The following table sets forth our operating income (loss) for the seven months ended December 31, 2006 and 2005 and the fiscal years ended May 31, 2006, 2005 and 2004:
The decrease in capitated contract revenue is primarily attributable to the termination of our Connecticut contract, the loss of which accounted for $3.4 million less revenue for the seven months ended December 31, 2006 versus 2005 and the termination of a Texas contract, the loss of which accounted for $3.2 million less revenue for the same periods. This was partially offset by additional business from existing clients in Pennsylvania, Texas, Michigan and Maryland. The decrease in non-capitated revenue is primarily attributable to the loss of a management services only customer in Michigan offset by additional business in Texas and Florida and a new client in Connecticut.
RESULTS OF OPERATIONS -YEAR ENDED MAY 31, 2006 AS COMPARED TO THE YEAR ENDED MAY 31, 2005.
Capitated contract revenues increased 4.5% or approximately $1.0 million to $23.0 million for the year ended May 31, 2006 compared to $22.0 million for the year ended May 31, 2005. This increase in revenue is primarily attributable to additional business from existing clients in Indiana and new customers in Pennsylvania and Maryland, but was partially offset by the termination of our Connecticut contract, the loss of which accounted for $1.9 million less revenue in fiscal 2006 than in fiscal 2005. Non-capitated revenue declined 62.2%, or $1.5 million, to $0.9 million for the fiscal year ended May 31, 2006, compared to $2.4 million for the fiscal year ended May 31, 2005. The decrease is primarily attributable to the loss of two management services only customers in Michigan and an ASO client in Texas.
RESULTS OF OPERATIONS -YEAR ENDED MAY 31, 2005 AS COMPARED TO THE YEAR ENDED MAY 31, 2004.
Historically, we have experienced increased member utilization during the months of March, April and May, and consistently low utilization by members during the months of June, July, and August. Such variations in member utilization impact our costs of care during these months, generally having a positive impact on our gross margins and operating profits during the June through August period and a negative impact on our gross margins and operating profits during the months of March through May. During the period September 2006 through December 2006, we experienced higher than expected member utilization costs as compared to the similar period of the previous year. We have attempted to address the high utilization costs incurred through rate increases with certain of our clients. We may continue to experience increased utilization costs in subsequent periods.
During the seven months ended December 31, 2006, our cash and cash equivalents increased by $80,000. Net cash used by continuing operations amounted to $539,000. Cash used in investing activities totaled $113,000, which is comprised primarily of $160,000 in additions to property and equipment offset by $35,000 in proceeds from a property insurance claim. Cash provided by financing activities consists primarily of $785,000 in net proceeds from the exercise of a Put Option to Woodcliff in exchange for 1,739,130 shares of our common stock in October of 2006. At December 31, 2006, cash and cash equivalents amounted to $5.5 million. We believe we have sufficient working capital to sustain current operations and meet our current obligations during the next twelve months.
The following is a schedule at December 31, 2006 of our long-term contractual commitments, future minimum lease payments under non-cancelable operating lease arrangements, and other long-term obligations:
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make significant estimates and judgments to develop the amounts reflected and disclosed in the consolidated financial statements, most notably our estimate for claims incurred but not yet reported (“IBNR”). On an on-going basis, we evaluate the appropriateness of our estimates and we maintain a thorough process to review the application of our accounting policies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
The following table provides a reconciliation of the beginning and ending balance of accrued claims payable for the seven months ended December 31, 2006 and fiscal years ended May 31, 2006, and 2005:
Changes in prior year claims expense were primarily due to changes in utilization patterns and changes in claim submission timeframes by providers. Management considers these changes in claims expenses to be immaterial when compared to the total claims expenses incurred in prior years
Many aspects of our business are not predictable with consistency, and therefore, estimating IBNR claims involves a significant amount of management judgment. Actual claims incurred could differ from the estimated accrued claims payable amount presented. The following are factors that would have an impact on our future operations and financial condition:
On a quarterly basis, we perform a review of our portfolio of contracts for the purpose of identifying loss contracts (as defined in the American Institute of Certified Public Accountants Audit and Accounting Guide - Health Care Organizations) and developing a contract loss reserve, if applicable, for succeeding periods. During the seven months ended December 31, 2006, we identified one contract that was not meeting its financial goals and in May 2007, entered into an agreement to obtain a rate increase of approximately 20% from the client. At December 31, 2006, we believe no contract loss reserve for future periods is necessary for this contract. Annual revenues from the contract are approximately $1.2 million.
We issue stock-based awards to our employees and members of our board of directors. Effective June 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment” and elected to apply the modified-prospective method to measure compensation cost for stock options at fair value on the grant date and recognize compensation cost on a straight-line basis over the service period for those options expected to vest. We use the Black-Scholes option pricing model, which requires certain variables for input to calculate the fair value of a stock award on the grant date. These variables include the expected volatility of our stock price, award exercise behaviors, the risk free interest rate, and expected dividends. We use significant judgment in estimating expected volatility of the stock, exercise behavior and forfeiture rates.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides that companies may elect to measure many financial instruments and certain other items at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period. The election, called the “fair value option,” will enable some companies to reduce the variability in reported earnings caused by measuring related assets and liabilities differently. SFAS 159 is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2007. We are in the process of evaluating the impact adoption of SFAS 159 will have on our consolidated financial statements.
CAUTIONARY STATEMENT FOR THE PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: Certain information included in this transition report on Form 10-K and in our other reports, Securities and Exchange Commission (SEC) filings, statements, and presentations is forward looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements concerning our anticipated operating results, financial resources,
increases in revenues, increased profitability, interest expense, growth and expansion, and the ability to obtain new behavioral healthcare contracts. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed herein and in our other reports, SEC filings, statements, and presentations. These risks and uncertainties include, but are not limited to, changes in local, regional, and national economic and political conditions, the effect of governmental regulation, competitive market conditions, varying trends in member utilization, our ability to manage healthcare operating expenses, the profitability of our capitated contracts, cost of care, seasonality, the risk that any definitive agreements or additional business will result from letters of intent entered into by us, and other risks detailed from time to time in our SEC reports.
Consolidated Balance Sheets, December 31, 2006 and May 31, 2006 and 2005
Consolidated Statements of Operations, Seven Months Ended December 31, 2006 and 2005, and Years Ended May 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows, Seven Months Ended December 31, 2006 and 2005, and Years Ended May 31, 2006, 2005, and 2004
We have audited the accompanying consolidated balance sheets of Comprehensive Care Corporation and Subsidiaries as of December 31, 2006, May 31, 2006, and May 31, 2005, and the related consolidated statements of operations, stockholders’ deficit and cash flows for the seven months ended December 31, 2006, and the years ended May 31, 2006, 2005 and 2004. 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.
The consolidated financial statements include the accounts of Comprehensive Care Corporation and its wholly owned subsidiaries. Significant inter-company accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current period presentation.
Healthcare operating expense is recognized in the period in which an eligible member actually receives services and includes an estimate of the cost of behavioral health services that have been incurred but not yet reported. See “Accrued Claims Payable” for a discussion of claims incurred but not yet reported. The Company contracts 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. The Company determines that a member has received services when the Company receives a claim within the contracted timeframe with all required billing elements correctly completed by the service provider. The Company then determines that the member is eligible to receive such services, the service provided is
The Company accrues losses under its capitated contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company performs this loss accrual analysis on a specific contract basis taking into consideration such factors as future contractual revenue, projected 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 projected future healthcare and maintenance costs are estimated based on historical trends and the Company’s estimate of future cost increases.
At any time prior to the end of a contract or contract renewal, if a capitated contract is not meeting its financial goals, the Company generally has the ability to cancel the contract with 60 to 90 days’ written notice. Prior to cancellation, the Company will usually submit a request for a rate increase accompanied by supporting utilization data. Although the Company’s clients have historically been generally receptive to such requests, no assurance can be given that such requests will be fulfilled in the future in the Company’s favor. If a rate increase is not granted, the Company has the ability, in most cases, to terminate the contract and limit its risk to a short-term period.
On a quarterly basis, the Company performs a review of its portfolio of contracts for the purpose of identifying loss contracts (as defined in the American Institute of Certified Public Accountants Audit and Accounting Guide - Health Care Organizations) and developing a contract loss reserve, if applicable, for succeeding periods. During the seven months ended December 31, 2006, we identified one contract that was not meeting its financial goals and in May 2007, entered into an agreement to obtain a rate increase of approximately 20% from the client. At December 31, 2006, we believe no contract loss reserve for future periods is necessary for this contract. Annual revenues from the contract are approximately $1.2 million.
Goodwill represents the cost in excess of the fair value of net assets acquired in purchase transactions. Pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized but is periodically evaluated for impairment to carrying amount, with decreases in carrying amount recognized immediately. The Company reviews goodwill for impairment annually, or more frequently if changes in circumstances or the occurrence of events suggest impairment exists. The test for impairment of goodwill requires the Company to make estimates about fair value, which are based on projected future cash flows. The Company performed an impairment test as of December 31, 2006, May 31, 2006, and May 31, 2005 and determined that no impairment of goodwill had occurred as of such dates.
The accrued reinsurance claims payable liability represents amounts payable to providers under a state reinsurance program associated with the Company’s contract to provide behavioral healthcare services to members of a Connecticut HMO. The Company’s contract with the HMO ended December 31, 2005. See Note 5 (1), “Major Contracts/Customers.”
On January 12, 2007, the sale of Woodcliff’s majority interest in the Company to Hythiam constituted a “change of ownership” under IRS Section 382 rules, which impose limitations on the ability to deduct prior period net operating losses on current federal tax returns. In the event that the Company has two or more ownership changes, Section 1.382-5(d) also describes a potential impact on the limitation for any losses attributable to the period preceding the earlier ownership change. The Company has determined that the latest change of ownership does not change the limitation of approximately $400,000 per year for net operating losses incurred prior to June 14, 2005, the date of the first change in control. Furthermore, the Company’s ability to use net operating losses incurred between June 15, 2005 and January 11, 2007 is limited to approximately $490,000 per year. Net operating losses for periods prior to June 15, 2005 and for the subsequent period of June 15, 2005 to January 11, 2007 may be deducted simultaneously subject to the applicable limitations. Any unused portion of such limitations can be carried forward to the following year. The Company may be subject to further limitation in the event that the Company issues or agrees to issue substantial amounts of additional equity.
Effective June 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,” using the modified prospective method, which requires companies to measure compensation cost for stock options issued to employees or non-employee directors at fair value on the grant date and recognize compensation cost over the service period for those options expected to vest. The Company uses a Black-Scholes valuation model to determine the fair value of options on the grant date, which is the same model previously utilized for footnote disclosures required under SFAS No. 148, “Accounting for Stock-Based Compensation-Transitional Disclosure.” The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation.
The weighted average fair value of options granted during the seven months ended December 31, 2005 was $1.42. The weighted average fair values of options granted for the fiscal years ended May 31, 2006, 2005, and 2004 were $1.42, $0.93, and $1.31, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.
FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments” requires disclosure of fair value information about financial instruments for which it is practical to estimate that value.
The carrying amounts and fair values of the Company’s financial instruments at December 31, 2006 and May 31, 2006 and 2005 are as follows:
(1) Effective December 31, 2005, the Company experienced the loss of a major contract to provide behavioral healthcare services to the members of a Connecticut HMO. This HMO had been a customer since March 2001. The agreement represented approximately 21.9%, or $3.4 million of our operating revenue for the seven months ended December 31, 2005, and 14.0%, or $3.4 million, 21.6%, or $5.3 million, and 13.7% or $3.8 million of the our operating revenue for the fiscal years ended May 31, 2006, 2005, and 2004, respectively. Additionally, this contract provided that the Company, through its contract with this HMO, receive additional funds directly from a state reinsurance program for the purpose of paying providers. During the fiscal years ended 2006, 2005, and 2004 the Company filed reinsurance claims totaling approximately $1.2 million, $2.7 million, and $2.1 million, respectively. Such claims represent cost reimbursements and, as such, are not included in the reported operating revenues and are accounted for as reductions of healthcare operating expenses. As of December 31, 2006, and May 31, 2006 and 2005, the Company reported $0, $0 and $372,000 as accounts receivable-managed care reinsurance contracts, with $2.5 million, $2.5 million and $3.2 million, respectively, reported as accrued reinsurance claims payable in the accompanying consolidated balance sheets. The difference between the reinsurance receivable amount and the reinsurance payable amount is related to timing differences between the authorization date, the date the money is received by the Company, and the date the money is paid to the provider. In certain cases, providers have submitted claims for authorized services having incorrect service codes or otherwise incorrect information that has caused payment to be denied by the Company. In such cases, there are contractual and statutory provisions that allow the provider to appeal a denied claim. If there is no appeal received by the Company within the prescribed amount of time, the Company may be required to remit the reinsurance funds back to the appropriate party. Accrued amounts for non-reinsurance claims incurred but not yet reported are estimated using methods similar to that used for other existing contracts, and totaled approximately $77,000 as of May 31, 2006. At December 31, 2006, management believes no further unpaid claims remain, but has not reduced the claims liability since the statutory limits have not expired relating to such claims.
(1) Amount represents proceeds due the Company under a life insurance policy. The Company is entitled to the insurance benefits as the result of a settlement of the Company’s claims against the seller of four corporations purchased in 1996. The proceeds were received in April 2007.
(2) Represents the current portion of a promissory note received in July 2006 as settlement of a dispute between the Company and a software vendor that had been engaged to design, but was unable to complete, a new managed care information system. The difference between the present value of the note and the Company’s investment of approximately $200,000 was recorded in the accompanying consolidated statement of operations as a “loss from software development.” The current portion of the receivable is a component of other current assets while the non-
current portion of approximately $44,000 appears as a note receivable in the accompanying consolidated balance sheet at December 31, 2006.
* At December 31, 2006, the debentures are convertible into 15,051 shares of common stock at a conversion price of $149.09 per share.
Significant components of the Company’s deferred tax assets are as follows:
After consideration of all the evidence, both positive and negative, management has determined that a valuation allowance at December 31, 2006 and May 31, 2006 and 2005 was necessary to fully offset the deferred tax assets based on the likelihood of future realization.
NOTE 16 - PREFERRED STOCK, COMMON STOCK, AND STOCK OPTION PLANS
As of December 31, 2006, there were 4,340 remaining shares of preferred stock authorized and available to issue, and 14,400 outstanding shares of Series A Preferred Stock. All outstanding shares were issued in June 2005 as a result of the sale of Series A Preferred Stock to Woodcliff for approximately $3.4 million in net cash proceeds. The Series A Preferred Stock is convertible into 4,235,328 shares of common stock at a conversion rate of 294.12 common shares for each preferred share. Woodcliff has the right to appoint the majority of the board of directors, has dividend and liquidation preferences, and anti-dilution protection. In addition, the Company needs Woodcliff’s consent for a sale or merger involving a material portion of its assets or business, any single or series of related transactions exceeding $500,000, and prior to incurring any debt in excess of $200,000. As discussed in Note 1, “Description of the Company’s Business and Basis of Presentation,” and Note 20, “Subsequent Events,” on January 12, 2007, Hythiam acquired control of a majority of the voting stock of the Company through its acquisition of Woodcliff.
(a) The debentures are convertible into 15,051 shares of common stock at a conversion price of $149.09 per share.
2002 Incentive Plan, there were 480,000 options available for grant and there were 490,000 options outstanding, of which 440,000 were exercisable. Additionally, as of December 31, 2006, under the 1995 Incentive Plan, there were 512,875 options outstanding and exercisable. There are no further options available for grant under the 1995 Incentive Plan.
The Company also 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. Prior to amendment in February 2006, the Plan awarded initial grants vesting in 25% increments beginning on the first anniversary of the date of grant, and annual grants vesting 100% as of the first annual meeting of stockholders following the date of grant, provided the individual remained a director as of those dates. Subsequent to amendment, outside directors receive an initial grant upon joining the Board and annual grants at each annual meeting of stockholders beginning with the 2006 annual meeting, each vesting in 20% increments beginning on the first anniversary of the date of grant, provided the director continues to serve on the Board on those dates. As further amended with the Board’s and shareholder approval, the maximum number of shares authorized for issuance under the Directors’ Plan was increased from 250,000 to 1,000,000, and non-employee directors serving as of the amendment date were granted a one-time award of 25,000 options. As of December 31, 2006, under the Directors’ Plan, there were 595,836 shares available for option grants and there were 305,832 options outstanding, of which 73,332 options were exercisable.
A summary of activity for the seven months ended December 31, 2006 is as follows:
The following table summarizes information about options granted, exercised, and vested for the seven months ended December 31, 2006 and 2005 and for the fiscal years ended May 31, 2006, 2005, and 2004.
The Company periodically issues warrants to purchase common stock as compensation for the services of consultants and marketing employees. Of the 406,000 warrants outstanding at December 31, 2006, 306,000 were issued in February of 2005 to two consultants and two employees as compensation for introducing strategic business partners to the Company. Such partners were responsible for the infusion of approximately $776,000 in cash to the Company in February and March 2005 in a private placement of the Company’s common stock. All such warrants have five-year terms. Valuation using the Black-Scholes pricing model was based on the following information:
No warrants were issued during the period June 1 thru December 31, 2006, or the year ended May 31, 2006.
Future minimum payments, by year and in the aggregate, under non-cancelable operating leases with initial or remaining terms of one year or more, consist of the following at December 31, 2006:
(4) The Company has insurance for a broad range of risks as it relates to its business operations. The Company maintains managed care errors and omissions, professional and general liability coverage. These policies are written on a claims-made basis and are subject to a $100,000 per claim self-insured retention. The managed care errors and omissions and professional liability policies include limits of liability of $1 million per claim and $3 million in the aggregate. The general liability has a limit of liability of $5 million per claim and $5 million in the aggregate. The Company is responsible for claims within the self-insured retentions or if the policy limits are exceeded. Management is not aware of any claims that could have a material adverse impact on the Company’s consolidated financial statements.
(5) On January 12, 2007, the members of Woodcliff sold their outstanding membership interests in Woodcliff to Hythiam (see Note 20, “Subsequent Events”). The change in membership interest of Woodcliff resulted in the resignation of three existing Company board members formerly nominated by Woodcliff, and the appointment of three new board members by Hythiam. The acquisition by Hythiam of the Woodcliff membership interests constitutes a “change of control” pursuant to the terms of the Company’s employment agreement with its Chief Executive Officer (“CEO”), which would entitle the CEO to be paid a severance benefit equal to twenty-four months base salary totaling $410,000 if she elects to terminate, at her sole discretion, her employment at any time within one year following the change in control.
(6) Two class action lawsuits and a complaint have been filed against the Company in the Delaware Court of Chancery. Until the actions are withdrawn or settled, the Company may incur further legal defense fees and may be subject to awards of plaintiff’s attorney fees or other fees, the amounts of which are not estimable. See Part I, Item 3, “Legal Proceedings” for a description of these matters.
(c) Includes $69,000 of expenses attributable to the sale of the Series A Preferred Stock.
(g) Includes a loss on impairment of approximately $118,000 with respect to the Company’s marketable securities.