This report includes forward-looking statements, the realization of which may be impacted by certain important factors discussed previously under Item 1A “Risk Factors.”
The following table sets forth our operating results from continuing operations comparing the combined operating results of Core and CompCare for the year ended December 31, 2009 to the operating results of the predecessor company, CompCare, for the years 2008 and 2007 (amounts in thousands):
Claims expense on at-risk contracts decreased by approximately 72.5%, or $22.1 million, for the year ended December 31, 2009 as compared to the year ended December 31, 2008, due to the expiration of the two major customer contracts described above. Claims expense as a percentage of at-risk revenues decreased from 89.4% for the year ended December 31, 2008 to 76.5% for the for the year ended December 31, 2009 due to high medical loss ratios experienced from serving the members of these expired contracts. Other healthcare operating expenses, attributable to servicing both at-risk contracts and ASO contracts, decreased by 30.1%, or approximately $1.8 million, due primarily to the elimination of costs associated with contracts that expired in 2008, such as salaries and external medical case review fees. Pharmacy expense of $0.8 million for the year ended December 31, 2009 represents the cost of behavioral prescription drugs attributable to a new contract. Overall, gross margin increased by $2.1 million from a loss of $1.3 million for the year ended December 31, 2008 to a gross profit of $0.7 million for the year ended December 31, 2009 due to the expiration of contracts with high utilization of behavioral services.
During the year ended December 31, 2009, we incurred $0.6 million of merger related costs, consisting mainly of financial advisory fees and legal fees. Equity based expenses of $8.9 million is comprised of $8.1 million of expense recognized upon the issuance of the warrants to executive employees, $0.1 million of expense related to the issuance of common stock to an employee pursuant to an employment agreement, $0.1 million of expense due to the early vesting of stock options as a result of the change in control, and $576,000 of expense related to the issuance of stock and warrants to outside consultants.
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 and sustain profitability and positive cash flow. Although considerable variability is inherent in such estimates, we believe that our unpaid claims liability is adequate. However, actual results could differ from the $4.7 million claims payable amount reported as of December 31, 2009.
offerings from which additional positive cash flow is expected. During the year ended December 31, 2009, we raised additional capital of $7.5 million for working capital purposes and the payment of accrued claims payable. Although management believes that our current cash position plus the continued support of our major stockholders will be sufficient to meet our current levels of operations, additional cash resources may be required should we wish to accelerate sales or complete one or more acquisitions. Additional cash resources may be needed if we do not meet our sales targets, cannot refinance our debt obligations, exceed our projected operating costs or if unanticipated expenses arise or are incurred. We do not currently maintain a line of credit or term loan with any commercial bank or other financial institution and have not made any other arrangements to obtain additional financing. We can provide no assurance that we will not require additional financing. Likewise, we can provide no assurance that if we need additional financing that it will be available in an amount or on terms acceptable to us, if at all. If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us, we may be unable to execute our business plan or pay our costs and expenses as they are incurred, which could have a material adverse effect on our business, financial condition and results of operations.
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 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.
Cost of care includes amounts paid to hospitals, physician groups and other managed care organizations under at-risk contracts. It also includes the costs of information systems, case management and quality assurance, which are attributable to both at-risk and ASO contracts.
In June 2009, the Financial Accounting Standards Board (“FASB”) established the Accounting Standards Codification (“ASC”) as the single authoritative source of accounting and reporting guidance to be applied when preparing financial statements in conformity with generally accepted accounting principles (“GAAP”). The guidance also specifically recognizes SEC rules and interpretations as authoritative GAAP for SEC registrants. The ASC does not change GAAP but instead requires that we refer to the ASC rather than to specific accounting pronouncements when describing the guidance that determines our accounting for transactions. We first incorporated references to the ASC in our interim financial statements for the quarter ended September 30, 2009.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51”, which was codified as Topic ASC 810 (“ASC 810”). ASC 810 requires that non-controlling (or minority) interests in subsidiaries be reported in the equity section of the company’s balance sheet, rather than in a mezzanine section of the balance sheet between liabilities and equity. ASC 810 also changes the manner in which the net income of the subsidiary is reported and disclosed in the controlling company’s income statement. ASC 810 additionally establishes guidelines for accounting for changes in ownership percentages and for deconsolidation. This standard is effective for financial statements for fiscal years beginning on or after December 1, 2008 and interim periods within those years. In accordance with ASC 810, our noncontrolling interest is classified as a component of equity.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which was primarily codified into ASC Topic 820, and which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. We have adopted this statement and incorporated its requirements into our disclosures and periodic tests of impairment of carrying values. In April 2009, the FASB issued additional guidance on this subject which provided information on how to determine the fair value of assets and liabilities in the current economic environment and reemphasizes that the objective of a fair value measurement remains an orderly, rather than forced, transaction between market participants at the measurement date under current market conditions. Our adoption of this guidance did not have a material effect on our consolidated financial statements.
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 audits 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 expressing an opinion on 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.
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 December 31, 2009 and 2008 and the consolidated results of their operations and their cash flows for the years ended December 31, 2009, 2008 and 2007, in conformity with U.S. generally accepted accounting principles.
Comprehensive Care Corporation (the “Company,” “CompCare,” “we”, “us,” or “our”) is a Delaware Corporation organized in 1969. Unless the context otherwise requires, all references to the “Company” include Comprehensive Behavioral Care, Inc. (“CBC”) and Core Corporate Consulting Group, Inc. (“Core”), each with their respective subsidiaries. Through CBC, we provide managed care services in the behavioral health and psychiatric fields. We manage the delivery of a continuum of psychiatric and substance abuse services to commercial, Medicare, Medicaid and Children’s Health Insurance Program (“CHIP”) members on behalf of employers, health plans, government organizations, third-party claims administrators, and commercial and other group purchasers of behavioral healthcare services. We also provide prior and concurrent authorization for physician-prescribed psychotropic medications for a major Medicaid HMO in Michigan, and behavioral pharmaceutical management services for a health plan in Puerto Rico. 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 primarily by unrelated vendors on a subcontract basis. Through Core, we market a variety of health related products, insurance, and discount plans to targeted markets such as the uninsured, the underinsured, and underserved ethnic groups.
On January 20, 2009, CompCare acquired Core, a privately held company, in exchange for CompCare common and convertible preferred stock. As a result of the merger, the former Core stockholders as a collective group obtained voting control of CompCare. Consequently, the transaction was accounted for as a reverse acquisition with Core designated as the accounting acquirer and CompCare as the predecessor. The combined entity elected to retain the Comprehensive Care Corporation name and status as a SEC registrant.
In order to mitigate these going concern issues, we are currently evaluating our operating plans to improve profitability via cost reduction and business expansion. For the period January 1 to April 1, 2010, we successfully added five new customers to our portfolio of clients and significantly expanded services to one existing client. We are also in discussions with our bond holders to extend the maturity date of our bonds, which were due April 15, 2010. We are aggressively exploring other means of raising capital through equity and debt financings. Although management believes that our current cash position plus the continued support of our major stockholders will be sufficient to meet its current levels of operations, additional cash resources may be required should we wish to accelerate sales or complete one or more acquisitions. Additional cash resources may be needed if we do not meet our sales targets, cannot refinance our debt obligations, exceed our projected operating costs or if unanticipated expenses arise or are incurred. There can be no assurance that our efforts will be successful.
Our managed care activities are performed under the terms of agreements with health maintenance organizations, preferred provider organizations, 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 at risk arrangements). The information regarding qualified participants is supplied by our clients and we review membership eligibility records and other reported information to verify its accuracy to determine the amount of revenue to be recognized. For the years ended December 31, 2009, 2008 and 2007 such agreements accounted for 77.6%, or $11.0 million, 97.0%, or $34.1 million, and 97.0%, or $36.3 million, respectively, of revenue. The remaining balance of our revenues is earned on a fee-for-service basis and is recognized as services are rendered.
Cost of care 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. 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 all of these requirements are met, the claim is entered into our claims system for payment.
At any time prior to the end of a contract or contract renewal, if a managed care contract is not meeting its financial goals, we generally have 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 our clients have historically been generally receptive to such requests, no assurance can be given that such requests will be fulfilled in the future in our favor. If a rate increase is not granted, we have the ability, in most cases, to terminate the contract and limit our risk to a short-term period.
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. At December 31, 2009 and 2008, no contract loss reserve for future periods was necessary.
Property and equipment are stated at cost. Expenditures for renewals and improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives ranging from 2 to 12 years. Leasehold improvements are amortized over the shorter of the lease term or the asset’s useful life. Amortization of assets acquired under capital leases is included in depreciation expense. Depreciation and amortization expense was $685,000, $153,000 and $154,000 for the years ended December 31, 2009, 2008 and 2007, respectively.
Non-controlling interest on our balance sheet as of December 31, 2009 and 2008 represents the minority owner’s interest in our majority owned subsidiary, CompCare de Puerto Rico, Inc. and incorporates adjustments to reflect the minority owner’s share of operating results for 2009 and 2008. CompCare de Puerto Rico, Inc. is 51% owned by Comprehensive Behavioral Care, Inc. and 49% owned by a major behavioral health services company based in San Juan, Puerto Rico.
Observable inputs that reflect quoted (unadjusted) market prices in active markets for identical assets or liabilities that are accessible at the measurement date;
Inputs other than quoted market prices included in Level 1 that are observable for the asset or liability either directly or indirectly; and
Unobservable inputs that reflect a reporting entity’s own assumptions in pricing an asset or liability.
ASC 820-10 requires us to segregate our assets and liabilities measured at fair value in accordance with the above hierarchy. During the years ended December 31, 2009 and 2008, we had no assets or liabilities required to be measured at fair value on a recurring basis. Therefore, there is no disclosure concerning assets or liabilities measured at fair value on a recurring basis. Other non-financial assets that are measured at fair value on a nonrecurring basis for the purposes of determining impairment include goodwill and identifiable intangible assets. See “Fair Value of Nonfinancial Assets” below.
For cash and cash equivalents and restricted cash, our carrying amount approximates fair value. Our financial assets and liabilities other than cash are not traded in an open market and therefore require us to estimate their fair value. Pursuant to the disclosure requirements prescribed by ASC 825-10, we use a present value technique, which is a type of income approach, to measure the fair value of these financial instruments. The rate used for discounting expected cash flows is a risk-free rate adjusted for systematic and unsystematic risk.
We grant stock options to our employees, non-employee directors and certain consultants (“grantees”) allowing grantees to purchase our common stock pursuant to stockholder approved stock option plans. Under ASC 718-10, “Compensation - Stock Compensation” we measure compensation cost for stock options issued to grantees at fair value on the grant date and recognize compensation expense over the service period for those options expected to vest. For stock options issued in exchange for the services of consultants, the transaction is measured at the fair value of the goods and services received or the fair value of the stock options issued, whichever is more reliably measurable as prescribed in ASC 505-50, “Equity.” We use a Black-Scholes valuation model to determine the fair value of options on the measurement date.
In calculating basic loss per share, net loss is divided by the weighted average number of common shares outstanding for the period. For the periods presented, diluted loss per share is equivalent to basic loss per share. The following table sets forth the computation of basic and diluted loss per share in accordance with ASC 260-10, “Earnings Per Share.”
During the year ended December 31, 2009, net cash and cash equivalents increased by $191,000. Net cash used in operations totaled $6.5 million, attributable in part to the payment of claims on our expired Indiana, Pennsylvania and Maryland contracts and expenditures to increase the size of our employee base to accommodate growth prospects. Cash used in investing activities is comprised primarily of $978,000 for the reverse acquisition of CompCare and $167,000 in additions to property and equipment. Cash provided by financing activities consists primarily of $4.8 million in net proceeds from the issuance of common and preferred stock, $490,000 representing a capital contribution from the minority owner of our Puerto Rico subsidiary and $2.7 million in net proceeds from the issuance of note obligations.
At December 31, 2009, cash and cash equivalents were approximately $694,000. We had a working capital deficit of $13.8 million at December 31, 2009 and an operating loss of $19.3 million for the year ended December 31, 2009. We expect that our existing contracts, plus the addition of new contracts implemented as of the date of this report, will reduce our operating losses. Management believes that with the addition of new contracts expected to be awarded to us, in addition to the continued financial support from our major stockholders, we will be able to sustain current operations over the next 12 months. We are looking at various sources of financing if operations cannot support our ongoing plan; however there are no assurances that we will be able to find such financing in the amounts or on terms acceptable to us, if at all. Failure to obtain sufficient debt or equity financing and, ultimately to achieve profitable operations and positive cash flows from operations during 2010 would adversely affect our ability to achieve our business objectives and continue as a going concern. There can be no assurance as to the availability of any additional debt or equity financing or that we will be able to achieve profitable operations and positive cash flows. These conditions raise doubt about our ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty.
In January 2009, CompCare merged with Core, which had previously purchased a 49% interest in CompCare to increase our pipeline for selling opportunities and to create additional distribution channels for product offerings from which additional positive cash flow is expected. During the year ended December 31, 2009, we raised additional capital of $7.5 million for working capital purposes and the payment of accrued claims payable. Although management believes that our current cash position plus the continued support of our major stockholders will be sufficient to meet its current levels of operations, additional cash resources may be required should we wish to accelerate sales or complete one or more acquisitions. Additional cash resources may be needed if we do not meet our sales targets, cannot refinance our debt obligations, exceed our projected operating costs or if unanticipated expenses arise or are incurred. We do not currently maintain a line of credit or term loan with any commercial bank or other financial institution and have not made any other arrangements to obtain additional financing. We can provide no assurance that we will not require additional financing. Likewise, we can provide no assurance that if we need additional financing that it will be available in an amount or on terms acceptable to us, if at all. If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us, we may be unable to execute our business plan or pay our costs and expenses as they are incurred, which could have a material adverse effect on our business, financial condition and results of operations.
At-risk revenues include contracts under which we assume the financial risk for the costs of member behavioral healthcare services in exchange for a fixed, per member per month fee. Under our administrative services only contracts, we may manage
(2) We currently contract with an HMO to provide behavioral healthcare services to approximately 208,000 Medicaid and Medicare members on an at-risk and ASO basis. Our contract with the HMO accounted for 27.1%, or $3.8 million, of our operating revenues for the year ended December 31, 2009 and 9.4%, or $3.3 million, of our operating revenues for the year ended December 31, 2008. The initial contract was for a one-year term and has been automatically renewed on an annual basis. Termination by either party may occur with 90 days written notice to the other party. The HMO has been a customer since June 2003.
Accounts receivable of $5,000 at December 31, 2009 and $1.6 million at December 31, 2008 consists of trade receivables resulting from services rendered under managed care capitation contracts.
The assets acquired by Core included identifiable intangible assets, such as CompCare’s customer contracts, provider network, and its accreditation from the NCQA. Identifiable intangible assets were valued using either an income or cost approach, while the other assets acquired and liabilities assumed were recorded at their carrying values, which approximated their fair values.
Utilizing a cost approach, we estimated the value of CompCare’s NCQA accreditation as the sum of the fee charged by the NCQA plus the estimated internal and external costs of preparing for the review.
In January 2009, prior to acquiring CompCare, Core purchased a 48.85% interest in CompCare for $1,500,000, yielding an implied purchase price of $3,071,000 for the entire company. In accordance with ASC 805-10, “Business Combinations,” the implied purchase price of CompCare was first allocated to the fair value of CompCare’s assets and liabilities, including identifiable intangible assets. The excess of implied purchase price over the fair value of net assets acquired was assigned to goodwill. Goodwill related to this acquisition is not deductible for tax purposes and in accordance with ASC 350-10, “Intangibles - Goodwill and other,” is not amortized, but instead is subject to periodic impairment tests. Identifiable intangible assets with definite useful lives are amortized on a straight-line basis over three years, which approximates their remaining lives. Deferred tax liabilities resulting from the difference between the assigned values and tax bases of identifiable intangible assets were not recorded due to net operating loss carryforwards.
(2) In June 2009 we issued a callable convertible promissory note to an existing investor in the Company. The note bears interest at the rate of 10% per annum payable at maturity and has a term of one year. At maturity, the principal plus accrued interest will be mandatorily converted into shares of the Company’s common stock at a conversion price of $0.35 per share. At any time prior to the maturity date of the note, the note holder may elect to convert the outstanding balance of the note plus any accrued interest into shares of the Company’s common stock at $0.35 per share. Upon giving the Company 30 days notice, at any time after June 30, 2009 and until the maturity date, the note holder may redeem all or part of the note and will be entitled to receive the outstanding balance plus accrued interest thereon calculated through the date of redemption.
(3) In October 2009 we issued a $100,000 promissory note to each of two individuals. The notes bear interest at a rate of 10% with interest payable at maturity. The notes are callable by the lenders with 30 days notice to the Company.
(4) In November 2009 we issued promissory notes in the amounts of $100,000 and $50,000 to two individuals, respectively. The notes bear interest at the rate of 10% with interest payable quarterly in arrears. At the option of the note holders, all or a portion of the principal and accrued but unpaid interest may be converted into common stock of the Company at maturity or at any time prior to maturity at a conversion price of $0.25 per share. At maturity, the balance of the note and accrued but unpaid interest not converted into Company common stock will be repaid.
(1) The debentures are due on April 15, 2010 and accordingly have been reclassified from long term debt at December 31, 2008 to note obligations due within one year at December 31, 2009. See Note 12 “Note Obligations Due Within One Year” and Note 22 “Subsequent Events.”
On January 12, 2007, the sale of an investor’s majority interest in the Company to Hythiam constituted a second “change of ownership” under IRS Section 382 rules. 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. We have determined that this 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, our ability to use net operating losses incurred between June 15, 2005 and January 12, 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 12, 2007 may be deducted simultaneously subject to the applicable limitations.
The purchase by Core of Hythiam’s ownership interest resulted in a third change in control of the Company. As a result, any losses incurred prior to January 20, 2009 are now subject to a lesser limitation, which approximates $361,000 per year. Any unused portion of such limitation can be carried forward to the following year. We may be subject to further limitation in the event that we issue or agree to issue substantial amounts of additional equity.
At December 31, 2009, the Company’s federal net operating loss carryforwards total approximately $19.4 million, of which approximately $6.8 million is not subject to Section 382 limitations from the first two changes in control transactions. These losses were incurred in the years ended May 31, 2002 through December 31, 2008, and expire in years 2022 through 2028. The Company may be unable to utilize some or all of its allowable tax deductions or losses, depending upon factors including the availability of sufficient taxable income from which to deduct such losses during limited carryover periods.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. Tax years that remain subject to examinations by tax authorities are 2008, 2007, and 2006.
After consideration of all the evidence, both positive and negative, management has determined that a valuation allowance at December 31, 2009 and 2008 was necessary to fully offset the deferred tax assets based on the likelihood of future realization.
In March 2009 the Company designated 7,000 shares of Series D Convertible Preferred Stock, par value $50.00 per share. No shares of Series D Convertible Preferred Stock are outstanding as of December 31, 2009. Of the 7,000 designated shares, 290 are presently acquirable through the exercise of warrants issued to members of the Board of Directors and certain members of management during 2009. Once issued, a Series D Convertible Preferred Share is convertible at any time after the date of issuance and without the payment of additional consideration into 100,000 shares of common stock, subject to adjustment in the event of any stock dividend,
stock split, combination or other similar recapitalization. Each holder of Series D Preferred Shares is entitled to notice of any stockholders’ meeting and to vote on any matters on which the shares of Company’s common stock may be voted. In a stockholder vote, a Series D Convertible Preferred Share is entitled to the number of votes that the holder of 500,000 shares of common stock would be entitled to by virtue of holding such shares of common stock. Series D Preferred Shares also enjoy liquidation and dividend preferences.
We are authorized to issue 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 determine 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.
(b) Promissory notes convertible into common stock totaled $2,650,000 at December 31, 2009. Such notes are convertible at any time at conversion prices ranging from $0.25 to $0.35. See Note 12 “Note obligations due within one year” and Note 14 “Long Term Debt.”
(c) Options to purchase common stock of the Company have been issued to employees and non-employee Board of Director members with exercise prices ranging from $0.25 to $2.16, with a weighted average price of $0.52.
(d) Warrants to purchase shares of the Company’s common stock have been issued the following:
non-employee individuals in exchange for consulting, financial advisory, or investment banking services in lieu of cash compensation.
(f) Once issued, shares of Series D Convertible Preferred Stock are convertible into shares of common stock at any time.
Convertible Preferred Stock was cancelled in July 2009. Warrants outstanding at December 31, 2009 may be exercised to purchase 290 shares of Series D Convertible Preferred Stock, which convert into 29,000,000 shares of common stock at a strike price of $25,000 per share (equal to $0.25 per common share). Each share of Series D Convertible Preferred Stock is entitled to 500,000 votes per share in a stockholder vote.
We grant stock options to our employees, non-employee directors and certain consultants (“grantees”) allowing grantees to purchase our common stock pursuant to stockholder-approved stock option plans. We currently have three active incentive plans, the 1995 Incentive Plan, the 2002 Incentive Plan and the 2009 Equity Compensation Plan (collectively, the “Plans”), that provide for the granting of stock options, stock appreciation rights, limited stock appreciation rights, restricted preferred stock, and common stock grants to grantees. Grants issued under the Plans may qualify as incentive stock options (“ISOs”) under Section 422A of the Internal Revenue Code of 1986, as amended. Options for ISOs may be granted for terms of up to ten years. The vesting of options issued under the 1995 and 2002 plans generally occurs after six months for one-half of the options and after 12 months for the remaining options. For the 2009 Equity Compensation Plan, the vesting period is determined by the Compensation Committee. The exercise price for ISOs must equal or exceed the fair market value of the 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 shares authorized for issuance is 10,000,000 under the 2009 Equity Compensation Plan, 1,000,000 under the 2002 Incentive Plan and 1,000,000 under the 1995 Incentive Plan. As of December 31, 2009, there were 8,275,000 options available for grant and 1,725,000 options outstanding under the 2009 Equity Compensation Plan. Under the 2002 Incentive Plan, there were 375,000 options available for grant and 585,000 options were outstanding and exercisable. Additionally, as of December 31, 2009, there were 88,000 options outstanding and exercisable under the 1995 Incentive Plan. There are no further options available for grant under the 1995 Incentive Plan.
A summary of our stock option activity and related information for the years ended December 31, 2009, 2008 and 2007 is as follows:
We periodically issue warrants to purchase shares of our common and preferred stock for the services of employees and non-employee directors.
During the year ended December 31, 2009, we issued warrants to purchase up to 390 shares of our Series D Convertible Preferred Stock, par value $50.00 per share, to members of the Board of Directors and certain members of senior management as an equity incentive to further align the interests of the directors and members of management with those of our stockholders. In July 2009, our Board cancelled a warrant to purchase 100 shares of Series D Convertible Preferred Stock granted to a former officer and board member. We valued the warrants at their estimated fair market value using the Black-Sholes pricing model and recognized approximately $8.1 million of expense related to these warrants. Each warrant has a three year term and may be exercised at any time to purchase shares of Series D Convertible Preferred Stock at an exercise price of $25,000 per share. If after six months from the issuance date of a warrant the market value of a share of Series D Convertible Preferred Stock exceeds the exercise price for a share of Series D Convertible Preferred Stock, then the holder may exercise the warrant by a cashless exercise and receive the number of shares of Series D Convertible Preferred Stock representing the net value of the warrant and forfeiting the appropriate number of warrants. The market value of a share of Series D Convertible Preferred Stock is equal to the product of (a) the per share market price of the Company’s common stock multiplied by (b) the number of shares of the Company’s common stock into which a share of Series D Preferred Stock is then convertible.
The following table summarizes information about warrants granted, exercised and vested for the year ended December 31, 2009, 2008 and 2007:
We use historical data and management judgment to estimate the expected term of the warrant. Expected volatility is based on the historical volatility of our traded stock. We have not declared dividends in the past nor do we expect to do so in the near future and as such we assume no dividend yield. The risk-free rate is based on the U.S. Treasury yield curve with the same expected term as that of the warrant at the time of grant. We adjusted our quoted stock price in the valuation to appropriately reflect trading restrictions on the warrant’s underlying asset. Valuation using the Black-Scholes pricing model was based on the following information:
For warrants that are fully vested and non-forfeitable at the date of issuance, the estimated fair value is recorded in additional paid-in capital and expensed when the services are performed and benefit is received as prescribed by ASC 505-50. For unvested warrants of which fair value is more reliably measurable than the fair value of the goods and services received, we expense the change in fair value during each reporting period using the graded vesting method.
We lease certain office space and equipment under leases expiring in 2012. The Tampa and Texas office leases contain annual escalation clauses and provisions for payment of real estate taxes, insurance, and maintenance and repair expenses. Total rental expense for all operating leases was approximately $538,000, $259,000 and $269,000, respectively, for the years ended December 31, 2009, 2008 and 2007.
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, 2009:
(1) Related to our discontinued hospital operations, Medicare guidelines allow the Medicare fiscal intermediary to re-open previously filed cost reports. Our fiscal 1999 cost report, the final year we were required to file a cost report, is being reviewed, in which case the intermediary may determine that additional amounts are due to or from Medicare. Management believes cost reports for fiscal years prior to fiscal 1999 are closed and considered final.
(4) The Company initiated an action against Jerry Katzman in July 2009 in the U.S. District Court for the Middle District of Florida alleging that Mr. Katzman, a former director, fraudulently induced the Company to enter into an employment agreement and, alternatively, that Mr. Katzman breached that alleged employment agreement. In December 2009, Mr. Katzman filed an answer and counterclaim. The counterclaim requests judgment in Mr. Katzman’s favor and compensatory damages to remedy alleged breaches of contract by the Company. We have and will continue to vigorously pursue our allegations and defend against the claims alleged by the defendant. Until the actions are withdrawn or settled, we may incur further legal fees and may be subject to awards of compensatory damages and defendant’s attorney fees.
During the period January 1 through April 1, 2010, we added five new customers to our portfolio of clients and significantly expanded services to one existing client. In the aggregate, we will manage an additional 275,000 lives on an at-risk and ASO basis for health plans servicing Medicaid, Medicare, CHIP, Healthy Families and commercial members. We expect revenues of approximately $8.0 million from these new contracts in 2010 and approximately $11.2 million in annual revenues thereafter.
During the period January 1 through April 14, 2010, we completed short term debt financing transactions totaling a net of approximately $0.8 million. The duration of the debt instruments ranged from one week to one year. Certain of the instruments contained provisions allowing the lender to convert the principal and interest of the debt into common stock of the Company. Warrants to purchase the Company’s stock were issued in conjunction with one debt instrument issued. We also completed the private placement of 200,000 shares of our common stock in exchange for $50,000 in April 2010.
Our 7 1/2% debentures matured on April 15, 2010 and are currently in default for $2,244,000 of principal and $84,150 of interest. We are currently in negotiations with bondholders representing more than 50% of the outstanding principal balance and believe that we will be able to successfully modify the terms of the debentures for these holders by extending the maturity date and increasing the quantity of common shares into which the debentures are convertible by lowering the conversion price. We are not able to estimate the financial effect resulting from a state of default with respect to the debentures held by the remaining bond holders.