We lease a total of 40 facilities, including 21 medical clinics in California. We own a 32,000 square-foot office building in Long Beach, California, which serves as our corporate headquarters.
We derived the following selected consolidated financial data (other than the data under the caption “Operating Statistics”) for the five years ended December 31, 2005 from our audited consolidated financial statements. You should read the data in conjunction with our consolidated financial statements, related notes and other financial information included herein. All dollars are in thousands, except per share data. The data under the caption “Operating Statistics” has not been audited.
(3) Salary, general and administrative expense ratio represents such expenses as a percentage of total revenue.
The following discussion of our financial condition and results of operations should be read in conjunction with the “Selected Consolidated Financial Data” and the accompanying consolidated financial statements and the notes to those statements appearing elsewhere in this report.
The following table details member months (defined as the aggregation of each month’s membership for the period) by state for the years ended December 31, 2005, 2004, and 2003:
Expenses related to medical care services include two components: direct medical expenses and medically related administrative costs. Direct medical expenses include payments to physicians, hospitals, and providers of ancillary medical services, such as pharmacy, laboratory, and radiology services. Medically-related administrative costs include expenses relating to health education, quality assurance, case management, disease management, 24-hour on-call nurses, member services, and compliance. In general, primary care physicians are paid on a capitation basis (a fixed amount per member per month regardless of actual utilization of medical services), while specialists and hospitals are paid on a fee-for-service basis. For the year ended December 31, 2005, approximately 85.5% of our direct medical expenses were related to fees paid to providers on a fee-for-service basis, with the balance paid on a capitation basis. Physician providers not paid on a capitated basis are paid on a fee schedule set by the state or by our contracts with these providers. We pay hospitals in a variety of ways, including fee-for-service, per diems, diagnostic-related groups, capitation and case rates.
Capitation payments are fixed in advance of periods covered and are not subject to significant accounting estimates. These payments are expensed in the period the providers are obligated to provide services. Fee-for-service payments are expensed in the period services are provided to our members. Medical care costs include actual historical claims experience and estimates of medical expenses incurred but not reported, or IBNR. Monthly, we estimate our IBNR based on a number of factors, including prior claims experience, inpatient hospital utilization data, and prior authorization of medical services. As part of this review, we also consider estimates of amounts to cover uncertainties related to fluctuations in provider billing patterns, claims payment patterns, membership, and medical cost trends. These estimates are adjusted monthly as more information becomes available. We employ our own actuary. We believe that our process for estimating IBNR is adequate, but medical care costs have, in the past, exceeded such estimates, and there can be no assurance that medical care costs will not exceed such estimates in the future.
G&A costs are largely comprised of wage and benefit costs related to our employee base and other administrative expenses. Some G&A services are provided locally, while others are delivered to our health plans from a centralized location. The major centralized functions are claims processing, information systems, finance and accounting services, and legal and regulatory services. Locally-provided functions include marketing (to the extent permitted by law and regulation), plan administration, and provider relations. Included in G&A expenses are premium taxes for the California HMO (beginning July, 2005), the Michigan HMO (beginning in the second quarter of 2003), the New Mexico HMO (beginning with its acquisition on July 1, 2004) and the Washington HMO.
Membership growth contributed $386.5 million to the increase in premium revenue. Year-end enrollment increased 13.3% to 893,000 members at December 31, 2005, from 788,000 members at the same date of the prior year. Membership growth was primarily the result of acquisitions in San Diego, California effective June 1, 2005, the start-up of our Indiana HMO effective April 1, 2005, and the full-year benefit of acquisitions made during 2004 in Washington, New Mexico, and Michigan. Member months for the year ended December 31, 2005 increased by 27.7% to 10,314,000 from 8,079,000 for the year ended December 31, 2004.
Other operating revenue decreased to $3.9 million for 2005 from $4.2 million for 2004. During 2005, savings sharing income recognized by our Utah HMO declined by $0.4 million. Revenue earned by our California medical clinics declined by $0.5 million in 2005. Revenue earned by our New Mexico HMO during 2005 for performing certain administrative services for the state was $0.6 million higher in 2005 than in 2004. Our New Mexico HMO terminated its involvement in this program effective July 1, 2005.
Nevertheless, we can give no assurances that the improved performance is not at least partially the result of factors beyond our control, nor can we give any assurances that the improved medical cost trends will continue.
Hospital costs for 2005 include $5.7 million of expense related to the settlement and anticipated settlement of certain claims made against us by various hospitals. These claims seek additional or first-time reimbursement for services ostensibly provided to our members that purportedly were not paid or were underpaid by us. The
G&A expenses for 2005 were $163.3 million as compared with $94.2 million for 2004. G&A expenses as a percentage of total revenue were 9.9% for 2005 as compared with 8.0% for 2004.
Premium taxes (which are included in G&A) increased to 2.8% of total revenue in 2005 from 2.1% of total revenue in 2004. Increased premium taxes were due to the inclusion of our New Mexico HMO in our consolidated results for all of 2005 as compared to only the second half of 2004; as well as the implementation of a premium tax in California effective July 1, 2005.
Interest expense increased to $1.5 million for 2005 from $1.0 million for 2004 due to increased average debt balances during 2005.
Income tax expense totaled $16.3 million in 2005, resulting in an effective tax rate of 37.1%, as compared to $31.9 million in 2004, resulting in an effective tax rate of 36.4%. During both 2005 and 2004, we pursued various strategies to reduce our federal, state, and local taxes.
Premium revenue for 2004 was $1,167 million, up $377.3 million (47.8%) from $789.5 million for 2003.
The remaining $124.2 million increase in premium revenue was attributable to increases in premium rates and proportionally greater increases in membership in those states with higher premium rates. Premium revenue on a per member per month basis is substantially higher at our New Mexico HMO than at our other HMOs.
Other operating revenue increased to $4.2 million for 2004 from $2.2 million for 2003. Other operating revenue for 2004 included $2.1 million of savings sharing income recognized by our Utah HMO. Our Utah HMO recognized no savings sharing income prior to 2004. For 2003, our Michigan HMO recognized approximately $0.7 million in savings sharing income. Our Michigan HMO’s contract with the state no longer contains risk sharing provisions and no risk sharing revenue was recognized by the Michigan HMO subsequent to the second quarter of 2003.
Depreciation and amortization expense for 2004 increased to $8.9 million from $6.3 million for 2003. The increase was primarily due to increased capital spending for computer equipment and leasehold improvements and increased amortization of acquisition costs.
As discussed above, other income for 2004 includes a pretax gain of $1.2 million recognized upon the termination of certain Collateral Assignment Split-Dollar Insurance Agreements between our company and the Molina Siblings Trust, a related party, during the first quarter of 2004.
Income tax expense totaled $31.9 million in 2004, resulting in an effective tax rate of 36.4%, as compared to $23.9 million in 2003, resulting in an effective tax rate of 36.0%. During both 2004 and 2003, we pursued various strategies to reduce our federal, state, and local taxes.
On June 1, 2005, we transitioned approximately 85,000 Medi-Cal and Healthy Families members living in San Diego County, California into our California HMO from Sharp Health Plan (Sharp) and Universal Care, Inc., a California corporation (Universal). We paid total consideration of $26.1 million in the Sharp transaction. Further consideration may be paid to Sharp through May 31, 2008 under an earn-out provision which compares the excess of medical revenues over medical expenses of the acquired contracts against an annual target during the 36 months after closing. Such further consideration may not exceed $3.5 million. We paid total consideration of $6.2 million in the Universal transaction.
At December 31, 2005, we had working capital of $189.2 million as compared to $202.2 million at December 31, 2004. At December 31, 2005 and December 31, 2004, cash and cash equivalents were $249.2 million and $228.1 million, respectively. At December 31, 2005 and December 31, 2004, our investments were $103.4 million and $88.5 million, respectively.
The states in which we operate prescribe the types of instruments in which our subsidiaries may invest their funds. Our restricted cash consists principally of certificates of deposit and treasury securities with maturities of up to 12 months.
The average annualized portfolio yield for the years ended December 31, 2005, 2004, and 2003 was approximately 3.0%, 1.4%, and 1.1%, respectively.
Net cash provided by operations was $97.3 million for 2005 and $91.0 million for 2004. While we had substantially lower net income in 2005 than in 2004, changes in working capital accounts (principally an increase in medical claims and benefits payable) offset the decrease to cash provided by operations generated by our reduced net income.
increased medical claims and benefits payable (a source of $57.1 million in 2005 compared to a source of $23.1 million in 2004);
As with our prior credit facility, our obligations under the amended and restated credit facility are secured by a lien on substantially all of our assets and by a pledge of the capital stock of our Michigan, New Mexico, Utah, and Washington HMO subsidiaries.
At June 30, 2005, we were not in compliance with certain financial ratio covenants, constituting an event of default under the credit agreement. In October 2005, we entered into an amendment and waiver pursuant to which the lenders waived the event of default under the credit agreement, including the financial covenants. In connection with the amendment and waiver we incurred fees of $485,000, which were capitalized as deferred financing cost to be amortized over the remaining term of the credit facility.
For the fifth month of service prior to the reporting date and earlier, we estimate our outstanding claims liability based upon actual claims paid, adjusted for estimated completion factors. Completion factors seek to measure the cumulative percentage of claims expense that will have been paid for a given month of service as of a date subsequent to that month of service. Completion factors are based upon historical payment patterns. The following table reflects the change in our estimate of claims liability as of December 31, 2005 that would have resulted had we changed our completion factors for the fifth through the twelfth months preceding that date by the percentages indicated. Our Utah HMO is excluded from these calculations, as the majority of the Utah business is conducted under a cost reimbursement contract. Amounts are in thousands.
We lease office space and equipment under various operating leases. As of December 31, 2005, our lease obligations for the next five years and thereafter are as follows: $9.6 million in 2006, $9.3 million in 2007, $8.7 million in 2008, $7.7 million in 2009, $6.6 million in 2010, and an aggregate of $6.1 million thereafter.
(1) During the second quarter of 2005 we made an equity investment of approximately $1.6 million in a medical service provider that provides certain medical services to our members. Upon the achievement by the medical service provider of certain benchmarks prior to December 31, 2006 we are obligated to invest an additional $1.9 million.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Molina Healthcare, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2006 expressed an unqualified opinion thereon.
The consolidated financial statements include the accounts of Molina Healthcare, Inc. and all majority-owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. Financial information related to subsidiaries acquired during any year is included only for the period subsequent to their acquisition.
Other operating revenue for the years ended December 31, 2005 and 2004 includes $1,767 and $2,100, respectively, recorded for estimated savings sharing income recognized by our Utah HMO. The estimated savings sharing is based upon claims experience for the period of July 1, 2003 through December 31, 2005 (see Receivables). Other operating revenue for the year ended December 31, 2003 includes $734 of savings sharing income earned by our Michigan HMO. Our Michigan HMO’s contract with the state no longer contains risk sharing provisions and no risk sharing revenue was recognized by the Michigan HMO subsequent to the second quarter of 2003. Revenue earned by our California medical clinics and by our New Mexico HMO for performing certain administrative services for the state (in 2004 and 2005) constitutes the remainder of our other operating revenue. Our New Mexico HMO ceased performing such services for the state effective July 1, 2005.
We arrange to provide comprehensive medical care to our members through a network of contracted hospitals, physician groups and other health care providers that includes our clinics. Medical care costs represent the direct cost of health care services, such as fees to contracted providers under capitation and fee-for-service arrangements and physician salaries at our clinics, as well as medically-related administrative costs relating to health education, quality assurance, case management, disease management, member services, and compliance.
We report reinsurance premiums as medical care costs, while related reinsurance recoveries are reported as deductions from medical care costs. We limit our risk of catastrophic losses by maintaining high deductible reinsurance coverage. We do not consider this coverage to be material as the cost is not significant and the likelihood that coverage will be applicable is low.
We assess the profitability of our contracts for providing medical care services to our members and identify those contracts where current operating results or forecasts indicate probable future losses. Anticipated future premiums are compared to anticipated medical care costs, including the cost of processing claims. If the anticipated future costs exceed the premiums, a loss contract accrual is recognized. No such accrual was required as of December 31, 2005 or 2004 other than that documented above in relation to the New Mexico TSA.
The contractual maturities of our investments as of December 31, 2005 are summarized below.
Gross realized gains and gross realized losses from sales of available-for-sale securities are calculated under the specific identification method and are included in investment income. Net losses on the sale of available-for-sale securities with book values of $4,909 and $29,322, respectively, were $220 and $19 in 2005 and 2004, respectively. In 2003, we sold available-for-sale securities with a book value of $3,112 for a gain of $1.
Unrealized losses at December 31, 2005 and 2004 have been determined to be temporary in nature. The decline in market value for these securities is the result of rising interest rates rather than a deterioration of the credit worthiness of the issuers. So long as we hold these securities to maturity, we are unlikely to experience losses. In the event that we dispose of these securities before maturity, we expect that realized losses, if any, will be immaterial. Also, the disclosures required under EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, have not been included because our unrealized losses are immaterial at December 31, 2005 and 2004.
Substantially all receivables due our California HMO at December 31, 2005 and 2004 were collected in January of 2006 and 2005, respectively.
Restricted investments, which consist of certificates of deposit and treasury securities, are designated as held-to-maturity and are carried at amortized cost, which approximates market value. The use of these funds is limited to specific purposes as required by each state.
Property and equipment are stated at historical cost. Replacements and major improvements are capitalized, and repairs and maintenance are charged to expense as incurred. Furniture and equipment are depreciated using the straight-line method over estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the term of the lease or five to 10 years, whichever is shorter. Buildings are depreciated over their estimated useful lives of 31.5 years.
We account for income taxes based on SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected
Our California HMO (beginning July 1, 2005), Michigan HMO, New Mexico HMO (beginning July 1, 2004), and Washington HMO are assessed a tax based upon premium revenue collected. Premium tax expense totaled $46,301, $24,333, and $9,194 in 2005, 2004, and 2003, respectively, and is included in salary, general and administrative expenses.
We carry medical malpractice insurance for health care services rendered through our clinics in California. Claims-made coverage under this insurance is $1,000 per occurrence with an annual aggregate limit of $3,000 for years ended December 31,2005 and 2004. We also carry claims-made managed care professional liability insurance for our HMO operations. This insurance is subject to a coverage limit of $5,000 per occurrence and in aggregate for each policy year.
At December 31, 2005, we had two stock-based employee compensation plans, which are described more fully in Note 12. 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 SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure.
We will adopt SFAS 123R effective January 1, 2006; however, we have not yet determined which of the aforementioned adoption methods we will use. Subject to a complete review of the requirements of SFAS 123R, based on stock options granted to employees through December 31, 2005, as well as stock options expected to be granted and shares expected to be issued under our Employee Stock Purchase Plan during 2006, we expect that the adoption of SFAS 123R on January 1, 2006, would reduce 2006 net earnings per diluted share by approximately $2,500 ($0.09). See Note 12 for further information on our stock-based compensation plans.
requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but entities are also permitted to restate financial statements of previous periods based on pro forma disclosures made in accordance with SFAS 123.
We currently expect to adopt SFAS 123R effective January 1, 2006; however, we have not yet determined which of the aforementioned adoption methods we will use. Subject to a complete review of the requirements of SFAS 123R, based on stock options granted to employees through December 31, 2005, as well as stock options expected to be granted and shares expected to be issued under our Employee Stock Purchase Plan during 2006, we expect that the adoption of SFAS 123R on January 1, 2006, would reduce 2006 net earnings per diluted share by approximately $2,200 ($0.08) each. See Note 12 for further information on our stock-based compensation plans.
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, investments, receivables, and restricted investments.
On November 3, 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, effective for reporting periods beginning after December 15, 2005. FSP FAS 115-1 addresses the determination of when an investment is considered impaired, whether that impairment is other than temporary and measurement of an impairment loss. It also provides considerations for the accounting subsequent to the recognition of an other-than-temporary (OTT) impairment and requires certain disclosures about unrealized losses that have not been recognized as OTT impairments. The guidance in this FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and No.124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The FSP also replaces the impairment evaluation guidance (paragraphs 10-18) of EITF Issue No. 03-1. EITF 03-1’s disclosure requirements remain in effect, and are applicable for year-end reporting and for interim periods if there are significant changes from the previous year-end. FSP FAS 115-1 is not expected to have a significant effect on our financial position and operating results.
On June 1, 2005, we transitioned approximately 85,000 Medi-Cal and Healthy Families members living in San Diego County, California into our California HMO from Sharp Health Plan (Sharp) and Universal Care, Inc., a California corporation (Universal). We transitioned these members into our California HMO to take advantage of the operational efficiencies arising from a larger membership base and to enter the San Diego, California market.
We paid total consideration of $26,088 in the Sharp transaction. Further consideration may be paid to Sharp through May 31, 2008 under an earn-out provision which compares the excess of medical revenues over medical expenses of the acquired contracts against an annual target during the 36 months after closing. Such further consideration may not exceed $3,500.
On December 30, 2005, we acquired the capital stock of Phoenix National Insurance Company, an Ohio corporation (“Phoenix”), for $10,827. On January 13, 2006, we changed the name of Phoenix to Molina Healthcare Insurance Company. The Phoenix purchase has been accounted for under the purchase method of accounting. Accordingly, the consideration paid has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated fair values. We acquired cash of $2,249, restricted investments of $5,689, and miscellaneous assets and liabilities of $417. Phoenix is licensed in forty-eight states and the District of Columbia. We have assigned to those licenses a value of $2,472. The entire value of the licenses is included in intangible assets, net, in the Consolidated Balance Sheets. The purchase price allocation may be adjusted upon completion of the final valuation of the remaining assets and liabilities of Phoenix. We intend to use Phoenix as a vehicle for developing new products, services, and markets that meet the health care delivery needs of persons eligible for Medicaid and other programs for low-income families and individuals.
Prior to the closing of the HCH acquisition, we announced a definitive agreement had been reached to transfer the commercial membership acquired in the HCH purchase to Lovelace Sandia Health System, Inc. (“Lovelace”). Effective August 1, 2004, the transfer was completed. We received a total of $17,994 (net of
approximately $265 in direct transactions costs) in connection with the transfer. We also entered into a transition services agreement (TSA) with Lovelace to provide commercial claims processing, customer and provider call handling, and billing and treasury services through the date the commercial contracts were expected to be fully transitioned to Lovelace. In exchange for those services, the New Mexico HMO was compensated by the buyer at a specific amount per member per month. The New Mexico HMO entered into the TSA as an inducement to the buyer to purchase the commercial membership and anticipated that the TSA would be unprofitable.
We established a reserve to record our net liability incurred in regard to the termination of the commercial health plan operations of HCH and Cimarron Health Plan. That reserve was calculated to be $2,900 representing the estimated cash outflows for the termination of commercial operations and transition services agreement, offset by $260, the net cash inflows of the commercial operations for the one-month period ended July 31, 2004. A summary of activity for this reserve for the period July 1, 2004 follows through December 31, 2005:
Allocation of acquisition cost in excess of net assets acquired (including effect of the Lovelace divestiture transaction) is as follows:
Subsequent to the effectiveness of the HCH purchase, we paid approximately $5,800 to retire all of HCH’s outstanding bank debt.
We retained the tangible assets and liabilities associated with the commercial business at August 1, 2004 (consisting of $4,812 of premiums receivable and $9,895 of medical claims payable).
The following summarizes net assets acquired at the date of acquisition (includes effect of the Lovelace divestiture transaction):
Effective June 1, 2004, we completed our acquisition of the Healthy Options (Medicaid) and Basic Health Plan contracts of Premera Blue Cross, adding approximately 56,000 members to the Washington HMO. We paid to Premera $18,000 for both contracts in addition to assuming an estimated $400 in medical related liabilities. The entire cost of the acquisition ($18,400) was assigned to the acquired payor contract, to be amortized over a period of fifteen years. We added these members into our Washington HMO to take advantage of the operational efficiencies arising from a larger membership base.
Under SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and indefinite lived assets are no longer amortized, but are subject to impairment tests on an annual basis or more frequently if impairment indicators exist. Under the guidance of SFAS No. 142, we used a discounted cash flow methodology to assess the fair values of our reporting units at December 31, 2005 and 2004. If book equity values of our reporting units exceed the fair values, we perform a hypothetical purchase price allocation. Impairment is measured by
Other intangible are comprised of the costs of acquired payor contracts, provider contracts and insurance licenses. These assets are being amortized over their useful lives ranging from 5 to 15 years. Amortization on intangible assets recognized for the years ending December 31, 2005, 2004, and 2003 was $7,431, and $4,043, and $2,701, respectively. We estimate our intangible asset amortization will be $8,084 in both 2006 and 2007; $7,592 in 2008; and $6,297 in both 2009 and 2010. The following table sets forth balances of identified intangible assets, by major class, for the periods indicated:
Depreciation expense recognized for the years ended December 31, 2005, 2004, and 2003 was $7,694, $4,826 and $3,632, respectively.
We lease two medical clinics from the Molina Family Trust. These leases have five five-year renewal options. In May 2001, we entered into a similar agreement with the Molina Siblings Trust for the lease of another medical clinic, which we also use as a backup data center. In December 2004, we purchased this clinic from the Molina Siblings Trust for $1,850. Rental expense for these leases totaled $96, $367, and $383 for the years ended December 31, 2005, 2004, and 2003, respectively. At December 31, 2005, minimum future lease payments for the two remaining leased clinics consist of the following:
On March 9, 2005, we entered into an amended and restated five-year secured credit agreement for a $180,000 revolving credit facility with a syndicate of lenders. The credit facility will be used for working capital
Borrowings under the credit facility are based, at our election, on the London interbank deposit, or LIBOR, rate or the base rate plus an applicable margin. The base rate will equal the higher of Bank of America’s prime rate or 0.5% above the federal funds rate. We also pay a commitment fee on the total unused commitments of the lenders under the credit facility. The applicable margins and commitment fee are based on our ratio of consolidated funded debt to consolidated EBITDA. The applicable margins will range between 1.00% and 1.75% for LIBOR loans and between 0% and 0.75% for base rate loans. The commitment fee will range between 0.375% and 0.500%. In addition, we will pay a fee for each letter of credit issued under the credit facility equal to the applicable margin for LIBOR loans and a customary fronting fee.
At June 30, 2005 and through August 8, 2005, we had borrowings of $3,100 outstanding under the credit facility, which were repaid in the third quarter.
The amended credit agreement includes usual and customary covenants for credit facilities of this type, including covenants limiting liens, mergers, asset sales, other fundamental changes, debt, acquisitions, dividends and other distributions, capital expenditures, and investments. The credit agreement also requires us to maintain a ratio of total consolidated debt to total consolidated EBITDA of not more than 2.00 to 1.00 at any time and a fixed charge coverage ratio of 1.75 to 1.00 for the quarter ended September 30, 2005 and thereafter ranging from 1.20 to 1:00 for the quarter ended June 30, 2006 up to 3.00 to 1.00 for all quarters ending after December 31, 2008. At December 31, 2005, we were in compliance with all financial covenants in the credit agreement.
In December 2004, we issued a mortgage note in the amount of $1,302 in connection with the purchase of a medical clinic from a related party (see Note 6. Related Party Transactions). In December 2005, we repaid the note in full.
At December 31, 2005, the Company has federal and state net operating loss carryforwards of $791 and $4,639, respectively. Both the federal and state net operating losses begin expiring in 2011.
The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Penalties associated with violations of these laws and regulations include significant fines and penalties, exclusion from participating in publicly-funded programs, and the repayment of previously billed and collected revenues.
Beginning on July 27, 2005, a series of securities class action complaints were filed in the United States District Court for the Central District of California on behalf of persons who acquired our common stock between November 3, 2004 and July 20, 2005. The class action complaints purport to allege claims against Molina Healthcare, Inc., J. Mario Molina, John C. Molina, and other officers, directors, and employees for alleged violations of the Securities Exchange Act of 1934 arising out of our issuance and subsequent revision of earnings guidance for the 2005 fiscal year. The class action complaints have been consolidated into a single consolidated action, Case No. CV 05-5460 GPS (SHx) (the “Class Action”). A lead plaintiff has been appointed in the Class Action, and the deadline to file an Amended and Restated Complaint is March 14, 2006. The Class Action is in the early stages, and no prediction can be made as to the outcome. We believe the Class Action is without merit and intend to defend against it vigorously.
Starko. Our New Mexico HMO is named as a defendant in a class action lawsuit brought by New Mexico pharmacies and pharmacists, Starko, Inc., et al. v. NMHSD, et al., No. CV-97-06599, Second Judicial District Court, State of New Mexico. The lawsuit was originally filed in August 1997 against the New Mexico Human Services Department (“NMHSD”). In February 2001, the plaintiffs named HMOs participating in the New Mexico Medicaid program as defendants, including the predecessor of the New Mexico HMO. Plaintiff asserts that NMHSD and the HMOs failed to pay pharmacy dispensing fees under an alleged New Mexico statutory mandate. Discovery has recently commenced. It is not currently possible to assess the amount or range of potential loss or probability of a favorable or unfavorable outcome. Under the terms of the stock purchase agreement pursuant to which we acquired Health Care Horizons, Inc., the parent company to the New Mexico HMO, an indemnification escrow account was established and funded with $6,000 in order indemnify our New Mexico HMO against the costs of such litigation and any eventual liability or settlement costs. Currently, $4,459 remains in the indemnification escrow fund.
Other providers have also contacted us seeking additional compensation for claims that we believe to have been settled. These matters, when finally concluded and determined, will not, in our opinion, have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
During 2005, we recorded a charge of approximately $5,700 in connection with the anticipated settlement of certain claims made against us by various hospitals, including the Tenet arbitration and the Department of Health matters discussed above. Through February of 2006, we had paid approximately $3,300 of the total amount expensed in 2005 in connection with these matters.
The United States Office of Personnel Management (OPM) has contacted our New Mexico HMO seeking repayment of approximately $3,800 in premiums paid by OPM on behalf of Federal employees for the years 1999, 2000 and 2002. OPM is also seeking recovery of approximately $500 in interest in connection with this matter. OPM is asserting that it did not receive rate discounts equivalent to the largest discount given by the New Mexico HMO for Similar Sized Subscriber Groups, as required by the New Mexico HMO’s agreement with OPM, during the years in question. We have evaluated the claim and concluded that any liability we may have regarding this matter, if such liability exists, will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
We have the ability and commitment to provide additional capital to each of our HMOs when necessary to ensure that statutory capital and surplus continue to meet regulatory requirements.
In 2002, we adopted the 2002 Equity Incentive Plan (2002 Plan), which provides for the granting of stock options, restricted stock, performance shares, and stock bonus awards to the company’s officers, employees, directors, consultants, advisors, and other service providers. The 2002 Plan was effective upon the effectiveness of our initial public offering of common stock in July of 2003. The 2002 Plan originally allowed for the issuance of 1,600,000 shares of common stock, of which up to 600,000 shares may be issued as restricted stock. Beginning January 1, 2004, and each year thereafter, shares eligible for issuance will automatically increase by the lesser of 400,000 shares or 2% of total outstanding capital stock on a fully diluted basis, unless the board of directors provides for a smaller increase. Awards were first made under the 2002 Plan during 2004.
During the year ended December 31, 2004, we issued options to purchase 302,200 shares (of which 45,768 were forfeited at December 31, 2005) at an estimated fair value of $3,960. Also during the year ended December 31, 2004, we awarded stock grants for 51,000 shares with a fair value at the date of grant of $1,908. During 2004 we recognized $179 in compensation expense in connection with stock grants issued in 2004.
Through July 2, 2003, we made periodic grants of stock options to key employees and non-employee directors under the 2000 Omnibus Stock and Incentive Plan (the 2000 Plan) and prior grants. Pursuant to the 2000 Plan, we were able to grant qualified and non-qualified options for common stock, stock appreciation rights, restricted and unrestricted stock and performance units (collectively, the awards) to officers and key employees based on performance. The 2000 Plan limited the number of shares that could be granted in one year to 10% of the outstanding common shares at the inception of the year. Exercise price, vesting periods and option terms were determined by the board of directors. During the year ended December 31, 2003, we issued options to purchase 70,000 shares of our common stock with an estimated fair value of $374. All such options were issued prior to July 2, 2003. All options granted through July 2, 2003 vested upon the completion of our initial public offering of common stock in July of 2003. Further grants under the 2000 Plan have been frozen.
eligible for issuance will automatically increase by the lesser of 6,000 shares or 1% of total outstanding capital stock on a fully diluted basis. During each six-month offering period, eligible employees may purchase common shares at 85% of their fair market value through payroll deductions. Each eligible employee is limited to a maximum purchase of $25 (as measured by the fair value of the stock acquired) per year. Shares issued pursuant to the Purchase Plan during the years ended December 31, 2005, 2004 and 2003 were 36,213; 37,050 and 80,130, respectively.
Through July 2, 2003, 632,840 of outstanding options were granted with exercise prices below fair value. Upon the effectiveness of our initial public offering of common stock in July 2003, all outstanding options vested immediately and all deferred stock-based compensation was expensed immediately. Additionally, the liability for stock-based compensation expense was reclassified to paid-in-capital. Compensation expense recognized in the consolidated statements of income in connection with these options was $1,236 for the year ended December 31, 2003.
Pro forma information regarding net income (loss) and earnings (loss) per share, as presented in Note 2, “Significant Accounting Policies,” is required by SFAS No. 123, as amended by SFAS No. 148, and has been determined as if we had accounted for our employee stock options under the fair value method of that Statement upon its initial effective date. The fair value for these options was estimated at the date of grant using a minimum value option-pricing model for grants made prior to our initial public offering in July 2003 and a Black-Scholes option-pricing model for grants made subsequent to our initial public offering with the following weighted-average assumptions: a risk-free interest rate of 4.11% in 2005; 4.15% in 2004 and 3.78% in 2003; expected stock process volatility of 53.2% in 2005 and 51.2% in 2004 (volatility is not applicable in 2003 as no grants were made that were subject to the Black-Scholes option-pricing model); dividend yield of 0% and expected option lives of 60 months.
The Minimum Value option-pricing model used prior to the effectiveness of our initial public offering was developed for use in estimating the fair value of traded options and warrants which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly-subjective assumptions, including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
In July 2003, we repurchased a total of 1,120,571 shares of common stock from two stockholders for $17.50 per share or an aggregate purchase price of $19,610. We purchased 912,806 of these shares from the MRM GRAT 301/2 and 207,765 shares from the Mary R. Molina Living Trust. All of these shares were subsequently retired.
Following are the condensed balance sheets of the Registrant as of December 31, 2005 and 2004, and the statements of income and cash flows for each of the three years in the period ended December 31, 2005.
In December 2004 we issued a mortgage note in the amount of $1,302 in connection with the purchase of a medical clinic from a related party, the Molina Siblings Trust. This facility also serves as our backup data center. Total purchase price for the facility was $1,850. In December 2005 we repaid the note in full.