A quantitative summary of our revenues by source category for 2012 and 2011 follows:
Our customer base primarily includes regional health plans that do not have their own behavioral network. We provide services primarily through a network of contracted providers that includes:
We typically enter into contracts on an annual basis to provide managed behavioral healthcare, substance abuse, and pharmacy management services to our customers’ members. Our arrangements with our clients fall into two broad categories:
At-risk arrangements under which our clients pay us a fixed fee per member in exchange for our assumption of the financial risk of providing services; and
We also cover pharmacy management services, where we receive an additional per-member per-month amount. We manage pharmacy services through the collection and analysis of pharmacy claims data which is provided by the health plan’s pharmacy benefit manager (“PBM”), whose primary functions are claims adjudication and drug cost negotiation. Through data analysis and usage evaluation against clinically sound, evidence-based criteria, we are able to identify ineffective, inappropriate and costly drug utilization. Our approach is to address these issues in a collaborative manner with the primary care physicians and psychiatrists through the provision of useful information based on our analysis. Our goal is to produce positive outcomes for patients while controlling pharmacy costs.
During 2012, we managed programs through which services were provided to recipients in 22 states, the District of Columbia and Puerto Rico. Our objective is to provide easily accessible, high quality behavioral healthcare and pharmacy services and to manage costs through measures such as the monitoring of hospital inpatient admissions and the review of authorizations for various types of outpatient therapy. Our goal is to combine access to quality behavioral healthcare services with effective management controls in order to ensure the most cost-effective use of healthcare resources.
management of prescription drugs on an at-risk basis for health plans, self-insured companies, and unions;
In March of 2013, we entered into an agreement with Local No. 29 of the Laborers International Union of North America to provide our Pharmacy Savings Management Program. Through the use of selected pharmacy benefits managers, pharmacy data analytics, and the development of cost-saving ancillary pharmacy programs, we believe we can reduce drug costs for our clients that utilize our program.
Effective January 1, 2013, we began providing administrative behavioral health services to approximately 3,000 members of a Medicare Advantage population serviced by a health plan in the state of California.
At-risk behavioral health contracts: Operating revenues from at-risk contracts decreased by 24.3%, or approximately $8.5 million, to $26.6 million for 2012 compared to $35.1 million for 2011. The decrease was primarily attributable to the loss of customers in Missouri, Texas and Wisconsin during the end of 2011 and throughout 2012 of $9.2 million and to the loss of contracts in Louisiana and Michigan of $3.3 million during the third and fourth quarters of 2012. The decrease was offset by approximately $4.1 million in additional revenues from new customers and others that were previously under contract.
Claims costs, at-risk behavioral health contracts: Claims expense on at-risk contracts decreased by 25.9%, or approximately $7.3 million, to $20.9 million for 2012 as compared to 2011. The decrease was primarily attributable to a reduction of claims related to contracts lost in Missouri, Texas, and Wisconsin during the fourth quarter of 2011 and throughout 2012 as described above as compared to the comparable period. The claims costs decrease was offset by increases of $1.5 million and $1.4 million resulting from the expansion of existing contracts and the addition of new at-risk business, respectively. Claims costs as a percentage of at-risk revenues decreased to 78.6% for 2012, from 80.4% for 2011, due to decreased utilization of services in 2012.
Contract loss allowance: During 2012, we reversed $450,000 of an excess contract loss allowance that we had established at December 31, 2011 for our Louisiana contract because the allowance was no longer needed due to the early termination of the contract.
At December 31, 2012, we had a working capital deficiency of approximately $23.1 million, including $2.9 million of debt that was past due and, therefore, in default, and a stockholders’ equity deficiency of approximately $22.9 million resulting from a history of operating losses. As a result, as set forth in Notes 2 and 7 to our consolidated financial statements, there is significant uncertainty as to our ability to continue our operations as a going concern.
Borrowings. We have used on an as-needed basis unsecured loans from related and unrelated individuals and companies to meet on-going working capital needs. The duration of the borrowings has ranged from one week to three years, with stated interest rates ranging from 7% to 24%. Certain of the loans have contained features such as the ability to convert all or a portion of the loan into our common stock, or have had a warrant for the purchase of our common stock issued in conjunction with the loan, or both. During 2012, we obtained approximately $125,000 in cash loans to fund our operations. Repayments of debt during 2012 were $378,000, which were funded from cash generated from operations and new borrowings. Future repayments are expected to be made from similar sources.
Use of common stock and warrants to purchase common stock in lieu of cash. Certain vendors and noteholders have accepted our common stock and warrants as payment for services, interest and debt. However, during 2012, we avoided cash outlays of only approximately $16,000 for services by issuing our common stock or warrants to purchase common stock.
We believe our accounting policies specific to our revenue recognition, accrued claims payable, premium deficiencies and claims expense, goodwill, and income taxes are critical to the preparation of our consolidated financial statements.
Revenue recognition. The majority of our managed care activities are performed under at-risk arrangements pursuant to terms of agreements primarily with health plans to provide contracted behavioral healthcare and pharmacy management services to subscribing members. For the years ended December 31, 2012 and 2011, such agreements accounted for approximately 96%, or $66.0 million and 96%, or $68.4 million, respectively, of our revenue. Revenue under these agreements is earned continuously over time regardless of services actually provided and, therefore, is recognized monthly based on the number of qualified members. The information regarding qualified members is supplied by our clients, and we review member eligibility records and other reported information to verify its accuracy and determine the amount of revenue to be recognized. The remaining balance of our revenues is earned and recognized as services are delivered on a non-risk basis.
We also manage the psychotropic drug benefit under certain behavioral health contracts for certain health plans’ subscribing members and are responsible for the cost of drugs dispensed. In accordance with the contracts, the health plan’s pharmacy benefit manager (“PBM”) performs drug price negotiation and claims adjudication. As such, payment for our pharmacy management services is withheld until a monthly or quarterly comparison of our total premium to total drug cost is made, at which time we receive or pay the difference. Accordingly, similar to our other at-risk arrangements, pharmacy drug management revenue is earned at a contracted rate per eligible member and recognized monthly.
Accrued claims payable. Claims expense, a major component of cost of revenue, is recognized in the period in which an eligible plan member actually receives services and includes a provision for claims incurred but not reported (“IBNR”). We contract with various healthcare providers including hospitals, physician groups and other licensed behavioral healthcare professionals either on a discounted fee-for-service or a per-case basis. We
determine that a member has received services when we receive a claim within the contracted timeframe with all required billing elements correctly completed by the service provider. We then determine whether the member is eligible to receive the service, the service provided is medically necessary and is covered by the benefit plan’s certificate of coverage, and the service is authorized by one of our employees, if required. If all of these requirements are met, the claim is entered into our claims system for payment.
The accrued claims payable liability represents the estimated ultimate net amounts owed for all behavioral healthcare services provided through the respective balance sheet dates, including estimated amounts for claims IBNR. We have used the same methodology and assumptions for estimating the IBNR portion of the accrued claims liability for the last two years.
Whenever we believe it is probable that a future loss will be incurred under our managed care contracts based on a perceived contractual premium deficiency, and we expect to be unable to cancel our obligation or renegotiate, and the amount of the loss can be reasonably estimated, we also provide for such expected losses. We perform this loss accrual analysis on a contract-by-contract basis by taking into consideration various factors such as future contractual revenue, estimated future healthcare and maintenance costs, and each contract’s specific terms related to future revenue increases as compared to expected increases in healthcare costs. The estimated future healthcare and maintenance costs are based on historical trends and expected future cost increases. Our analysis at December 31, 2011 identified one contract for which it is probable that a loss will be incurred during the remaining contract term. Based on available information, we had estimated the loss at $450,000 and established an allowance for the loss on our consolidated balance sheet. At December 31, 2012, no contract loss allowance for future periods was necessary.
During 2011, we reversed our remaining claims amounts of approximately $0.8 million related to two contracts which were terminated in 2008 and for which no additional claims submission was expected. We also decreased our prior year claims expense by $0.5 million for one major contract in Puerto Rico which started in the third quarter of 2010. The adjustment was primarily due to the lack of claims payment history.
No dividends are expected to be paid for the expected life of the instruments, therefore, we assume a dividend rate of zero.
We have audited the accompanying balance sheets of Comprehensive Care Corporation and Subsidiaries (the Company) as of December 31, 2012 and 2011 and the related consolidated statements of operations, stockholders’ equity deficiency, and cash flows for each of the two years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The consolidated financial statements include the accounts of Comprehensive Care Corporation and its wholly owned subsidiaries, each with their respective subsidiaries (collectively referred to herein as, the “Company,” “CompCare,” “we”, “us,” or “our”).
We provide managed care services in the behavioral health, substance abuse, and pharmacy management fields for commercial, Medicare, Medicaid and Children’s Health Insurance Program (“CHIP”) members primarily on behalf of health plans. Our managed care operations include administrative service agreements, fee-for-service agreements, and capitation contracts. The customer base for our services includes both private and governmental entities. Our services are provided by unrelated vendors on a subcontract basis.
The Company has elected to not adopt the option available under United States generally accepted accounting principles (“GAAP”) to measure any eligible financial instruments or other items at fair market value at this time. Accordingly, the Company measures all of its assets and liabilities on the historical cost basis of accounting, except as otherwise required by GAAP.
Inter-company accounts and transactions have been eliminated in consolidation. Certain minor reclassifications of prior period amounts have been made to conform to the current year presentation.
Accounts and notes receivable are carried net of an allowance at their estimated collectible value. Since customer credit is generally extended on a short-term basis, accounts receivable do not bear interest and are uncollateralized. We manage credit risk and determine necessary allowances by evaluating customers’ credit worthiness before extending credit and periodically for collectability, based primarily on customers’ past credit history and current financial conditions and general economic conditions, results of prior collection efforts, the relative strength of our relationship therewith and, in the event of a dispute, its legal position and the estimated cost of proposed collection proceedings. Management has not established a policy for when to charge off uncollectible accounts receivable or to use external collection agencies and makes such decisions on a case-by-case basis. The maximum losses that the Company would incur if a customer failed to pay would be limited to the carrying value of the receivable after any related allowances provided.
The carrying amounts of cash, accounts receivable and accounts payable approximate their estimated fair value due to the short-term nature of these instruments. Since our other financial liabilities are not traded in an open market, we generally use a present value technique, which is a level 3 input, as defined in GAAP, to measure the estimated fair value of these financial instruments, except for valuing stock options and warrants (see below). The rate used for discounting expected cash flows is a risk-free rate adjusted for systematic and unsystematic risk.
Due to the inherent nature of related party transactions, we have not attempted to estimate the fair value of liabilities payable to related parties of the Company. As such, promissory notes payable with carrying values of $3,000,000 and $3,090,000, respectively, at December 31, 2012 and 2011, are excluded from the following table. The carrying amounts and estimated fair values of other financial instruments (all are liabilities) at December 30, 2012 and 2011, are as follows (in thousands):
Revenue under our contractual agreements to provide behavioral healthcare and pharmacy management services to subscribing members is earned regardless of services actually provided and, therefore, recognized monthly based on the number of qualified members. The information regarding qualified members is supplied by our clients subject to our periodic review of their member eligibility records and other reported information to verify its accuracy and determine the amount of revenue to be recognized. Similar to our other at-risk arrangements, pharmacy drug management revenue is recognized monthly based on a contracted rate per eligible member.
Costs of revenues consist of three major components: claims costs, pharmacy costs and healthcare operating expense. Claims costs are recognized in the period in which an eligible member actually receives services and includes an estimate for costs of behavioral health services that have been incurred but not yet reported.
We accrue an estimate of incurred legal defense costs to be incurred in connection with pending disputes and litigation matters as part of our estimated minimum probable losses (see Note 7c).
We are subject to the income tax jurisdictions of the U.S., Puerto Rico and multiple state tax jurisdictions. However, our provisions for income taxes for 2012 and 2011 include only state income taxes (see Note 9).
We grant stock options and warrants (see Note 8) to our employees, non-employee directors, note holders and certain consultants and clients allowing them to purchase our common stock pursuant to approved terms. The estimated value of the warrants issued with debt instruments is recorded as a discount on notes payable and amortized as interest expense over the term of the notes using the effective interest method.
Intangible assets at December 31, 2011, were composed of costs of customer contracts, a provider network, and accreditation. We used a straight-line method to amortize these assets over their estimated lives, which approximated three years and ended in 2012. Annual amortization for 2012 and 2011 was $28,000 and $507,000. See also Note 11.
(1) This note came due and was renewed for an additional one-year term in May 2012. As consideration for the renewal of the note, warrants to purchase 25,000 shares of our common stock at $0.15 per share were issued. The warrants were vested upon issuance and have a three-year term.
(2) During 2012, each of these two notes came due and was renewed for additional one-year terms. For the renewal of one note, we issued a three-year warrant for the purchase of 25,000 shares of our common stock at an exercise price of $0.25.
(4) This note was repaid in full in June and July 2012.
(6) During 2010 and 2011 we issued 10% senior promissory notes maturing April 15, 2012, in exchange for certain of our the outstanding subordinated debentures that had previously matured on April 15, 2010, but were not repaid. In April 2012, the promissory notes were extended to mature on April 15, 2013, and the interest rate was increased to 14% payable semiannually. In conjunction with these notes, we also issued warrants to purchase an aggregate of approximately 7.0 million shares of our common stock at an exercise price of $0.25 per share. All of the warrants have five-year terms and are currently exercisable.
(1) Represents our 7 1/2% convertible subordinated debentures that matured on April 15, 2010, and have not been repaid or exchanged for senior notes. The outstanding debentures are convertible into 12,198 shares of our common stock at $44.02 per share. Except for their classification among current liabilities, we are not able to estimate the financial effect resulting from the state of default with respect to these outstanding debentures (Note 7b).
(3) Represents a promissory note for the sum of two notes that were consolidated into one in August 2011 now payable in monthly installments of $10,000 of principal plus interest at 10%. At December 31, 2012, eight of the required principal payments had not been paid.
(4) In connection with these notes, we issued to the noteholders five-year warrants to purchase an aggregate of 900,000 shares of our common stock at $0.44 per share. The warrants were vested and exercisable at issuance. The notes are additionally convertible into our common stock at $0.25 per share. In March 2013, we repaid $400,000 of the notes and executed an agreement to extend the maturity of the remaining $1.4 million to January 31, 2014, reduce the conversion price to $0.125 per share, and decrease the warrant exercise price to $0.22 per share. We also agreed to assign certain receivables and a potential arbitration recovery to the creditor as a source of future repayment, but not in excess of $300,000.
(6) This is a 14% convertible promissory note issued in December 2011 with interest only payable in quarterly installments until June 2013 when all principal comes due. At any time during the term of the note, the holder may elect to convert the principal and unpaid interest to our common stock at $0.25 per share. In connection with this note, we also issued a five-year warrant to purchase 50,000 shares of our common stock at $0.44 per share. The warrant was vested at issuance.
(8) The note was issued in November 2011 to a major stockholder, is due in full in May 2013.
Future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more, consist of the following at December 31, 2012 (amounts in thousands):
In addition, based on recent experience, our business has been concentrated among a few major customer contracts, as was the case during 2012 and 2011 when our major Puerto Rico contract generated 81.5% or $56.1 million, and 67.9% or $48.4 million, respectively, of our revenues. Customer concentrations such as this present the risk of large fluctuations in business volume should the contract terminate, which occurred with the expiration of the aforementioned Puerto Rico contract in 2012.
(2) We and a former customer are being sued for damages of approximately $1.7 million for allegedly unpaid claims for behavioral health professional services rendered in, 2007 and 2008. We filed a counterclaim for breach of a settlement agreement that we believed resolved many of the claims that are the subject of the complaint, which we therefore, now believe is without merit and are vigorously opposing.
Management believes that the provision is adequate for the estimated probable minimum losses, including legal defense costs, to be incurred from these matters.
In accordance with the employment agreement between the Company and our Board Chairman and CEO, Clark Marcus, we are obligated to pay to Mr. Marcus a total of approximately $5.7 million in base salary over the next five years. In addition, we will pay on his behalf approximately a total of $68,000 in health insurance premiums and $603,000 in life insurance premiums, also over the next five years. This compensation may, at our election, be only accrued but not paid, in whole or in part, until such time as we receive financing and/or generate sufficient cash flows, after the payment of our operating expenses, with which to pay Mr. Marcus his agreed compensation.
We also have a class of convertible preferred stock, Series D, for which 7,000 shares are authorized and 250 shares were issued during the year ended December 31, 2012. The shares, which were granted in January 2012, do not vest until the tenth anniversary of the grant date. Such shares were issued in exchange for the cancelation of 120 previously granted warrants to purchase Series D shares. Once vested, a Series D preferred share will be convertible at any time into 100,000 shares of common stock, subject to adjustment in the event of any common stock dividend, split, combination thereof or other similar recapitalization, without additional consideration. Prior to vesting and thereafter, each Series D convertible preferred share is entitled to all voting, dividend, liquidation and other rights accorded a share of Series D convertible preferred stock. As to dividends, the Series D stock is noncumulative. If a dividend is declared on the common stock, each share of Series D stock is entitled to receive a dividend equal to 50% of the dividend declared for the common stock as if the Series D stock had been converted. Despite their nonvested status, voting rights of each share nevertheless consist of the right to cast the number of votes equal to those of 500,000 shares of common stock. Unless otherwise required by applicable law, holders of shares of Series D have the right to vote together with holders of common stock as a single class on all matters submitted to a vote of our stockholders. At December 31, 2012, approximately $3.4 million of compensation expense remained to be recognized over the next 9 years related to the Series D shares.
During 2012, we issued warrants to purchase an aggregate of 125,000 shares of our common stock to note holders. Shares acquirable pursuant to the warrants vest at the warrant grant date and/or at specified dates throughout the 24 or 36 month term of the warrants.
Due to the significant uncertainty of future realization (Note 9), we did not recognize the effect of approximately $624,000 of potential tax benefits attributable to equity-based expense recorded for warrants issued to key employees for 2011.
price for ISOs must equal or exceed the fair market value of the underlying shares on the date of grant. The Plans also provide for the full vesting of all outstanding options under certain change of control events. The maximum number of common shares authorized for issuance under the Plans is 52,000,000. As of December 31, 2012, there were a total of 44,448,000 shares available for grant and 6,518,000 options outstanding, 6,201,334 of which were exercisable, under the Plans.
The following table summarizes information about options granted and vested during the years ended December 31.
During 2012 and 2011, we granted options for common shares to employees, non-employee directors and one consultant. Total recognized compensation costs during 2012 and 2011 were approximately $235,000 and $1.2 million. As of December 31, 2012 and 2011, there was approximately $50,000 and $315,000 of unrecognized compensation cost related to options expected to be recognized over a weighted-average period of 11 and 19 months. Due to significant uncertainty of future realization (Note 9), we did not recognize the effect of approximately $41,000 and $404,000 of potential tax benefits attributable to stock-based compensation expense recorded during 2012 and 2011.
A summary of common stock options outstanding and exercisable as of December 31, 2012 follows:
Reconciliation between the income tax expense recorded in the financial statements and the amount computed by applying the statutory Federal income tax rate (34%) to loss before income tax is as follows (amounts in thousands):
We recognized interest expense of approximately $0.6 million and $0.7 million during 2012 and 2011, respectively, in connection with loans from major stockholders of the Company.