Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations -------------------------
The year ended December 31, 1997 compared to the year ended - ----------------------------------------------------------- December 31, 1996. - ------------------
Revenues for the year ended December 31, 1997 increased by $101.0 million to $663.8 million, an increase of 18.0% as compared to 1996. This increase was primarily due to a 24.7% membership increase, offset in part by a 16.9% decline in the average governmental premium revenue PMPM as a result of the growth in the lower premium revenue PMPM Medicaid line of business and a .8% decline in the average commercial premium revenue PMPM. Commercial premiums increased $10.5 million or 2.3% to $457.6 million, primarily as a result of a 3.2% increase in membership. Governmental premiums increased $92.6 million or 85.9% to $200.5 million as a result of a 123.9% increase in membership primarily generated by growth in the Medicaid line of business in California and Indiana.
Health care expenses for the year ended December 31, 1997, including increases to health care claims reserves in the third and fourth quarter, increased by $127.9 million to $630.9 million, an increase of 25.4% as compared to 1996. Health care expenses as a percentage of premium revenues (the "medical loss ratio") increased 5.3 percentage points to 95.9%, primarily as a result of the growth in the higher medical loss ratio Medicaid line of business, higher prescription drug costs and increases to health care claims reserves.
settlement of certain obligations pursuant to the former chief financial officer's employment agreement.
Investment income for the year ended December 31, 1997 increased by $1.0 million to $7.5 million as compared to $6.5 million in 1996. The slight increase in investment income was primarily due to higher cash and investment balances.
For the year ended December 31, 1997, the Company reported a provision for income taxes of $61,000 and an offsetting income tax benefit of $61,000 due to the Company increasing its deferred tax asset in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes". The Company reported a $3.3 million income tax benefit for the year ended December 31, 1996, primarily due to the recognition of a $4.0 million tax benefit ($3.4 million recognized in the fourth quarter). (See "
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, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. 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. CONSOLIDATED BALANCE SHEETS (Amounts in thousands except par value)
MAXICARE HEALTH PLANS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)
Maxicare Health Plans, Inc., a Delaware corporation ("MHP"), is a holding company which owns various subsidiaries, primarily health maintenance organizations ("HMOs"). MHP operates HMOs in California, Indiana, Illinois, Louisiana, North Carolina, South Carolina and Wisconsin. All of MHP's HMOs are federally qualified by the United States Department of Health and Human Services and are generally regulated by the Department of Insurance of the state in which they are domiciled (except the California HMO, which is regulated by the California Department of Corporations).
The accompanying consolidated financial statements include the accounts of the Company. All significant intercompany balances and transactions have been eliminated.
Realized gains and losses and unrealized losses judged to be other than temporary with respect to available-for-sale and held-to- maturity securities are included in the determination of net income. The cost of securities sold is based on the specific identification method. Fair values of marketable securities are based on published or quoted market prices.
Estimated Amortized Fair (Amounts in thousands) Cost Value --------- --------- Available-for-sale: Due in one year or less................ $10,812 $10,854
Due after one year through five years.. 37,031 37,027 ------- ------- $47,843 $47,881 ======= =======
Other.................................. 4,387 4,889 ------- ------- Accounts receivable, net............... $26,024 $33,107 ======= =======
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 such deficiencies exist at December 31, 1997.
Effective December 15, 1997 the Company was required to adopt Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings per Share". SFAS No. 128 requires the presentation of "basic earnings per share" (which excludes dilution) and "diluted earnings per share" as replacements for primary earnings per share and fully diluted earnings per share. Restatement of all earnings per share calculations presented in the financial statements is required by SFAS No. 128.
Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of investments in
marketable securities and premiums receivable. The Company's 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 which may be invested in any one issuer. Concentrations of credit risk with respect to premiums receivable are limited due to the large number of employer groups comprising the Company's customer base. As of December 31, 1997 management believes that the Company had no significant concentrations of credit risk.
Assets held under capital leases at December 31, 1997 and 1996 of $696,000 and $872,000, respectively, (net of $1,043,000 and $749,000, respectively, of accumulated amortization) are comprised primarily of equipment leases. Amortization expense for capital leases is included in depreciation expense.
Future minimum lease commitments for noncancelable leases at December 31, 1997 were as follows:
designed to assure that in the event of an unsolicited or hostile attempt to acquire the Company, the Board would have the opportunity to consider and implement a course of action which would best maximize shareholder value. Under the Rights Plan, each shareholder will receive a dividend of one Right for each share of the Company's outstanding Common Stock. Each Right shall entitle the holder thereof to purchase 1/500th of a share of the Company's Series B Preferred Stock (the "Series B Preferred") for $45.00 (the "Exercise Price"). Each 1/500th Series B Preferred (the "Preferred Fraction") share shall be entitled to one vote in all matters being voted on by the holders of Common Stock and shall also be entitled to a liquidation preference of $0.20.
The Rights will initially be attached to the Company's 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 the Company's Common Stock. At that time, certificates evidencing the Rights shall be distributed to shareholders, the Rights shall detach from the Common Stock and shall become exercisable. When such buyer acquires 15% or more of the Company's 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 the Company is 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.
Pursuant to the Reorganization Plan, Mr. Peter J. Ratican, Chief Executive Officer and President, and Mr. Eugene L. Froelich, formerly Chief Financial Officer and Executive Vice President - Finance and Administration ("Senior Management") each received stock options, which are all currently exercisable and which expire on December 5, 2000, to purchase up to 277,778 shares of Common Stock at a price of $6.54 per option share. As of January 1, 1992, the Company entered into employment agreements with Senior Management. Under the terms of these employment agreements, each
In July 1996, the Company approved the Senior Executives 1996 Stock Option Plan (the "Senior Executives Plan"). Under the terms of the Senior Executives Plan, the Company may issue up to an aggregate of 700,000 nonqualified stock options to Mr. Ratican and Mr. Froelich (the "Senior Executives" and individually the "Senior Executive"). On the date the Senior Executives Plan was adopted, each Senior Executive received a grant of stock options to purchase 70,000 shares of Common Stock. Commencing January 1, 1997, and each January 1st thereafter through and including January 1, 2000, each Senior Executive then employed by the Company shall receive a grant of stock options to purchase 70,000 shares of Common Stock. Mr. Froelich's continuing participation in the Senior Executives Plan ceased when his employment with the Company was terminated in December 1997. Options granted under the Senior Executives Plan are at an exercise price equal to 100% of the fair market value of the stock at the date of grant, vest immediately and expire 10 years From the date of grant.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997, 1996 and 1995, respectively: volatility factors of the expected market price of the Company's common stock of .43, .43 and .41; a weighted-average expected life of the options of 5.0, 5.0 and 4.8 years; risk-free interest rate of 6.0% and dividend yield of 0%.
Pro forma earnings (loss) per common share: Basic $ (2.13) $ .98 $ 1.71 Diluted $ (2.13) $ .93 $ 1.52
The Company has measured the total compensation cost of the Restricted Stock awards as the excess of the quoted market price of similar but unrestricted shares of stock at the award date, subject to certain adjustments, over the purchase price, if any, of the Restricted Stock. The quoted market price of shares of the Company's Common Stock at the date of grant was $16.125, and the Restricted Stock was awarded to the Executives at no cost. The total compensation cost of the Restricted Stock grants recognized through December 31, 1997 was $1,706,000.
On February 18, 1997 the Company entered into recourse loan agreements with Peter J. Ratican and Eugene L. Froelich the Chief Executive Officer and Chief Financial Officer of the Company, respectively (collectively the "Executives" and individually the "Executive"), whereby the Company loaned to each Executive $2,229,028 in connection with the exercise of certain stock options granted to the Executives on February 25, 1992. The loans are evidenced by a secured Promissory Note which provides for interest compounding monthly at the one year London Interbank Offered Rate plus 50 basis points in effect from time to time and subject to certain adjustments in the event the Company enters into a transaction to borrow funds. The interest rate in effect as of February 18, 1997 was 6.25%. All principal and accrued interest is due at the maturity date of April 1, 2001 or upon an event of default; provided however, that if Executive shall sell any shares of the Company's Common Stock serving as security under the loan agreement, the Executive shall pay a pro rata share of the proceeds to the Company to be applied against any outstanding principal and accrued interest of such Executive as of such date. The principal and accrued interest at December 31, 1997 has been reflected as a reduction of shareholders' equity.
1997 1996 1995 (Amounts in thousands) ------- ------- ------- Current: Federal...................... $ (12) $ 518 $ 236 State........................ 73 215 139 ------- ------- ------- 61 733 375 ------- ------- ------- Deferred: Federal...................... (3,400) (3,400) State........................ (61) (600) (600) ------- ------- ------- (61) (4,000) (4,000) ------- ------- ------- Benefit for income taxes....... $ -- $(3,267) $(3,625) ======= ======= =======
The federal and state deferred tax liabilities (assets) are comprised of the following at December 31:
Deferred tax asset.......... $ (18,061) $ (18,000) $ (14,000) ========= ========= =========
On December 5, 1990 (the "Effective Date") the Company emerged from protection under Chapter 11 pursuant to the Company's joint plan of reorganization, as modified (the "Reorganization Plan"). Upon the Effective Date of the Reorganization Plan, the Company experienced a "change of ownership" pursuant to applicable provisions of the Internal Revenue Code (the "IRC"). As a result of the ownership change, the Company's 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 the Company has recognized for financial statement reporting purposes an annual limitation for its NOLs of approximately $6.3 million per year. In 1996, the Company
SFAS No. 109 "Accounting for Income Taxes" requires that the tax benefit of such NOLs be recorded as an asset to the extent that management assesses the utilization of such NOLs to be more likely than not. Management has estimated, based on the Company's recent history of operating results and its expectations for the future, that future taxable income of the Company will more likely than not be sufficient to utilize a minimum of approximately $45 million of NOLs. Accordingly, the Company has recognized an aggregate deferred tax asset of $18.1 million as of December 31, 1997 related to anticipated future utilization of NOLs.
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 Internal Revenue Code. The Savings Plan calls for the Company to match up to 3% of total compensation, not to exceed the employee's contribution. The Company's contributions totaled $400,000, $350,000 and $302,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
which covers key executives as selected by the Board. Benefits are based on years of service and average compensation in the last three years of employment. Compensation expense recognized in connection with the SERP was $984,000 for the year ended December 31, 1997. Of this compensation expense recognized in 1997, $700,000 related to the immediate recognition of the discounted present value of vested retirement benefits for the Company's former Chief Financial Officer and an additional former executive which was included in the $3.0 million management restructuring charge recorded in the fourth quarter of 1997 (see Note 9 - Litigation and Management Restructuring Charges).