We do not own any real property. The following table sets forth certain information regarding our leased properties as of May 31, 2003. All leases are triple net leases, under which CompCare bears all costs of operations, including insurance, taxes, and utilities.
Our Fiscal 2003 results include a $7.7 million, non-operating gain related to the IRS settlement (see Note 13 - “Income Taxes” to the audited, consolidated financial statements). Additionally, results included a $470,000 non-operating gain related to the Medi-Cal settlement (see Note 16 - “Commitments and Contingencies” to the audited, consolidated financial statements), $88,000 of revenue related to a favorable settlement of one hospital cost report and the elimination of a $75,000 reserve for another cost report, both pertaining to the Company’s hospital business segment that was discontinued in Fiscal 1999. As a result, CompCare reported net income of $7.5 million, or $1.91 earnings per share ($1.72 diluted earnings per share) and an operating loss of $608,000, for the year ended May 31, 2003 compared to the net loss of $770,000, or $0.20 loss per share (basic and diluted), and an operating loss of $774,000, for the fiscal year ended May 31, 2002. Excluding the $8.2 million of non-operating gains from net income would have resulted in a $729,000 net loss ($0.19 loss per basic and diluted share) for the fiscal year ended May 31, 2003.
No tax provision for federal income taxes was recorded during the fiscal year ended May 31, 2003, as the $7.7 million non-operating gain specific to the IRS settlement is non-taxable. Additionally, management has determined that a valuation allowance at May 31, 2003 and 2002, was necessary to fully offset any deferred tax assets based on the likelihood of future realization.
We reported a net loss of $770,000 and an operating loss of $774,000 for the fiscal year ended May 31, 2002 compared to the operating loss of $1.2 million for the fiscal year ended May 31, 2001. Operating revenues increased by 51.9%, or $9.4 million, to $27.6 million for the fiscal year ended May 31, 2002 compared to $18.2 million for the fiscal year ended May 31, 2001. This increase was attributable to two major contracts implemented during Fiscal 2001 and membership growth from state sponsored children’s health insurance programs.
General and administrative expenses decreased by approximately $0.3 million, or 7.8%, for the fiscal year ended May 31, 2002 as compared to the fiscal year ended May 31, 2001. This decrease was attributable to our continuing efforts to reduce general and administrative costs. General and administrative expense as a percentage of operating revenue decreased from 21.1% for the fiscal year ended May 31, 2001 to 12.8% for the fiscal year ended May 31, 2002.
Our unpaid claims liability is estimated using an actuarial paid completion factor methodology and other statistical analyses. These estimates are subject to the effects of trends in utilization and other factors. Any significant increase in member utilization that falls outside of our estimations would increase healthcare operating expenses and may impact our ability to achieve profitability and positive cash flow. Although considerable variability is inherent in such estimates, we believe that the unpaid claims liability is adequate. However, actual results could differ from the $4.1 million claims payable amount reported as of May 31, 2003.
During Fiscal 2003, net cash used in operations amounted to $1.7 million, which approximates the net amount paid by the Company to complete its settlement with the Internal Revenue Service. Having concluded this settlement, the Company recorded a non-operating gain of $7.7 million during the fiscal year ended May 31, 2003, significantly reducing its working capital deficiency and stockholder’s deficit, which amount to $4.4 million and $5.0 million, respectively, as of May 31, 2003. Our capital needs during Fiscal 2004 will include a portion of the $0.4 million required to implement a new, customized management information system that will enable us to meet HIPAA requirements, streamline our entire clinical and claims functions, and offer service improvements to our participating providers (see “Management Information Systems” above). We are currently pursuing sources of financing on terms that would support our future capital needs and provide available funds for working capital in Fiscal 2004. We cannot state with any degree of certainty whether any required additional equity or debt financing will be available to us during Fiscal 2004 and, if available, that the source of financing would be available on terms and conditions acceptable to us. These conditions raise substantial doubt about the Company’s ability to continue as a going concern, which is dependent upon our ability to continue to generate sufficient cash flow to meet our obligations on a timely basis, obtaining additional financing as may be required and, ultimately, attaining an operating profit.
deferred credits related to an excess of fair value of acquired assets over cost from a business combination for which the acquisition date was before July 1, 2001 immediately upon adoption of SFAS 142. As of June 1, 2001, the Company had an unamortized deferred credit of $55,000 that related to an acquisition in 1996. As a result, the Company recognized $55,000 as the cumulative effect of a change in accounting principle during the quarter ended August 31, 2001.
Prior to the adoption of SFAS 142, we amortized goodwill on a straight-line basis over estimated lives up to 20 years. Had we accounted for goodwill consistent with the provisions of SFAS 142 in prior years, the Company’s net loss would have been affected as follows (in thousands, except per share amounts):
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, our success in (i) expanding the managed behavioral healthcare operations, (ii) effective management in the delivery of services, and (iii) risk and utilization in context of capitated payouts.
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 CompCare to the additional risk that contracts negotiated and entered into may ultimately be determined to be unprofitable if utilization levels require us to deliver and provide services at capitation rates which do not account for or factor in such utilization levels.
We typically contract with small to medium sized HMO’s who may be adversely affected by the continuing efforts of governmental and third party payers to contain or reduce the costs of healthcare through various means. Our clients may fall under state supervision or otherwise be subject to state discipline placing them at risk of losing membership to their competitors in which case we may be unable to contract with any succeeding HMOs. They may also determine to manage the behavioral healthcare benefits “in house” and, as a result, discontinue contracting with the Company. Additionally, our clients may be acquired by larger HMO’s, in which case there can be no assurance that the acquiring company would renew our contract.
As of May 31, 2003, we managed approximately 627,000 lives in connection with behavioral and substance abuse services covered through Medicaid in Connecticut, Florida, Michigan and Texas. The aggregate number of Medicaid lives was reduced by approximately 166,000 effective January 1, 2003 due to the termination of the contracts described under Note 4(1) - “Major Contracts/Customers” to the audited, consolidated financial statements. Any changes in Medicaid reimbursement could ultimately affect the Company through contract bidding and cost structures with the health plans first impacted by such changes. The State of Texas has passed legislation that will reduce the amount of funds allocated to our clients to cover behavioral healthcare services to Medicaid and Children’s Health Insurance Program (“CHIP”) recipients in the State of Texas. Such legislation is subject to pending bills that, if passed, could restore some of the benefits to these programs. Under the recently passed legislation, the outpatient behavioral healthcare benefits available to adult Medicaid and CHIP recipients will be provided by the HMOs and their subcontractors, including the Company, on a very limited basis while the inpatient benefits for CHIP recipients may not be covered by the HMOs and their subcontractors. For the fiscal year ended May 31, 2003, we had operating revenue of $3.7 million and $4.5 million, respectively, specific to contracts covering Texas CHIP and Texas Medicaid recipients. These changes to Texas Medicaid and CHIP programs could have a material, adverse impact on our operations. However, we believe certain of our clients will continue to require the types of services we provide to mitigate their exposure to treat serious medical conditions that may result from the lack of adequate behavioral healthcare benefits. We are closely monitoring developments in Texas, but currently cannot predict what financial impact, if any, these changes may have on our business. Additionally, we cannot predict whether other states in which we operate may pass legislation that would reduce our revenue through changes in the reimbursement rates or in the number of eligible participants. In either case, we may be unable to reduce our costs to a level that would allow us to maintain current gross margins specific to our Medicaid and CHIPS programs.
CompCare is subject to extensive and evolving state and federal regulations relating to the nation’s mental health system as well as changes in Medicaid and Medicare reimbursement that could have an effect on the profitability of our contracts. These regulations range from licensure and compliance with regulations related to insurance companies and other risk-assuming entities, to licensure and compliance with regulations related to healthcare providers. These laws and regulations may vary considerably among states. As a result, CompCare may be subject to the specific regulatory approach adopted by each state for regulation of managed care companies and for providers of behavioral healthcare treatment services.
CompCare holds licenses or certificates to perform utilization review and third party administrator (“TPA”) services in certain states. Certain of the services provided by our managed behavioral healthcare subsidiaries may be subject to such licensing requirements in other states. There can be no assurance that additional utilization review or TPA licenses will not be required or, if required, that CompCare will qualify to obtain such licenses. In many states, entities that assume risk under contract with licensed insurance companies or health plans have not been considered by state regulators to be conducting an insurance or HMO business. As a result, we have not sought licensure as either an insurer or HMO in any state. If the regulatory positions of these states were to change, our business could be materially affected until such time as we are able to meet the regulatory requirements. Currently, we cannot quantify the potential effects of additional regulation of the managed care industry, but such costs will have an adverse effect on future operations to the extent that they are not able to be recouped in future managed care contracts.
CompCare 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 protected health information. Entities subject to HIPAA include some healthcare providers and all healthcare plans. To meet the specific requirements of HIPAA, we will incur costs to insure the adequacy and security of our healthcare information system and communication networks. Additionally, we will incur costs to implement a new clinical information system that will process 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 (see “Management Information Systems” above). The expected timetable for us to be compliant is currently October 2003 for transaction code changes due to our October 2002 filing of a formal compliance plan. The Company has met the deadline for compliance with the privacy rules, which was April 14, 2003. Additionally, we have filed our Electronic Health Care Transactions and Code Sets Standards Model Compliance Plan with the Centers for Medicare and Medicaid Services. While these efforts will be ongoing, we expect 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.
Assumptions relating to the foregoing involve judgments that are difficult to predict accurately and are subject to many factors that can materially affect results. Budgeting and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our budgets which may in turn affect the Company’s results. In light of the factors that can materially affect the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that our objectives or plans will be achieved.
The Company’s managed care activities are performed under the terms of agreements with health maintenance organizations (“HMOs”), preferred provider organizations (“PPOs”), and other health plans or payers to provide contracted behavioral healthcare services to subscribing participants. Revenue under a substantial portion of these agreements is earned monthly based on the number of qualified participants regardless of services actually provided (generally referred to as capitation arrangements). The information regarding qualified participants is supplied by the Company’s clients and the Company relies extensively on the accuracy of the client remittance and other reported information to determine the amount of revenue to be recognized. Such agreements accounted for 87.4%, or $28.2 million, of revenue for the fiscal year ended May 31, 2003, 84.7%, or $23.4 million, of revenue for the fiscal year ended May 31, 2002, and 79.2%, or $14.4 million, of revenue for the fiscal year ended May 31, 2001. The balance of the Company’s revenues is earned on a fee-for-service basis and is recognized as services are rendered.
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, 2003 or May 31, 2002.
The weighted average fair values of options granted were $0.72, $0.40, and $0.14 in Fiscal 2003, 2002, and 2001, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.
In calculating basic earnings (loss) per share, net income (loss) is divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the assumed exercise or conversion of all dilutive securities, such as options, warrants, and convertible debentures. No such exercise or conversion is assumed where the effect is antidilutive, such as when there is a net loss. The following table sets forth the computation of basic and diluted earnings (loss) per share in accordance with Statement No. 128, Earnings Per Share (amounts in thousands, except per share data):
The accompanying consolidated financial statements are prepared on a going concern basis. During the quarter ended February 28, 2003, the Company completed a settlement with the Internal Revenue Service (“IRS”) and reached an agreement with its former tax advisor with respect to the related tax advisor fees (see Note 13 - “Income Taxes”). Having concluded these settlements, the Company recorded a non-operating gain of $7.7 million during the quarter ended February 28, 2003, significantly reducing its working capital deficiency and stockholders’ deficit, which amount to $4.4 million and $5.0 million, respectively, as of May 31, 2003. The IRS settlement required the Company to make a cash payment in February 2003 of approximately $2.2 million, which was offset in part by $525,000 collected from its former tax advisor. As a result, net cash used in operations during the year ended May 31, 2003 amounted to $1.7 million, which approximates the decrease in cash and cash equivalents during such fiscal year.
During the fiscal year ended May 31, 2003, the Company had three contracts with one HMO to provide behavioral healthcare services to Florida members. The combined revenue from these contracts accounted for 11.7%, or $3.8 million, of the Company’s operating revenues during the fiscal year ended May 31, 2003 compared to 17.0%, or $4.7 million, for the fiscal year ended May 31, 2002 and 17.6%, or $3.2 million, for the fiscal year ended May 31, 2001. This HMO has been our customer since November 1998. On September 24, 2002, the Company received a written, 90-day termination notice, dated September 20, 2002, from this client. As such, these contracts covering Florida members terminated effective January 1, 2003. Additionally, the Company has one major contract with an affiliate of this HMO (see Item 2 below).
The Company has contracts with one HMO to provide behavioral healthcare services to contracted commercial, Medicaid, and Children’s Health Insurance Program members in Texas. This business accounted for approximately 7.5%, or $2.4 million, 7.3%, or $2.0 million, and 3.7%, or $0.7 million, of the Company’s operating revenues during the fiscal years ended May 31, 2003, 2002 and 2001, respectively. This HMO has been a customer of the Company since November 1998. The original contract term was for one year and the contract provides for automatic one-year renewal terms. During Fiscal 2003, this HMO customer added Medicaid members that had been covered by another of the Company’s HMO customers that had been placed under conservatorship by the State of Texas. The combined contracts of both HMO customers, including the business transferred to the Company’s current Texas client during Fiscal 2003, represented approximately 11.9%, or $3.9 million, 12.2%, or $3.4 million, and 9.1%, or $1.7 million, of the Company’s operating revenues during the fiscal years ended May 31, 2003, 2002 and 2001, respectively.
* Excludes $24,000 in 2003, $109,000 in 2002, and $448,000 in 2001 of recoveries from accounts previously written off.
Other receivable at May 31, 2002 represented $2.5 million advanced to the Company’s former tax advisor to prepare a federal income tax refund claim that is more fully described in Note 13 - “Income Taxes.” During the quarter ended February 28, 2003, the Company completed a settlement with the IRS and reached an agreement with its former tax advisor requiring the tax advisor to repay $525,000 to the Company, which was received in February 2003. As a result of the resolution to the IRS matter, the Company extinguished the tax liability and recorded a non-operating gain of approximately $7.7 million net of related expenses, including approximately $2.0 million of unrecovered fees paid to its former tax advisor.
As a result of the adoption of SFAS 142, effective June 1, 2001, no amortization expense was recorded during the fiscal years ended May 31, 2003 or 2002 compared to approximately $72,000 of amortization expense recorded during the fiscal year ended May 31, 2001. SFAS 141 requires the elimination of any unamortized deferred credits related to an excess of fair value of acquired assets over cost from a business combination for which the acquisition date was before July 1, 2001 immediately upon adoption of SFAS 142. As of June 1, 2001, the Company had an unamortized deferred credit of $55,000 that related to an acquisition in 1996. As a result, the Company recognized $55,000 as the cumulative effect of a change in accounting principle during the quarter ended August 31, 2001.
Prior to the adoption of SFAS 142, the Company amortized goodwill on a straight-line basis over estimated lives up to 20 years. Had the Company accounted for goodwill consistent with the provisions of SFAS 142 in prior years, the Company’s net loss would have been affected as follows (in thousands, except per share amounts):
As a result of the resolution of this matter, the Company extinguished the $12.1 million liability and recorded a non-operating gain in the quarter ended February 28, 2003 of approximately $7.7 million net of related expenses, including $2.0 million representing the unrecovered portion of the $2.5 million of fees previously paid to its tax advisor. The gain represented earnings per share of $1.97 (diluted earnings per share of $1.77). No taxable income resulted from the settlement of the liability.
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 one thousand hours of service are eligible to participate in the Plan. During Fiscal 2003, the Plan was modified to comply with recent Internal Revenue Service (“IRS”) guidelines. Each participant may contribute from 2% to 50% 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 management. The Company’s employer matching contributions were approximately $9,000, $9,000, and $10,000 to the Plan in Fiscal 2003, 2002, and 2001, respectively.
The Company currently has two active incentive plans, the 1995 Incentive Plan and the 2002 Incentive Plan (“Plans”), that provide for the granting of stock options, stock appreciation rights, limited stock appreciation rights, and restricted stock grants to eligible employees and consultants to the Company. Grants issued under the Plans may qualify as Incentive Stock Options (“ISOs”) under Section 422A of the Internal Revenue Code. Options for ISOs may be granted for terms of up to ten years and are generally exercisable in cumulative increments of 50% each six months. Options for Non-statutory Stock Options (“NSOs”) may be granted for terms of up to 13 years. The exercise price for ISOs must equal or exceed the fair market value of the shares on the date of grant, and 65% in the case of other options. The Plans also provide for the full vesting of all outstanding options under certain change of control events. The maximum number of shares authorized for issuance is 500,000 under the 2002 Incentive Plan and 1,000,000 under the 1995 Incentive Plan. As of May 31, 2003, there were 315,500 options available for grant and there were 184,500 options outstanding, of which 49,750 options were exercisable, under the 2002 Incentive Plan. Additionally, as of May 31, 2003, there were 400 options available for grant and there were 867,225 options outstanding, of which 864,225 options were exercisable, under the 1995 Incentive Plan.
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 protected health information. Entities subject to HIPAA include some healthcare providers and all healthcare plans. To meet the specific requirements of HIPAA, the Company recently determined it would need to make a significant investment in its current information system or in a new information system that would better meet the future needs of the Company. As a result, the Company has entered into a Letter of Intent with Qualifacts Systems, Inc. (“Qualifacts) to design a new, customized management information system that will enable the Company to meet HIPAA requirements. The Company expects to incur approximately $0.4 million of costs to customize the Qualifacts system and activate the licenses needed for Qualifacts and other, related third-party software.
In July 2002, the Company entered into a Repayment Agreement with the Department to resolve this liability, recorded at $950,000 at May 31, 2002, at a substantially reduced amount. The terms of the Repayment Agreement required the Company to either 1) pay one lump sum of $450,000 to the Department on or before September 1, 2002 or 2) beginning September 1, 2002, the Company would be required to make three monthly installment payments of $160,000 each, with the last payment being due on or before November 1, 2002, for a total of $480,000 as full and complete satisfaction of the outstanding liability. As of November 30, 2002, after making three installment payments to the Department of $160,000 each, the Company had fully satisfied its obligations under the terms of the settlement agreement. As a result, the Company recorded a non-operating gain of $470,000 on settlement of the liability during the quarter ended November 30, 2002.
From time to time, the Company and its subsidiaries are also parties and their property is subject to ordinary, routine litigation incidental to their business, in which case claims may exceed insurance policy limits and the Company or any one of its subsidiaries may have exposure to a liability that is not covered by insurance. Management is not aware of any such lawsuits that could have a material adverse impact on the Company’s financial statements.
Includes the $7.7 million gain in settlement of the IRS matter (see Note 13 - “Income Taxes”).