10-Q 1 f10q_093003.txt MAMSI FORM 10-Q SEPTEMBER 30, 2003 1 --------------------------------------------------------------- --------------------------------------------------------------- UNITED STATES 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 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 -------- -------- ------------------------------ COMMISSION FILE NUMBER 1-13340 ------------------------------ 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. --------------------------------------------------------------- -------------------------------------------------------------- 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (Note 1) (in thousands except share amounts)

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. 3 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED STATEMENTS OF INCOME (in thousands except share amounts) (Unaudited)

See accompanying notes to these financial statements. 4 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED STATEMENTS OF INCOME (in thousands except share amounts) (Unaudited)

See accompanying notes to these financial statements. 5 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (Unaudited)

See accompanying notes to these financial statements. 6 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (Unaudited)

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 8 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):

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):

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):

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):

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.

11 Reconciliations of segment data to the Company's consolidated data is as follows:

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:

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 12 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. 13 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

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:

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)

MID ATLANTIC MEDICAL SERVICES INC 10-Q