The Company's operating facilities are held through leaseholds. At December 31, 1999, the Company leased approximately 212,000 square feet at 13 locations with an aggregate current monthly rental expense of approximately $174,000. These leases have remaining terms of up to 4 years. The Company's leased properties include administrative locations for its HMOs and corporate facilities and other miscellaneous facilities.
In 1999, the Company completed its restructuring program to exit unprofitable markets by asset sales or plan closings and concentrate on its continuing health care businesses in California, Indiana and Louisiana (the "continuing operations"). As of December 31, 1999, the continuing operations accounted for commercial membership of approximately 279,400 members, Medicaid membership of approximately 170,300 members and Medicare membership of approximately 16,900 members.
Commercial premiums for the year ended December 31, 1999 decreased $53.1 million to $412.5 million as compared to $465.6 million for 1998. The
Company's commercial premiums for its continuing operations increased by $12.7 million to $412.0 million for 1999 as compared to $399.3 million for 1998 primarily due to premium rate increases offset in part by a decrease in membership. The Company's commercial membership for its continuing operations of 279,400 members as of December 31, 1999 decreased by 3,900 members as compared to the prior year period primarily as a result of pricing discipline. The average commercial premium revenue per member per month ("PMPM") increased 6.5% as compared to 1998.
Medicaid premiums for the year ended December 31, 1999 decreased $3.3 million to $201.2 million as compared to $204.5 million for 1998. The Company's Medicaid premiums for its continuing operations increased by $8.0 million primarily as a result of premium rate increases in California and Indiana. As of December 31, 1999 the California and Indiana health plans had 108,600 and 61,700 Medicaid members, respectively as compared to 125,400 and 69,500 Medicaid members, respectively as of December 31, 1998. The decline in California is primarily attributable to the California health plan not having ongoing participation in the new managed care program in San Bernardino and Riverside counties which was fully implemented and transitioned effective September 30, 1999. The decline in Indiana is primarily attributable to the Indiana health plan not participating in the central region after January 1999 due to the loss of its capitated network provider. Effective March 2000 the Indiana health plan had restructured its provider network in the central region and had commenced enrollment of members. The average Medicaid premium PMPM for the continuing operations increased by 4.3%, primarily due to premium rate increases in California and Indiana.
For the year ended December 31, 1999, the Company reported a provision for income taxes of $55,000 and an offsetting income tax benefit of $55,000 due to the Company increasing its deferred tax asset. For the year ended December 31, 1998, the Company reported a provision for income taxes of $106,000 and an offsetting income tax benefit of $106,000 due to the Company increasing its deferred tax asset. (See "Item 8. Financial Statements and Supplementary Data - Note 7 to the Company's Consolidated Financial Statements").
The year ended December 31, 1998 compared to the year ended December 31, 1997
The Company's reported loss of $27.5 million for 1998 was, among other factors, significantly impacted by the specific operations targeted in the Company's restructuring plan which was implemented in 1998. The significant factors contributing to the loss of $27.5 million were the following: 1) $22.3 million of losses associated with the Wisconsin, Illinois and Carolinas health plans, 2) $7.3 million of losses associated with the Southern Indiana Medicaid line of business (the provider network arrangement has been restructured effective July 1998 from a fee for service network to a capitated risk arrangement,, 3) $3.8 million of losses associated with the commercial line of business in Southern Indiana (as of January 1, 1999 the Indiana health plan is no longer providing health care coverage to the member base which generated these losses; accordingly, the Company has mitigated its ongoing financial risk in this marketplace), 4) $2.0 million provider insolvency/impairment charge, and 5) $1.2 million of costs associated with a shareholder action. In the aggregate these aforementioned factors accounted for approximately $36.6 million in losses for the year ended December 31, 1998 which were in part offset by other operating results of the Company.
Health care expenses for the year ended December 31, 1998 were $684.4 million as compared to $630.9 million for 1997. This increase in health care expenses was in part a result of growth in all continuing operations lines of business and an increase in pharmacy costs reduced by approximately $8.3 million of health care costs applied against the reserve for loss contracts and divestiture costs established in 1998. Although prescription drug costs are expected to continue to rise, this trend was somewhat mitigated by enhanced procedures and controls implemented from June 1998 through September 1998 to promote cost effective use of prescription drug benefits.
For the year ended December 31, 1998, the Company recorded $16.5 million of charges composed of 1) a $12.5 million charge for loss contracts and divestiture costs related to the discontinued health plans, 2) a $2.0 million litigation charge substantially related to the Company's former Illinois health plan and 3) a $2.0 million charge for provider insolvency/impairment related to certain of the Company's capitated provider arrangements including the arrangement with MedPartners Provider Network, Inc. (see "Item 1. Business - Business Risks and Cautionary Statements - MedPartners Provider Network, Inc."). For the year ended December 31, 1997, the Company recorded $9.0 million of charges composed of 1) a $6.0 million litigation charge as a result of a ruling by the Commonwealth of Pennsylvania Board of Claims denying the Company recovery on its receivable of $5.0 million due the Company from the Pennsylvania Department of Public Welfare and 2) a $3.0 million management restructuring charge for termination expenses primarily related to the settlement of certain obligations pursuant to the former chief financial officer's employment agreement.
For the year ended December 31, 1998, the Company reported a provision for income taxes of $106,000 and an offsetting income tax benefit of $106,000 due to the Company increasing its deferred tax asset. 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. (See "Item 8. Financial Statements and Supplementary Data - Note 7 to the Company's Consolidated Financial Statements").
1999 of the claims payable related to the Company's divested Wisconsin, Illinois and Carolinas health plans.
as of December 31, 1999 and 1998. Additionally, MHP received $10.7 million and $11.7 million in dividends from its operating subsidiaries in 1999 and 1998, respectively. In March 2000 the Indiana HMO obtained approval from the Indiana Department of Insurance to dividend $1.5 million to MHP; accordingly, these funds were distributed to MHP in March 2000 and as a result have supplemented the liquidity position of MHP. (See "Item 8. Financial Statements and Supplementary Data" and "Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - Schedule I").
Business Strategy - The Company's business strategy includes strengthening its position in the markets it serves by: marketing an expanded range of managed care products and services, providing superior service to the Company's members and employer groups, enhancing long-term relationships and arrangements with health care providers, and selectively targeting geographic areas within a state for expansion through increased penetration or development of new areas. The Company continually evaluates opportunities to expand its business as well as evaluates the investment in these businesses.
Year 2000 - The Company has undergone a Year 2000 readiness program to upgrade and test its systems in preparation for the year 2000 and to assess Year 2000 issues relative to its computing information systems and related business processes. As a result of the assessment process, necessary changes and/or augmentations to the Company's systems were made including selected systems being retired and replaced with packaged software from large vendors that is Year 2000 compliant. The total estimated cost of the program incurred since 1997 through December 31, 1999 was approximately $1.5 million and projected future costs of the program are estimated to be minimal. As of December 31, 1999, the Company's core legacy systems were complete as to testing and confirmation as Year 2000 compliant. The Company did not experience any disruption to its computing information systems effective with the year 2000 and through March 24, 2000. There can be no assurance, however, that the Company will not experience Year 2000 disruptions or operational issues including those as a result of the Company's vendors and customers. The Company continues to keep business process contingency plans in place in the event a significant Year 2000 matter should occur.
Maxicare Health Plans, Inc., a Delaware corporation ("MHP"), is a holding company which owns various subsidiaries, primarily health maintenance organizations ("HMOs"). MHP conducts ongoing HMO operations in California, Indiana and Louisiana (see Note 9). 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).
Maxicare Life and Health Insurance Company ("MLH"), a licensed insurance company and wholly-owned subsidiary of MHP, operates preferred provider organizations ("PPOs") in California, Indiana and Louisiana which constitute approximately 1% of the consolidated enrollment of MHP and subsidiaries (the "Company") at December 31, 1999. In addition, MLH writes policies for group life and accidental death and dismemberment insurance; however, these lines of business make up less than 1% of the Company's revenues for the year ended December 31, 1999.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. 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.
The Company's restricted investments consist of securities restricted to specific purposes as required by various governmental regulations. These securities have been designated as held-to-maturity as the Company has the intent and the ability to hold them to maturity. These securities are stated at amortized cost.
During 1999, the Company sold available-for-sale marketable securities having a book value of $3.0 million, realizing a net gain of approximately $2,500. During 1998, the Company sold available-for-sale marketable securities having a book value of $15.5 million, realizing a net gain of approximately $43,000. During 1997, the Company sold marketable available-for-sale securities having a book value of $15.9 million, realizing a net gain of approximately $178,000.
The contractual maturities of investments at December 31, 1999 were as follows:
Estimated 	 	Amortized	 Fair (Amounts in thousands)	 Cost 	 Value 		---------	--------- Available-for-sale: 	Due in one year or less................	 $ 1,322	$ 1,321
Due after one year through five years..	 390 381 	 	 ------- 	------- 	 	 $ 1,712 	$ 1,702 		 ========	========
1999	 1998 (Amounts in thousands) 		-------	------- Premiums receivable....................	$22,368	$35,020 Allowance for retroactive billing adjustments..................	 (1,892)	 (5,481) 				 -------	------- Premiums receivable, net...............	 20,476	 29,539
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, 1999 management believes that the Company had no significant concentrations of credit risk.
The Company has 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 $1.8 million, $2.5 million and $2.3 million reported for the years ended December 31, 1999, 1998 and 1997, respectively.
Future minimum lease commitments for noncancelable leases at December 31, 1999 were as follows:
Operating Capitalized 		 	 Leases 	 Leases 	(Amounts in thousands) 		---------	----------- 	2000..........................	 $ 2,162	 $ 461 2001..........................	 2,462	 391 	2002..........................	 1,328	 385 	2003..........................	 340	 288 	2004 . . . . . . . . . . . . . 	 178	 9 	Total minimum		 ------ 	------ 	 obligations.................	 $ 6,470 1,534 		 	 ======
Long-term 		 	 	 ------ 	 obligations.................		 		 $933 			 		 ======
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 "Distribution Date"), 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. The Rights shall attach to all common shares held by the Company's shareholders of record as of the close of business on March 16, 1998. Shares of Common Stock that are 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. The Company 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 the Company of owning an amount in excess of 15% of the Company's Common Stock as of the date hereof has been "grandfathered" with respect to their current position, including allowance for certain small incremental additions thereto.
In December 1990, the Company approved the 1990 Stock Option Plan (the "1990 Plan"). Under the terms of the 1990 Plan, as amended, the Company may issue up to an aggregate of 1,000,000 nonqualified stock options to directors, officers and other employees. In July 1995, the Company approved the 1995 Stock Option Plan (the "1995 Plan"). Under the terms of the 1995 Plan, the Company may issue up to an aggregate of 1,000,000 nonqualified or incentive stock options to directors, officers and other employees. In June 1999, the Company approved the 1999 Stock Option Plan (the "1999 Plan"). Under the terms of the 1999 Plan, the Company may issue up to an aggregate of 750,000 nonqualified or incentive stock options to directors, officers and other employees. Under the 1990 Plan, the 1995 Plan and the 1999 Plan, stock options granted to date have been nonqualified stock options which expire no later than 10 years from the date of grant and vest in equal installments on the first, second and third anniversaries from the date of grant. Stock options granted to date under the 1990 Plan, the 1995 Plan and the 1999 Plan have been at an exercise price equal to the fair market value of the stock at the date of grant.
In July 1996, the Company approved the Outside Directors 1996 Formula Stock Option Plan (the "Formula Plan"). Under the terms of the Formula Plan, the Company may issue up to an aggregate of 125,000 nonqualified stock options to directors who are not employees or officers of the Company (the "Outside Directors"). On the date the Formula Plan was adopted, each Outside Director received a grant of stock options to purchase 5,000 shares of Common Stock. Commencing January 2, 1997, and each January 2nd thereafter, each Outside Director then serving on the Board shall receive a grant of stock options to purchase 5,000 shares of Common Stock. Options granted under the Formula Plan are at an exercise price equal to the fair market value of the stock at the date of grant, vest six months from the date of grant and expire 10 years from the date of grant.
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. Mr. Ratican's continuing participation in the Senior Executives Plan ceased when his employment with the Company terminated effective June 30, 1999. Options granted under the Senior Executives Plan are at an exercise price equal to the fair market value of the stock at the date of grant, vest immediately and expire 10 years from the date of grant.
On February 27, 1995 the Board approved Restricted Stock Grant Agreements awarding 65,000 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 the Company on December 11, 1997. Mr. Ratican's Restricted Stock vested on February 27, 1998 upon the expiration of the three-year vesting period.
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 (individually the "1997 Ratican Note" and the "1997 Froelich Note", respectively). The 1997 Ratican Note and the 1997 Froelich Note 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 and for all of 1997 was 6.25%, the interest rate in effect for 1998 was 6.44% and the interest rate in effect for 1999 was 5.60%. 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 balances of such Executive as of such date. In connection with the Ratican Settlement Agreement (see Note 9), 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.
The benefit for income taxes for the year ended December 31 consisted of the following:
The differences between the benefit for income taxes at the federal statutory rate of 34% and that shown in the Consolidated Statements of Operations are summarized as follows for the years ended December 31:
1999	 1998	 1997 (Amounts in thousands) 	-------	-------	------- Tax provision (benefit) at statutory rate.................	$(4,170)	$(9,362)	$(8,528) State income taxes..................	 55	 106	 73 Exercise of nonqualified stock options...........................	 (1,755)
2003			$ 166.2 	 2004		 92.7 	 2005		 9.3 	 2006 	 2.5 	 2007		 1.5 	 2012		 35.9 2018	 	 92.4 2019 7.0 		 		------- 	Total NOL carryforwards	 $ 407.5 			=======
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 determined its annual limitation for its pre-change NOLs is $9.2 million per year or an aggregate amount of $139 million over the carryover period. The Company 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, the Company believes 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, the Company is allowed to carryover such amount to subsequent years during the carryover period. From December 5, 1990 through December 31, 1999 the Company has utilized approximately $55 million of the pre-change NOLs for federal income tax return purposes and has recognized approximately $105 million of pre-change NOLs for financial statement reporting purposes. The Company is unable to quantify to what extent, if any, the Company may be able to fully utilize its remaining pre-change NOLs prior to their expiration. Should the Company experience a second "change of ownership", the limitation under Section 382 of the IRC on NOLs would be recalculated.
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 and available tax planning strategies, 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 $18.2 million as of December 31, 1999 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 IRC. 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 were approximately $380,000, $390,000 and $400,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 9 - LOSS CONTRACTS, DIVESTITURE COSTS, LITIGATION, MANAGEMENT SETTLEMENT AND OTHER CHARGES
On September 30, 1998, the Company completed the sale of its Wisconsin health plan which had approximately 4,700 commercial members and approximately 10,200 Medicaid members. On October 16, 1998, the Company completed the sale of its Illinois health plan which had approximately 22,600 commercial members. In addition, on September 30, 1998, the Company announced it would cease offering in North and South Carolina, all commercial health care lines of business, including its commercial health maintenance organization, preferred provider organization and point of service product lines. The Company's Carolinas health plans did not provide commercial health care coverage beyond March 1999.
In the fourth quarter of 1997 the Company recorded a $3.0 million management settlement charge for termination expenses primarily related to the settlement of certain obligations pursuant to the employment agreement of Eugene L. Froelich, the Company's former Chief Financial Officer.
In March 1997 the Company received a ruling from the Commonwealth of Pennsylvania Board of Claims (the "Claims Board") denying the Company any recovery on its claims against the Pennsylvania Department of Public Welfare (the "DPW") in connection with the operation of a Medicaid managed care program from 1986 through 1989 by Penn Health Corporation, a subsidiary of the Company. Accordingly, the Company recorded in the first quarter of 1997 a $6.0 million non-cash litigation charge to fully reserve for the recorded estimate of $5.0 million due the Company from the DPW and related litigation costs. On April 24, 1997, the Company filed an appeal with the Commonwealth of Pennsylvania Commonwealth Court seeking to overturn the Claims Board's order and to award the Company damages. DPW filed a cross-appeal, appealing the portion of the Claims Board's order imposing liability upon the DPW for breach of contract. In addition, the Company pursued claims against certain providers who participated in the Medicaid programs for breach of the Company's Reorganization Plan in the United States Bankruptcy Court in California. The Company has reached a settlement with the DPW regarding the Company's claims against the DPW (the "DPW Settlement"). A settlement was also reached by the Company of the Company's claims in the Bankruptcy Court against certain providers (the "Provider Settlement"). The DPW Settlement and the Provider Settlement (collectively, the "Global Settlement") provide for the dismissal of the pending litigation against the settling parties and for DPW's payment to the Company of $4.7 million (including approximately $300,000 held in escrow for the Company's benefit), plus accrued interest thereon. On March 26, 1999, the United States Bankruptcy Court approved the Global Settlement and the Company's agreement with the Creditors' Committee to pay $400,000 to the Penn Health bankruptcy estate for distribution to creditors pursuant to the Reorganization Plan. Pursuant to the DPW Settlement, the $300,000 held in escrow was released to the Company and payment of an additional $4.5 million (inclusive of accrued interest) was made to the Company in early May 1999. From these settlement funds the Company funded $400,000 to the Penn Health bankruptcy estate resulting in the recognition of $4.1 million in other income recorded in the first quarter of 1999.
The following is a tabulation of the quarterly results of operations for the years ended December 31, 1999 and 1998: