-- "Management's Discussion and Analysis of Financial Condition and Results of Operations").
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS - THE YEAR ENDED MAY 31, 2001 COMPARED TO THE YEAR ENDED MAY 31, 2000.
Healthcare operating expenses increased by approximately $0.3 million, or 1.9%, for the fiscal year ended May 31, 2001 as compared to the fiscal year ended May 31, 2000. This increase is directly attributable to the new business added during Fiscal 2001. Healthcare operating expense as a percentage of operating revenue decreased from 89.2% for the fiscal year ended May 31, 2000 to 84.9% for the fiscal year ended May 31, 2001. Efforts are being made to further increase revenues during Fiscal 2002 without adding significantly to our healthcare operating costs.
General and administrative expenses decreased by approximately $3.1 million, or 44.9%, for the fiscal year ended May 31, 2001 as compared to the fiscal year ended May 31, 2000. General and administrative expense as a percentage of revenue decreased from 39.4% for the fiscal year ended May 31, 2000 to 20.3% for the fiscal year ended May 31, 2001. This decrease is attributable to the significant cost reductions that were initiated following the loss of two major, managed care contracts in Fiscal 2000.
Management believes that the Company's current infrastructure is sufficient to support continued revenue growth during Fiscal 2002 without the need for any significant increase to staff or other operating costs.
The Company reported an operating loss of approximately $6.1 million from continuing operations for the fiscal year ended May 31, 2000, primarily attributable to the loss of two major, managed care contracts during the fourth quarter of Fiscal 1999. Additionally, this loss included approximately $0.9 million of restructuring expenses in connection with the elimination of the Company's California office and affiliated employees, approximately $0.6 million of increased marketing and other costs specific to the Company's efforts to regain business, approximately $0.1 million of operating costs incurred to manage the Company's Year 2000 readiness program, and approximately $0.1 million of costs in connection with the NCQA accreditation. These expenses were offset in part by $0.3 million of revenue related to favorable cost report settlements that took place during the year. This is compared to an operating loss of $3.2 million from continuing operations reported for the fiscal year ended May 31, 1999, which included approximately $0.9 million of bad debt expense specific to two major contracts that terminated during Fiscal 1999, $0.3 million of bad debt expense specific to hospital accounts receivable that were written off after the March 11, 1999 disposal date, and $0.2 million of bad debt expense specific to CCI contracts that terminated prior to May 31, 1999. Additionally, the Company incurred $0.8 million of expense in its unsuccessful bid for a managed care contract in Argentina and approximately $0.6 million of restructuring costs related to the loss of the PCA contract in Puerto Rico during Fiscal 1999.
Other operating expenses from continuing operations decreased by $2.3 million for the fiscal year ended May 31, 2000 compared to the fiscal year ended May 31, 1999. This decrease is primarily attributable to the $0.9 million of bad debt expense recognized during the fiscal year ended May 31, 1999 specific to the two major, managed care contracts that terminated during Fiscal 1999, $0.3 million of bad debt expense specific to hospital accounts receivable that were written off after the March 11, 1999 disposal date, and $0.2 million of bad debt expense specific to CCI contracts that were terminated prior to May 31, 1999. In contrast to the $1.6 million of bad debt expense recognized in Fiscal 1999, the Company recognized recoveries totaling $0.6 million during the fiscal year ended May 31, 2000. Additionally, expense for depreciation and amortization decreased by $0.2 million during Fiscal 2000 in comparison to the prior year. These gains were offset by a restructuring charge related to the elimination of the Company's California administrative office and related executive staff during Fiscal 2000. Such costs exceeded the prior year restructuring charge, which pertained to the loss of the Puerto Rico contract, by approximately $0.2 million.
At May 31, 2001, the Company had unrestricted cash and cash equivalents of $2.9 million. During the fiscal year ended May 31, 2001, the Company used $0.1 million in its continuing operations. Additionally, $0.5 million was provided by its investing activities. The Company reported a net loss of approximately $1.1 million for the fiscal year ended May 31, 2001, compared to a net loss of $5.8 million for the fiscal year ended May 31, 2000. The Company has an accumulated deficit of $63.6 million and total stockholders' deficit of $11.8 million as of May 31, 2001. Additionally, the Company's current assets at May 31, 2001 amounted to approximately $7.5 million and current liabilities were approximately $19.3 million, resulting in a working capital deficiency of approximately $11.8 million. The Company's primary use of available cash resources is to expand its managed care business and fund operations.
This Annual Report on Form 10-K contains certain forward-looking statements that are based on current expectations and involve a number of risks and uncertainties. Factors that may materially affect revenues, expenses and operating results include, without limitation, the Company's success in (i) expanding the managed behavioral healthcare operations, (ii) effective management in the delivery of services, (iii) risk and utilization in context of capitated payouts, and (iv) retaining certain refunds from the IRS (see Note 13 to the audited consolidated financial statements -- "Income Taxes").
The Company currently has ten contracts with three HMOs to provide behavioral healthcare services under commercial, Medicaid, and Medicare plans, to contracted members in Connecticut, Florida, and Texas. These combined contracts represent approximately 51.7% and 14.1% of the Company's operating revenue for the fiscal year ended May 31, 2001 and 2000, respectively. The terms of each contract are generally for one-year periods and are automatically renewable for additional one-year periods unless terminated by either party.
As of May 31, 2001, the Company had stockholders' deficit of $11.8 million and a working capital deficiency of approximately $11.8 million. The Company had a net loss for the fiscal year ended May 31, 2001 of approximately $1.1 million. There can be no assurance that the Company will be able to achieve and sustain profitability or that the Company can achieve and maintain positive cash flow on an ongoing basis. Present results of operations are not necessarily indicative of anticipated future results of operations.
The Company may be required to repay a portion of the tax refunds received from the Internal Revenue Service for Fiscal 1996 and 1995, which amounted to $9.4 million and $5.4 million, respectively (see "Taxes" below and Note 13 to the audited, consolidated financial statements - "Income Taxes"). Further, the Company may be required to repay some amount to Medi-Cal in connection with the judgment entered on February 26, 1999, which is more fully described under Item 1, Legal Proceedings, above.
Managed care operations are at risk for costs incurred to supply agreed upon levels of service. Failure to anticipate or control costs could have material, adverse effects on the Company. Additionally, the business of providing services on a full-risk capitation basis exposes the Company to the additional risk that contracts negotiated and entered into may ultimately be determined to be unprofitable if utilization levels require the Company to deliver and provide services at capitation rates which do not account for or factor in such utilization levels.
The levels of revenues and profitability of healthcare companies may be affected by the continuing efforts of governmental and third party payers to contain or reduce the costs of healthcare through various means. In the United States, there have been, and the Company expects that there will continue to be, a number of federal and state proposals to implement governmental controls on the price of healthcare. It is uncertain what legislative proposals will be adopted or what actions federal, state or private payers for healthcare goods and services may take in response to any healthcare reform proposals or legislation. The Company cannot predict the effect that healthcare reforms may have on its business and no assurance can be given that any such reforms will not have a material adverse effect on the Company.
The Company has issued or committed to issue 9,000 shares related to the 7 1/2% convertible subordinated debentures due April 15, 2010, and options or other rights to purchase approximately 1,103,000 shares. The Company may contemplate issuing additional amounts of debt, equity or convertible securities in public or private transactions for use in fulfilling its future capital needs (see "Need for Additional Funds; Uncertainty of Future Funding"). Issuance of additional equity could adversely affect the trading price of the Company's Common Stock.
We have audited the accompanying consolidated balance sheets of Comprehensive Care Corporation and subsidiaries as of May 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the three years in the period ended May 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comprehensive Care Corporation and subsidiaries as of May 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended May 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3, the Company's working capital deficiency and stockholders' deficit raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Notes 3 and 13. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
In cases where the Company retains the financial responsibility for authorizations, hospital utilization, and the cost of other behavioral healthcare services, the Company establishes an accrual for estimated claims payable.
Estimated future healthcare costs and expenses in excess of estimated future premiums are recorded as a loss when determinable. No such deficiencies existed at May 31, 2001 or May 31, 2000.
Cash in excess of daily requirements is invested in short-term investments with original maturities of three months or less. These investments aggregated $1.5 million and $1.8 million at May 31, 2001 and 2000, respectively. These investments are included in cash equivalents in the accompanying consolidated balance sheets.
Restricted accounts classified as current assets are required under capitated contracts, primarily the Puerto Rico contract that expired March 31, 1999 (see Note 17 -- "Commitments and Contingencies", Item 4). Non-current restricted accounts include $0.3 million of cash held in trust in connection with the Company's Directors and Officers liability insurance policy.
The accrued claims payable liability represents the estimated ultimate net amounts owed for all behavioral healthcare services provided through the respective balance sheet dates.
The Company calculates deferred taxes and related income tax expense using the liability method. This method determines deferred taxes by applying the current tax rate to net operating loss carryforwards and to the cumulative temporary differences between the recorded carrying amounts and the corresponding tax basis of assets and liabilities. A valuation allowance is established for deferred tax assets unless their realization is considered more likely than not. The Company's provision for income taxes is the sum of the change in the balance of deferred taxes between the beginning and the end of the period and income taxes currently payable or receivable.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, in the event that the exercise price of the Company's employee stock options is less than the market price of the underlying stock on the date of grant, compensation expense is recognized.
In Fiscal 2001 and 2000, the Company recognized deferred compensation totaling $1,000 and $18,000, respectively, in relation to options that were issued to non-employee consultants. Such amounts were based on the
In calculating basic earnings (loss) per share, net income (loss) is adjusted for dividends on preferred stock and is divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the assumed conversion of all dilutive securities, such as options and convertible preferred stock. No such exercise or conversion is assumed where the effect is antidilutive, such as when there is a loss from continuing operations.
The carrying amounts and fair values of the Company's financial instruments at May 31, 2001 and 2000, are as follows:
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets", which establishes new standards for the treatment of goodwill and other intangible assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001 and permits early adoption for companies with a fiscal year beginning after March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as of the adoption date. Additionally, the Company will be required to perform an impairment test as of the adoption date, annually thereafter, and whenever events and circumstances occur that might effect the carrying value of these assets. The Company has not yet determined whether it will elect early adoption or what effect, if any, the impairment test of goodwill will have on the Company's results of operations and financial position.
For the years ended May 31, 2001, 2000, and 1999, the Company incurred losses from continuing operations of approximately $1.1 million, $5.8 million, and $3.0 million, respectively. As of May 31, 2001, the Company had a working capital deficiency of approximately $11.8 million and a stockholders' deficit of approximately $11.8 million. In addition, for the years ended May 31, 2001, 2000, and 1999, continuing operations used cash of approximately $0.1 million, $5.3 million, and $1.4 million, respectively. The working capital deficiency referred to above results primarily from a $12.1 million liability related to Federal income tax refunds received in prior years. The ultimate outcome of the Internal Revenue Service audit whereby it is seeking recovery of the refunds from the Company, including the amount to be repaid, if any, and the timing thereof, is not determinable (see Note 13 -- "Income Taxes").
During Fiscal 2001 and 2000, management has taken steps to trim costs and save cash, including making significant staff reductions, centralizing certain contract management and clinical functions, and eliminating the Company's California administrative office and related executive staff positions. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required and, ultimately, to attain profitability.
(1) The Company had contracts with Humana Health Plans ("Humana") under which it provided services to members in Florida. Effective June 30, 2000, Humana completed the sale of its North Florida Medicaid business to HealthEase of Florida, Inc. Additionally, Humana's contracts with the Company, which cover specific commercial, Medicaid and Medicare populations of approximately 60,000 members in Florida terminated September 30, 2000. Fiscal 2001 operations include $0.7 million, or 3.7%, of operating revenue specific to the Humana contracts compared to $6.0 million, or 33.8%, and $6.8 million, or 17.4%, for the fiscal years ended May 31, 2000, and 1999, respectively.
Effective July 1, 2000, the Company entered into a contract with one HMO to continue to provide behavioral healthcare services to approximately 100,000 of 160,000 Florida members that were managed by the Company under contracts with Humana as of June 2000. The initial term of this contract is for one year and the contract provides for automatic annual extensions. The combined revenue from the contracts that were transitioned from Humana, plus one existing contract that the Company had with this HMO and one new contract that the Company has with an affiliate of this HMO, accounted for 24.1%, or $4.6 million, of the Company's operating revenues during the fiscal year ended May 31, 2001 compared to 2.3%, or $0.4 million, for the fiscal year ended May 31, 2000.
ended May 31, 2001, these five contracts represented approximately 18.7%, or $3.5 million, of the Company's operating revenue.
Recoveries are reflected on the Company's statement of operations as a reduction to the provision for doubtful accounts.
(a) May 31, 2001 amount includes a $0.3 million bad debt recovery and $0.1 million for an insurance settlement received in June 2001, which are more fully described in Note 18.
On August 31, 2000, the Company entered into a prepayment agreement and note modification with Jefferson Hills Corporation ("JHC") in connection with the secured promissory note, which originated out of the sale in Fiscal 1999 of the Company's Aurora, Colorado facility to JHC (see Note 14). The terms of the prepayment agreement required JHC to immediately remit $500,000 to the Company as a prepayment on the note. Additionally, the note was modified to reflect a remaining balance due totaling $170,000 and to require JHC to make monthly principal and interest payments until April 2006. One final principal payment in the amount of approximately $146,000 will be due from JHC in April 2006. As an inducement to JHC to make such prepayment, the Company credited JHC with an aggregate of approximately $996,000. As a result, the Company recorded a non-operating loss during the quarter ended August 31, 2000 of approximately $496,000 in connection with this transaction.
On July 24, 1998, the Company completed a debenture exchange offer with its debentureholders. An aggregate of $0.4 million of principal amount of Debentures, representing approximately 17% of the issued and outstanding Debentures, were tendered for exchange to the Company pursuant to the terms of the Exchange Offer and a total of 33,185 shares of Common Stock were issued by the Company. The resulting gain on the Debenture Exchange of $0.1 million after related costs and expenses was recorded as an extraordinary gain in the accompanying consolidated statement of operations for the year ended May 31, 1999. The debentures are convertible into approximately 9,000 shares of Common Stock at a conversion price of $248.12 per share.
After consideration of all the evidence, both positive and negative, management has determined that a valuation allowance at May 31, 2001 and 2000, was necessary to offset the deferred tax assets based on the likelihood of future realization.
The Company offers a 401(k) Plan (the "Plan"), which is a defined contribution plan qualified under Section 401(k) of the Internal Revenue Code, for the benefit of its eligible employees. All full-time and part-time employees who have attained the age of 21 and have completed six consecutive months of employment are eligible to participate in the Plan. Effective June 1, 1995, eligibility was modified to six months of employment and a minimum of twenty (20) regularly scheduled hours per week. Each participant may contribute from 2% to 15% of his or her compensation to the Plan subject to limitations on the highly compensated employees to ensure the Plan is non-discriminatory. Company contributions are discretionary and are determined by the Company's Board of Directors or the Planning Committee. The Company's employer matching contributions were $10,000, $17,000, and $22,000 to the Plan in Fiscal 2001, 2000, and 1999 respectively.
The Company is authorized to issue up to 60,000 shares of Preferred Stock, $50.00 par value, in one or more series, each series to have such designation and number of shares as the Board of Directors may fix prior to the issuance of any shares of such series. Each series may have such preferences and relative participation, optional or special rights with such qualifications, limitations or restrictions stated in the resolution or resolutions providing for the issuance of such series as may be adopted from time to time by the Board of Directors prior to the issuance of any such series.
On November 17, 1998, the Company's Board of Directors approved the re-pricing of stock option grants to employees below the level of Executive Officers, subject to each employee returning his or her old options for cancellation. The cancelled options were replaced by an equivalent number of new options at an exercise price equal to the November 30, 1998 closing price of $3.5625.
The Company has a non-qualified stock option plan for its outside directors (the "Directors' Plan"). Each non-qualified stock option is exercisable at a price equal to the Common Stock's fair market value as of the date of grant. Initial grants vest annually in 25% increments beginning on the first anniversary of the date of grant, provided the individual is still a director on those dates. Annual grants will become 100% vested as of the first annual meeting of the Company's stockholders following the date of grant, provided the individual is still a director as of that date. An optionee who ceases to be a director shall forfeit that portion of the option attributable to such vesting dates on or after the date he or she ceases to be a director. The maximum number of shares authorized for issuance under the Directors' Plan is 250,000. As of May 31, 2001, there were 185,834 options available for grant under the Directors' Plan. The Company had no outside directors and there were no options outstanding to former directors as of May 31, 2001.
(a) Includes 120,000 options exercisable at $6.6875 per share held by former Chief Executive Officer that were cancelled in connection with his separation from the Company in January 2000.
A summary of options outstanding and exercisable as of May 31, 2001 follows:
Adjusted pro forma information regarding net income or loss and earnings or loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The weighted average fair values of options granted were $0.14, $0.41, and $4.91 in Fiscal 2001, 2000, and 1999, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
The Company's pro forma information is as follows (in thousands except for loss per share information):
The Company leases certain facilities and equipment. The facility leases contain escalation clauses based on the Consumer Price Index and provisions for payment of real estate taxes, insurance, and maintenance and repair expenses. Total rental expense for all operating leases applicable to continuing operations was $0.7 million, $0.8 million, and $1.3 million for fiscal years 2001, 2000, and 1999, respectively. During Fiscal 2000 and Fiscal 1999, the Company received rental income of $84,000 and $106,000, respectively, in connection with the sublease of a portion of its California facilities (which were closed in Fiscal 2000) to entities operated by the Company's former Chief Executive Officer ("CEO"). The Company has no future obligation under the California lease, having completed a transfer of this lease in Fiscal 2000 to an entity managed by the Company's former CEO.
On February 2, 2001, the Company entered into a lease agreement for premises to serve as the principal business and executive offices for the Company and CBC, its principal operating subsidiary. CBC is the principal lessee under the lease, and the Company is the guarantor of the lease. The lease, which began on March 22, 2001, is for a term of 5 years and 2 months and provides for a base rent of approximately $22,000 per month for the first 12 months of the lease term, with intervening escalations during each successive 12 month period under the lease term, with a final monthly rental of approximately $25,000. In connection with this lease, the Company posted a lease security deposit in February 2001, in the amount of $65,000.
During the year ended May 31, 2001, the Company lowered its estimate by approximately $0.3 million specific to interest charges that were previously accrued in connection with this liability. This change in estimate was based on information provided to the Company by the California Department of Health Services. As of May 31, 2001, the Company has approximately $1.0 million accrued relating to this matter.
On March 29, 2001, the Company submitted an offer to the State of California to resolve this liability at a substantially reduced amount. On April 23, 2001, the Company received a letter, dated April 11, 2001,
from the State of California advising the company that its proposed settlement offer was not accepted and, additionally, requesting payment of approximately $0.8 million. The Company is contemplating a second settlement offer. There can be no assurance that the State of California will give consideration to such offer or agree to alternate terms.
(5) The Company would remain liable to perform the services covered under subcapitation agreements if the parties with which the Company subcapitates were unable to fulfill their responsibilities under such agreements.
The Company is subject to extensive and evolving state and federal regulations, including licensure and compliance with regulations related to healthcare providers, insurance companies, and other risk assuming entities. These laws and regulations may vary considerably among states and, as a result, the Company may be subject to the specific regulatory approach adopted by each state for the regulation of managed care companies and for providers of behavioral healthcare treatment services. Currently, management cannot quantify the potential effects of additional regulation of the managed care industry, but such costs could have an adverse effect on future operations to the extent that they are not able to be recouped in future managed care contracts.
The Company is subject to the requirements of the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). The purpose of the HIPAA provisions is to improve the efficiency and effectiveness of the healthcare system through standardization of the electronic data interchange of certain administrative and financial transactions and, also, to protect the security and privacy of transmitted information. Entities subject to HIPAA include all healthcare providers and all healthcare plans. To meet the specific requirements of HIPAA, the Company will incur costs to insure the adequacy and security of its healthcare information system and communication networks. Additionally, the Company may incur costs to implement the specific transaction codes required by HIPAA for claims, payment, enrollment, eligibility, or to become compliant with security and privacy rules, which may be more stringent for providers of certain behavioral healthcare services. The expected timetable to be compliant is currently October 2002 for transaction code changes and April 2003 for compliance with the privacy rules. The Company is currently evaluating its systems and policies that are impacted by HIPAA. While these efforts will be ongoing, the Company expects to meet all compliance rules and timetables with respect to the HIPAA regulations. Failure to do so may result in penalties and have a material adverse effect on the Company's ability to retain its customers or to gain new business.
(a) Reflects a $0.6 million reclassification between Healthcare Operating and General and Administrative Expenses to conform to the 2001 presentation. This reclassification had no effect on the previously reported results of operations or stockholders' deficit. (b) Includes $0.1 million of costs in connection with the NCQA accreditation. (c) Includes $0.9 million of restructuring expenses in connection with the elimination of the Company's California office and affiliated employees and approximately $0.1 million of non-operating gains. (d) Includes $0.3 million of revenue related to favorable cost report settlements completed during the year and $0.1 million of non-operating gains, primarily related to property tax refunds received specific to assets disposed of during Fiscal 1999 or earlier.