medical care ratio decreased to 81.9 percent for the nine months ended
September 30, 2003 as compared to 85.5 percent for the comparable period in
2002. The reasons for this decrease are consistent with the items discussed in
the quarterly analysis.
The administrative expense ratio decreased to 10.3 percent for the first nine
months of 2003 as compared to 10.7 percent for the comparable period in 2002.
The reasons for this decrease are consistent with the items discussed in the
quarterly analysis.
The net margin rate increased from 3.5 percent for the first nine months of 2002
to 5.9 percent for the comparable period of 2003. This increase is consistent
with the factors previously described.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business is not capital intensive and the majority of the
Company's expenses are payments to hospitals, physicians and other 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 operating
line-of-credit, will continue to be sufficient to meet the Company's cash
requirements in the future.
The Company's cash and investment securities increased $161.0 million from
$493.9 million at December 31, 2002 to $654.9 million at September 30, 2003,
primarily due to the timing of medical expense payments which traditionally lag
behind the receipt of increased premiums per member, a $27.2 million contractual
payment received from a vendor in February 2003, cash received from the exercise
of stock options and net income offset by the effect of treasury stock purchases
and other capital expenditures. Accounts receivable increased from $118.1
million at December 31, 2002 to $122.6 million at September 30, 2003,
principally due to the timing of customer payments and increased membership
offset by an $8.5 million provision recorded at September 30, 2003 related to
the Company's Federal Employees' Health Benefits Program business. Prepaid
expenses, advances and other increased from $37.1 million at December 31, 2002
to $41.9 million at September 30, 2003, primarily due to the unamortized portion
19
of prepayments for insurance policies which cover the Company's assets and
business operations and an increase in working capital advances paid to Maryland
hospitals.
Net property and equipment decreased from $82.7 million at December 31, 2002 to
$81.3 million at September 30, 2003, due to depreciation expense exceeding
capital expenditures in 2003.
Claims payable increased from $297.3 million at December 31, 2002 to $340.3
million at September 30, 2003, primarily due to increased membership, an
increase in medical expenses per member, and the timing of payments to
physicians and health care practitioners. Deferred premium revenue increased
from $33.9 million at December 31, 2002 to $39.1 million at September 30, 2003,
due to a increase in cash payments received in advance of the premium coverage
period. Unearned revenue increased from $14.6 million at December 31, 2002 to
$17.2 million at September 30, 2003, primarily due to the receipt of contractual
advances.
Additional paid-in capital increased from $466.2 million at December 31, 2002 to
$673.1 million at September 30, 2003, due to the exercise of employee stock
options, as well as an 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 $269.3 million at December 31, 2002 to
$427.1 million at September 30, 2003, due to the increase in the market value of
the Company's stock and the purchase of 2.0 million additional shares of the
Company's common stock held by 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 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 $276.2 million at December 31, 2002 to $332.2
million at September 30, 2003, due to the repurchase of 1,226,700 additional
shares of common stock by the Company at a total cost of $56.0 million. At
September 30, 2003, approximately $35.7 million of unspent authorization was
available for future purchases. During October 2003, the Company repurchased an
additional 5,000 shares of its common stock for a total cost of approximately
$0.3 million before the repurchase program was suspended due to the proposed
merger with UnitedHealth Group. (See Note 7 in Item 1 - Notes to the
Consolidated Financial Statements).
The Company currently has access to total revolving credit facilities of $25.5
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 September 30, 2003, 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 $21.3
million. In addition, at September 30, 2003, there were no amounts drawn against
these facilities, and approximately $614,000 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.
20
Following is a schedule of the short-term capital resources available to the
Company:
September 30, December 31,
(in thousands) 2003 2002
------------ ------------
Cash and cash equivalents $ 9,187 $ 7,144
Investment securities 654,737 486,740
Working capital advances
to Maryland hospitals 25,034 23,791
----------- -----------
Total available liquid assets 688,958 517,675
Credit line availability 20,711 20,217
----------- -----------
Total short-term capital resources $ 709,669 $ 537,892
=========== ===========
The Company believes that cash generated from operations along with its current
liquidity and borrowing capabilities are adequate for both current and planned
expanded operations.
The Company's major business operations are principally conducted through its
HMOs and its insurance company. HMOs and insurance companies are subject to
state regulations that, among other things, require those companies to maintain
certain levels of equity and Risk Based Capital ("RBC"), and restrict the amount
of dividends and other distributions that may be paid to their parent
corporation. As of September 30, 2003, those subsidiaries of the Company were in
compliance with all minimum capital requirements and exceeded all RBC - Company
Action Level requirements.
CONTRACTUAL OBLIGATIONS
There were no material changes in contractual obligations at September 30, 2003
when compared with December 31, 2002.
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 of the present yield in market interest rates over the next
year would not materially affect 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 September 30, 2003 when compared with December 31, 2002.
SUBSEQUENT EVENT
On October 27, 2003, MAMSI and UnitedHealth Group announced that they had
entered into an agreement and plan of merger pursuant to which MAMSI will merge
with and into a wholly-owned subsidiary of UnitedHealth Group. If the merger is
completed, each outstanding share of MAMSI common stock will be converted into
the right to receive 0.82 shares of UnitedHealth Group common stock and $18.00
in cash. MAMSI currently anticipates that the merger will be completed in the
first quarter of 2004, however it is possible that delays could require that the
merger be completed at a later time. Because the merger is subject to closing
conditions, including the approval of MAMSI stockholders and the approval of
21
regulatory agencies that have broad discretion in administering regulations,
MAMSI cannot predict the exact timing of the completion of the merger. The
agreement is subject to a termination fee of approximately $116.4 million to be
paid by MAMSI if the agreement is terminated due to the Company taking certain
actions. For more information regarding the proposed merger, please refer to
MAMSI's Form 8-K/A filed with the Securities and Exchange Commission on October
27, 2003.
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."
ITEM 4. CONTROLS AND PROCEDURES
Based on the evaluation carried out under the supervision of the Chief Executive
Officer and Chief Financial Officer of the Company as of the end of the period
covered by this quarterly report, the Company's disclosure controls and
procedures are adequately designed to ensure that the information required to be
included in this report has been recorded, processed, summarized and reported on
a timely basis. There have not been any significant changes in the Company's
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect the Company's internal controls over
financial reporting.
22
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 right of the Company to
subrogate against other insurance companies for injuries to members arising out
of third-party liabilities based on the provisions of the Maryland HMO Act, as
interpreted by the Maryland Court of Appeals in Reimer v. Columbia Medical Plan.
The action against the Company was filed in the Circuit Court for Montgomery
County, Maryland. The Company removed the case to federal court under the
Employee Retirement Income Security Act of 1974 and the case was remanded to the
Circuit Court for Montgomery County, Maryland on February 4, 2003. On September
30, 2003, the Montgomery County Circuit Court judge presiding over the case
denied the plaintiffs' class certification motion, leaving the case as a
single-plaintiff proceeding. The Company believes that its operations with
respect to the law are valid and is pursuing all available defenses. The Company
does not believe that, at this time, the ultimate outcome of this action will be
material to the Company's financial statements.
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
Exhibit
Number Description of Document
- ------- -----------------------
10.1 Employment Agreement between the Company and
Mark D. Groban
10.2 Employment Agreement between the Company and
Thomas P. Barbera.
10.3 Employment Agreement between the Company and
Robert E. Foss.
10.4 Employment Agreement between the Company and
Sharon C. Pavlos.
31.1 Certification of Chief Executive Officer
Pursuant to Rule 13a-14(a)/15d-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of Chief Financial Officer
Pursuant to Rule 13a-14(a)/15d-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
23
32.1 Certification of Chief Executive Officer
Pursuant to Title 18, United States Code,
Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer
Pursuant to Title 18, United States Code,
Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
In a report on Form 8-K dated August 7, 2003, the Company reported under Item
12, Results of Operations and Financial Condition, its financial results for the
quarter ended June 30, 2003.
24
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: November 14, 2003 /s/ Robert E. Foss
______________________________
Robert E. Foss
Senior Executive Vice President and
Chief Financial Officer
(duly authorized officer and
principal financial officer)