On May 24, 2001 the Missouri Department of Insurance placed our subsidiary, Maxicare Life and Health Insurance Company, Inc., under administrative supervision. Maxicare Life and Health Insurance Company, Inc. ceased offering all products effective December 31, 2001, effectively ceasing all operations. On January 28, 2002 the Missouri Department of Insurance placed Maxicare Life and Health Insurance Company, Inc. into rehabilitation. On March 4, 2003 the Board of Directors of Maxicare Life and Health Insurance Company agreed to its liquidation. It is unlikely that we will receive any distribution of assets from Maxicare Life and Health Insurance Company.
We reported a net loss of $3.3 million, or $.33 per share (basic and diluted), from continuing operations for the year ended December 31, 2001. We sustained a loss of $31.6 million, or $6.46 per share (basic and diluted), from continuing operations for the year ended December 31, 2000. Year 2000 results from continuing operations included an $18.2 million non-cash charge associated with the write off of deferred tax assets.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Maxicare Health Plans, Inc. at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Maxicare Health Plans, Inc., a Delaware corporation (“MHP”), is a holding company that owns various subsidiaries, primarily in the field of managed care. As of January 1, 2002 substantially all operations of MHP and its subsidiaries were terminated. Additionally, as of December 31, 2002 we were operating with a substantial capital deficiency (see “Liquidity” below).
We operated an HMO in California (the “California HMO”) prior to May 25, 2001. On May 25, 2001, the California Department of Managed Health Care issued an order appointing a conservator for the California HMO. Also on that date the California HMO filed for Chapter 11 bankruptcy protection. Effective June 5, 2001, the California HMO and the California Department of Managed Health Care reached an agreement allowing the California HMO’s bankruptcy filing to remain in effect. All operations of the California HMO were terminated December 31, 2001. On February 26, 2003 the California HMO’s Liquidating Plan of Reorganization was confirmed in the United States Bankruptcy Court. It is unlikely that we will receive any distribution of assets from the California HMO.
At December 31, 2002 we had a consolidated working capital deficiency of approximately $7.5 million, and a deficiency in shareholders’ equity of approximately $9.6 million. Furthermore, of our total cash and cash equivalents of $2.6 million at December 31, 2002, all but $183,000 was held at subsidiaries where the transfer of cash to MHP requires the approval of regulatory authorities. As noted above, we had no continuing business activities after March 15, 2002. We are in the process of evaluating the ultimate disposition of MHP and its surviving subsidiaries.
We are involved in various legal actions brought against us in the normal course of business, some of which seek damages in amounts that exceed those accrued in our consolidated balance sheets. The ultimate liability for these legal actions cannot be determined and could materially affect our consolidated financial position, results of operations or cash flows, if resolved unfavorably. See “Note 3 - Commitments and Contingencies”.
In or about November 1999, in substance, MHP, on its own behalf and also on behalf of various closed and then operating subsidiaries, commenced an action in the United States Court of Federal Claims against the United States, seeking to recover approximately $9 million for the underpayment of amounts due for health care coverage provided to employees of the United States Office of Personnel Management. The parties are engaged in settlement discussions. We cannot give any assurances as to the ultimate collection of amounts associated with this action.
Management is exploring possible strategies to realize any possible value remaining in the Company; however, given our financial condition and the claims against us, it is very possible that management will not be successful in these efforts, and we may seek protection under the Bankruptcy Code.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. As a result of the placement of Maxicare Indiana, Inc. into rehabilitation on May 4, 2001, the consolidated financial statements include the operations and accounts of the Indiana HMO and Maxicare Life and Health Insurance Company, Inc (the outstanding shares of which were transferred to the Indiana HMO on March 9, 2001) only through May 3, 2001. As a result of the California HMO’s bankruptcy on May 24, 2001 the consolidated financial statements include its operations and accounts only through that date. The Consolidated Statements of Operations for the year ended December 31, 2001 include a gain of $16.4 million realized by MHP in the second quarter of 2001 upon the occurrence of these events. The gain represents the extent to which consolidated losses of these subsidiaries through May 3, 2001 (the Indiana HMO and Maxicare Life and Health Insurance Company, Inc.) and May 24, 2001 (the California HMO) exceeded MHP’s investment in them.
Furniture and equipment are recorded at cost and include assets acquired through capital leases and improvements that significantly add to the productive capacity or extend the useful lives of the assets. Costs of maintenance and repairs are charged to expense as incurred. Depreciation for financial reporting purposes is provided on the straight-line method over the estimated useful lives of the assets. The costs of major remodeling and improvements are capitalized as leasehold improvements. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining term of the applicable lease or the life of the asset.
Reinsurance ceded contracts do not relieve the Health Care Assurance Company, Ltd., from its obligations to policyholders. Health Care Assurance Company, Ltd., remains liable to its policyholders for the portion reinsured to the extent that Maxicare Life and Health Insurance Company, Inc. does not meet the obligations assumed under the reinsurance agreements. Consequently, allowances are established for amounts deemed not collectible. At December 31, 2002, there were no significant amounts recoverable from Maxicare Life and Health Insurance Company, Inc.
The cost of health care services is expensed in the period we are obligated to provide such services. We establish an accrual for estimated claims payable including claims reported as of the balance sheet date and estimated (based upon utilization trends and projections of historical developments) costs of health care services rendered but not reported. Estimated claims payable are continually monitored and reviewed and, as settlements are made or accruals adjusted, differences are reflected in current operations.
Estimated future health care costs and maintenance expenses under a group of contracts in excess of estimated future premiums and reinsurance recoveries on those contracts are recorded as a loss when determinable. No premium deficiencies existed at December 31, 2002 and 2001.
At December 31, 2002 we had several stock-based employee compensation plans as described in Note 4. We account for these plans under the recognition and measurement principles (the intrinsic-value method) prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation cost for stock options is reflected in net income and is measured as the excess of the market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair-value recognition provision to stock-based employee compensation.
The fair value for the options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2000: volatility factor of the expected market price of the Company’s common stock of .59; a weighted-average expected life of the options of 5.0 years; risk-free interest rate of 6.1%, and dividend yield of 0%. No options were granted in 2002 or 2001.
Stock options are excluded from the calculation of diluted loss per share for 2002, 2001 and 2000 because the inclusion of stock options would have an anti-dilutive effect.
All of the Company’s consolidated subsidiaries that maintain cash and investment balances require regulatory approval before transferring cash to MHP. Of the $2.6 million of cash and cash equivalents held by MHP and consolidated subsidiaries at December 31, 2002, approximately $183,000 was held directly by MHP; the remainder was held by subsidiaries requiring approval of regulatory authorities in order to transfer cash to MHP. Subsequent to December 31, 2002, we were able to transfer $100,000 from one of our subsidiaries to MHP.
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of investments in marketable securities. Our investments in marketable securities are managed by internal investment managers within the guidelines established by the board of directors, which, as a matter of policy, limit the amounts that may be invested in any one issuer. As of December 31, 2002, we believe that we had no significant concentrations of credit risk.
On or about June 25, 2001, the Commissioner of the Indiana Department of Insurance (the “Commissioner”), as the rehabilitator of Maxicare Indiana, Inc., the Company’s Indiana HMO, filed a complaint (the “Complaint”) in the Marion County Circuit Court of Indiana against the Company and the five directors of the Indiana HMO, one of whom was a director of the Company. The Commissioner amended the Complaint on February 1, 2002. The Complaint, as amended, alleges, in substance, that: (1) the directors of the Indiana HMO breached their fiduciary duty by failing to maintain a plan providing for continuation of care benefits in the event that the Indiana HMO was placed in receivership, and that the Company is also liable for such failure; (2) the Company fraudulently concealed the financial condition of the Indiana HMO; (3) the Company manipulated the finances of the Indiana HMO for the Company’s own benefit; and (4) the Company received preferential and/or fraudulent transfers of money from the Indiana HMO. The amended Complaint requests money damages but does not specify the amount of damages sought, except that it seeks approximately $3.5 million respecting the alleged preferential and/or fraudulent transfers. All defendants answered the amended Complaint on April 5, 2002. Pre-trial discovery is proceeding but is not yet completed. The Company believes that the claims against it are without merit and intends to vigorously defend the suit.
On or about July 1, 2002, Mr. Froelich commenced an action in the Superior Court of the State of California, County of Los Angeles, against the Company and certain unnamed Company officers/directors. The complaint alleges that defendants’ denial of a lump sum payment to Mr. Froelich under the Company’s Supplemental Executive Retirement Program and the suspension of payments to him under such Program for one year constituted breaches of contract, breaches of fiduciary duty and violations of the Employee Retirement Income Security Act. The action seeks compensatory damages of no less than $1.0 million, punitive damages in an amount to be determined and an award of attorneys’ fees. On July 23, 2002, defendants served an answer to the complaint, and on July 26, 2002, defendants removed the case from California state court to the United States District Court for the Central District of California. On January 31, 2003, the District Court granted summary judgment in favor of the Company dismissing the action, and Mr. Froelich’s time to appeal has expired.
On or about February 10, 2003, Peter J. Ratican, a shareholder and former executive officer and director of MHP, commenced an action against the Company in the Superior Court of the State of California, alleging that the Company had breached his consulting agreement with it and claiming damages in excess of $700,000. On March 11, 2003, Mr. Ratican obtained an attachment in the amount of $767,000 against the Company in connection with his claim. There has been no pre-trial discovery to date in the case. The Company intends to defend the action and to assert offsets and counterclaims against Mr. Ratican.
On September 1, 2000, the Company entered into an Application and Business Services Agreement (the “Trizetto Agreement”) with the Trizetto Group, Inc. (“TZG”). The Trizetto Agreement called for TZG to provide a full range of management information services to us over a period of seven years in exchange for monthly payments. It also called for a termination payment to be made by us under certain circumstances. In March 2001, the Company assigned the Trizetto Contract to Maxicare, the Company’s California HMO. The California Department of Managed Health Care and the Committee of Creditors Holding Unsecured Claims in the California HMO’s bankruptcy proceeding have questioned the validity of that assignment. The California HMO has continued to pay TZG for post-petition services at a monthly amount less than that contemplated in the Trizetto Agreement while TZG has provided services at a lower level than that contemplated in the Trizetto Agreement. TZG has asserted various pre- and post-petition claims in the California bankruptcy proceeding in connection with the Trizetto Agreement. On or about March 13, 2003, TZG sued the Company in California state court, alleging breach of the Trizetto Agreement and claiming over $12 million in damages. There have been no further proceedings to date in this case.
Effective February 2, 2000, the Company entered into a Services Agreement for Back Office Administration with Nichols TXEN Corporation calling for Nichols TXEN to provided certain claims adjudication services to certain of our subsidiaries in exchange for a predetermined per member per month fee. On September 18, 2002 CSC Healthcare, Inc. (“CSC”), the successor in interest to Nichols TXEN, filed a complaint in the Circuit Court of Jefferson County, Alabama seeking approximately $880,000 plus interest from the Company under the contract. This action has been stayed and the claim is now being heard in arbitration, which is in a preliminary stage. The Company believes that the claim against it is without merit and intends to vigorously defend the arbitration. The Company has asserted counterclaims against CSC in the arbitration alleging that it was fraudulently induced to enter into the contract and that CSC failed to perform under the contract, thereby causing damages to the Company in an amount not less than $5 million.
the MLH shares by the Company to Maxicare Indiana, Inc. is null and void. The Company intends to present its position to the Missouri Department of Insurance at the appropriate time.
Other than those noted above, no claims have been filed against the Company by the creditors of Maxicare Life and Health Insurance Company, Inc., the California HMO or the Indiana HMO. However, claims may be filed against us by such creditors in the future.
We are also involved in other legal actions in the normal course of business. We do not believe that any ultimate liability in excess of amounts accrued which would likely arise from these actions would materially affect our consolidated financial position, results of operations or cash flows, except that the matters described above involving the Indiana Department of Insurance, TZG, Medimpact and the renovation of leased space, may have such effect.
We have operating leases, some of which provide for initial free rent and all of which provide for subsequent rent increases. Rental expense is recognized on a straight-line basis with rental expense of $.1 million, $.8 million and $2.5 million reported for the years ended December 31, 2002, 2001 and 2000, respectively.
We are authorized to issue 80,000,000 shares of common stock, par value $.01 per share, and 5,000,000 shares of preferred stock, par value $.01 per share. The board of directors has the right to determine the rights, preferences and privileges of one or more series of preferred stock. As of December 31, 2002, the board of directors had created two series of preferred stock - Series A Convertible Cumulative Preferred Stock, consisting of 2,500,000 shares, and Series B Preferred Stock, consisting of 500,000 shares. As of December 31, 2002, there were no shares of either series of preferred stock outstanding.
The Rights initially attached to our Common Stock and will not be exercisable until a shareholder, or group of shareholders acting together, without the approval of the Board, announce their intent to become a 15% or more owner in our Common Stock. At that time, certificates evidencing the Rights shall be distributed to shareholders (the “Distribution Date”) and the Rights shall detach from the Common Stock and shall become exercisable. When such buyer acquires 15% or more of our Common Stock, all Rights holders, except the non-approved buyer, will be entitled to acquire an amount of the Preferred Fraction at a rate equal to twice the Exercise Price divided by the then market price of the Common Stock. In addition, if we are acquired in a non-approved merger, after such an acquisition, all Rights holders, except the aforementioned 15% or more buyer, will be entitled to acquire stock in the surviving corporation at a 50% discount in accordance with the Rights Plan. The Rights attached to all common shares held by our shareholders of record as of the close of business on March 16, 1998. Shares of Common Stock newly-issued after that date will also carry Rights until the Rights become detached from the Common Stock. The Rights will expire on February 23, 2008. We may redeem the Rights for $.01 each at any time before a non-approved buyer acquires 15% or more of the Company’s Common Stock. Any current holder that has previously advised us of owning an amount in excess of 15% of our Common Stock as of the date hereof has been “grandfathered” with respect to their current position, including allowance for certain small incremental additions thereto.
On February 27, 1995 the Board approved Restricted Stock Grant Agreements awarding 13,000 shares of Restricted Stock each to Mr. Ratican and Mr. Froelich (individually the “Executive”). Mr. Froelich’s Restricted Stock vested upon the termination of his employment with us on December 11, 1997. Mr. Ratican’s Restricted Stock vested on February 27, 1998 upon the expiration of the three-year vesting period.
In connection with a settlement agreement with Mr. Ratican, as of April 24, 1999, the 1997 Ratican Note and related loan documents were amended extending the term from April 1, 2001 to June 30, 2003 (the Restated 1997 Ratican Note). The Restated 1997 Ratican Note provides that on the maturity date, in lieu of payment of the original principal balance and all accrued interest thereon (the “Maturity Balance”), Ratican may fully satisfy his obligations under the Restated 1997 Ratican Note through the payment to the Company for payment to the applicable state and Federal tax authorities the applicable minimum state and federal withholding amounts and FICA taxes due from Mr. Ratican resulting from the reduction of the Maturity Balance to zero.
At December 31, 2002, we had net operating loss carryforwards (“NOLs”) for federal tax purposes expiring as follows (amounts are in millions):
On December 5, 1990 (the “Effective Date”) the Company emerged from protection under Chapter 11 pursuant to our joint plan of reorganization, as modified (the “Reorganization Plan”). Upon the Effective Date of the Reorganization Plan, we experienced a “change of ownership” pursuant to applicable provisions of the Internal Revenue Code (the “IRC”). As a result of the ownership change, our pre-change NOL carryforwards of approximately $325 million are subject to limitation under provisions of Section 382 of the IRC. From the Effective Date through December 31, 1995 we have recognized for financial statement reporting purposes an annual limitation for its NOLs of approximately $6.3 million per year. In 1996, we determined that our annual limitation for our pre-change NOLs is $9.2 million per year or an aggregate amount of $139 million over the carryover period. We also determined during 1996 that $182 million of additional limitation is available for income tax return purposes under other provisions of Section 382 of the IRC. Accordingly, we believe that approximately $321 million of the total pre-change NOLs of $325 million will be available for utilization for federal income tax return purposes over the carryover period. In the event the current limitation amount is not fully utilized, we are allowed to carryover such amount to subsequent years during the carryover period. From December 5, 1990 through December 31, 2002 we have utilized approximately $55 million of the pre-change NOLs for federal income tax return purposes. We are unable to quantify to what extent, if any, we may be able to fully utilize our remaining pre-change NOLs prior to their expiration. Should we experience a second “change of ownership”, the limitation under Section 382 of the IRC on NOLs would be recalculated.
In accordance with SFAS 109 we have reserved the full amount of the deferred tax asset at December 31, 2002. Should we recognize any future benefits from a reduction of the valuation allowance, this will result in a reduction to our income tax expense.
We previously adopted the Maxicare Health Plans, Inc. Savings Incentive Plan (the “Savings Plan”). The Savings Plan is a defined contribution 401(k) profit sharing plan covering those of our employees who have satisfied certain eligibility requirements. The primary eligibility requirement is that an employee must have completed six months of eligible service. The cost of the Savings Plan is shared by the participants and the Company. Eligible employees may defer from 1% to 15% of base compensation on a before-tax basis in accordance with Section 401(k) of the IRC. The Savings Plan calls for us to match up to 3% of total compensation, not to exceed the employee’s contribution. Our contributions were approximately $330,000 for the year ended December 31, 2000. We made no contributions for the year ended December 31, 2002 and 2001. The Savings Plan was terminated effective February 28, 2002.
During the first quarter of 2002 we determined that the termination of our business operations eliminated our need for certain leased equipment, principally high volume copying equipment, held under capital lease agreements. We have returned that equipment to the lessor and have recorded an impairment charge of approximately $1.0 million on our consolidated statements of operations in March, 2002 to write off the entire net book value of these leased assets. The liability associated with these leased assets remains on our consolidated balance sheets.
In 2002 we recognized a gain of $671,000 in connection with the settlement of a former executive’s claim under our Supplemental Executive Retirement Plan. This gain was recognized in conjunction with the previously discussed collection of a note issued by the same executive. Please see “Note 5 - Notes Receivable From Shareholders”. Additionally in 2002 we recorded $880,000 in legal reserves in connection with a contract we had previously entered into for the benefit of our subsidiaries. In the fourth quarter of 2000, we recorded charges of $785,000 for employee severance costs and $725,000 in litigation reserves for costs associated with the defense and settlement of various legal actions.
There are no results for discontinued operations for the year ended December 31, 2002. The operating results of the discontinued operations for the years ended December 31, 2001 and 2000 are summarized as follows:
There were no net assets or liabilities of discontinued operations as of December 31, 2002 or 2001.