We lease space at two locations in California. Both of these leases terminate in 2004. Our executive offices are located at 11231 South La Cienega Boulevard, Los Angeles, California 90045, pursuant to a lease expiring in May 2004. Under the terms of this lease, we pay a monthly rental of approximately $19,500, plus a percentage of operating costs and annual increases. Through March 31, 2004, the California HMO was sharing space with us and paying a substantial portion of our lease costs, and may continue to do so.
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 “Item 8, Note 3 - Commitments and Contingencies” to our Consolidated Financial Statements.
The California HMO continues to contribute to the payment of the operating lease obligations of MHP. Although there can be no assurance that such payments will continue, management believes it likely that the California HMO will contribute approximately $49,000 to the payment of operating lease obligations in 2004. Such payments by the California HMO are unlikely to continue after May 31, 2004.
We have made no payments to the lessor in connection with the leased assets since the first quarter of 2002. The liability associated with these leased assets remains on our consolidated balance sheets.
Amount of benefits owed and payment periods are dependent upon a number of factors, among them the life expectancies of the participants.
We have audited the accompanying consolidated balance sheets of Maxicare Health Plans, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the information with respect to the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
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, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 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” or “the Company”), is a holding company that formerly operated health maintenance organizations and other subsidiaries, primarily in the field of managed care. As of March 15, 2002 all operations of MHP and its subsidiaries were terminated. MHP and its subsidiaries have not engaged in any business activities since that date. At December 31, 2003 we had negative net worth of $3.5 million and a working capital deficiency of $1.5 million. See “Liquidity and Going Concern” below.
All significant subsidiaries formally operated by MHP (the California and Indiana HMOs and Maxicare Life and Health Insurance Company, Inc.) were placed into bankruptcy, rehabilitation and administrative supervision, respectively, in May of 2001 and are currently in liquidation. We will receive no distribution of assets from the California HMO, are unlikely to receive any distribution of assets from the Indiana HMO, and cannot determine whether or not we will receive a distribution of assets from Maxicare Life and Health Insurance Company, Inc. Any distribution from Maxicare Life and Health Insurance Company, Inc., if assets ultimately are available for distribution, will require regulatory approval.
At December 31, 2003 we had a consolidated working capital deficiency of approximately $1.5 million, and a deficiency in shareholders’ equity of approximately $3.5 million. Furthermore, of our total cash and cash equivalents of $5.4 million at December 31, 2003, $2.5 million was held at Health Care Assurance Company, Ltd. The transfer of cash to MHP from Health Care Assurance Company, Ltd. requires the approval of regulatory authorities.
The placement of the Indiana HMO (to which MHP had contributed the capital stock of Maxicare Life and Health Insurance Company, Inc.) into rehabilitation on May 4, 2001 and the bankruptcy filing of the California HMO on May 25, 2001 have effectively ended our involvement in the managed care industry. As a result, we have treated our HMO subsidiaries and Maxicare Life and Health Insurance Company, Inc. as discontinued operations in the preparation of these financial statements. Our remaining operations (parent, Health Care Assurance Company, Ltd., and the AIM program) are insignificant. Although these operations are dependent upon the California and Indiana HMOs, they represent services not intrinsically linked to the managed care industry and have been treated as continuing operations.
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 and are amortized using the straight-line method over the shorter of the remaining term of the applicable lease or the life of the asset. All furniture and equipment have been depreciated or written off as of December 31, 2002.
Health Care Assurance Company, Ltd., provided excess of loss health care reinsurance coverage to the California HMO through November 30, 2001 for the costs of medical services provided to Medi-Cal enrollees in California. From January 1, 1996 through April 30, 2001 Maxicare Life and Health Insurance Company, Inc. assumed 90% of the claims risk pursuant to this coverage. The effect on Health Care Assurance Company, Ltd.’s premiums written and earned in 2001 was as follows (amounts are in thousands):
All policy obligations under the reinsurance and retrocession agreements between Health Care Assurance Company, Ltd., Maxicare Life and Health Insurance Company, Inc. and the California HMO were fully settled during 2003.
Since the Company has satisfied all obligations under policies previously written and all claims notification and payment periods have expired during 2003, the Company released the remaining claims reserves of $736,000 and the $410,000 received from Transamerica into income.. These amounts were recorded as negative health care expense of $1,146,000 in 2003.
At December 31, 2003 we had several stock-based employee compensation plans as described in Note 4. We account for the 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 our stock at the date of grant over the amount an employee must pay to acquire the stock. We have adopted the disclosure provisions required by Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure.
The following table illustrates the effect on net income and earnings per share if we 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. No options were granted in 2003, 2002 or 2001.
Health Care Assurance Company, Ltd., our wholly-owned subsidiary, holds $2.5 million of our cash. The transfer of cash to MHP from Health Care Assurance Company, Ltd. requires the approval of regulatory authorities.
In or about November 1999, 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 recovery in connection with the underpayment of amounts due for health care coverage provided to employees of the United States Office of Personnel Management.
Effective February 2, 2000, we 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. Subsequently, CSC Healthcare Inc. (“CSC”), the successor in interest to Nichols TXEN, commenced an arbitration (the “Arbitration”) in Atlanta against us before the American Arbitration Association, claiming our breach of the parties’ Service Agreement for Back Office Administration and contract damages of approximately $1,300,000. On December 1, 2003, the Arbitration and a related case brought by CSC against us in Alabama State court were settled and all claims and counterclaims dismissed. Pursuant to such settlement, we paid CSC $300,000 and recognized a gain, reflected as negative litigation and management settlement charges, of $580,000 in the fourth quarter of 2003, for the difference between the liability previously accrued in connection with this matter and the ultimate settlement of $300,000.
On or about June 25, 2001, the Commissioner of the Indiana Department of Insurance (the “Commissioner”), as the rehabilitator of Maxicare Indiana, Inc., our Indiana HMO, filed a complaint (the “Complaint”) in the Marion County Circuit Court of Indiana against us 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. While the amended Complaint requests money damages in largely unspecified amounts, we understand the Commissioner’s claims against us to be in excess of $48.0 million. All defendants answered the amended Complaint on April 5, 2002. Pre-trial discovery has not been completed. We believe that the claims against us are without merit and intend to vigorously defend the suit. The amounts sought by the Commissioner are significantly in excess of liabilities recorded on our Consolidated Balance Sheets. The ultimate resolution of this matter, if unfavorable, could materially affect our consolidated financial position, results of operations and cash flows.
By order dated March 9, 2001, the Missouri Department of Insurance approved the transfer of all of the outstanding shares of Maxicare Life and Health Insurance Company, Inc. from the Company to Maxicare Indiana, Inc., on the condition that control of MLH remain with the Company. We believe that this condition has not been complied with and that, accordingly, the transfer of the MLH shares by us to Maxicare Indiana, Inc. is null and void. We intend to present our position to the Missouri Department of Insurance at the appropriate time.
Six former employees of the Indiana HMO have made demand on us for the payment of approximately $400,000 in severance payments. We believe these claims are without merit.
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 and totaled $200,000, $100,000 and $800,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The California HMO continues to contribute to the payment of the operating lease obligations of MHP. Although there can be no assurance that such payments will continue, management believes it likely that the California HMO will contribute approximately $49,000 to the payment of operating lease obligations in 2004. Such payments are unlikely to continue after May 31, 2004.
Each Right entitled the holder thereof to purchase 1/500 of a share of our Series B Preferred Stock (the “Series B Preferred”) for $45.00 (the “Exercise Price”). Each 1/500 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.
In July 1995, our shareholders approved the 1995 Stock Option Plan (the “1995 Plan”). Under the 1995 Plan, we may issue up to 200,000 nonqualified or incentive stock options to directors, officers and other employees. In June 1999, our shareholders approved the 1999 Stock Option Plan (the “1999 Plan”). Under the 1999 Plan, we may issue up to 150,000 nonqualified or incentive stock options to directors, officers and other employees. In September 2000, our shareholders approved the 2000 Stock Option Plan (the “2000 Plan”). Under 2000 Plan, we may issue up 800,000 nonqualified or incentive stock options to directors, officers and other employees. Under the 1995 Plan, the 1999 Plan and the 2000 Plan, stock options granted to date have been nonqualified stock options which expire no later than 10 years from the date of grant. Stock options granted to date under the 1995 Plan, the 1999 Plan and the 2000 Plan have been at an exercise price equal to or greater than the fair market value of the stock at the date of grant.
In July 1996, our shareholders approved the Senior Executives 1996 Stock Option Plan (the “Senior Executives Plan”). Under the Senior Executives Plan, we were authorized to issue up to 140,000 nonqualified stock options to Peter J. Ratican and Eugene L. Froelich, former Chief Executive Officer and Chief Financial Officer of the Company, respectively (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 14,000 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 us was to receive a grant of stock options to purchase 14,000 shares of Common Stock. Mr. Froelich’s continuing participation in the Senior Executives Plan ceased when his employment with us was terminated in December 1997. Mr. Ratican’s continuing participation in the Senior Executives Plan ceased when his employment with us 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. No options have been granted under the Senior Executives Plan subsequent to January 1999.
The NOLs presented above exclude certain additional benefits that may be realized upon the ultimate disposition of the Indiana HMO and Maxicare Life and Health Insurance Company, Inc. Certain NOL’s associated with the California HMO, that were to expire in 2022 and prior years, have been eliminated and replaced by an NOL expiring in 2023 as a result of the Company taking a worthless stock deduction upon its surrender of the common stock of the California HMO upon the approval of a liquidating plan of reorganization in 2003.
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 $85.3 million are subject to limitation under provisions of Section 382 of the IRC. From December 5, 1990 through December 31, 2003 we have utilized approximately $32.8 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.
Accordingly, we have reserved the full amount of the deferred tax asses at December 31, 2003. Deferred taxes will be recorded when realized in income tax returns. Any future benefits from a reduction of the valuation allowance will reduce our income tax expense.
The following is a tabulation of the quarterly results of operations for the years ended December 31, 2003 and 2002.