We do not own any real property. We lease our Tampa corporate office and lease no other properties. In our Tampa office we maintain clinical operations, business development, accounting, financial and regulatory reporting and other management information systems, and provider and member service functions. Future payments under this noncancelable lease for office space are included in Note 7 to our consolidated financial statements included in Item 8 of Part II herein. We believe our current office space is suitable and adequate to meet our existing needs and that additional facilities will be available for lease to meet our future needs, if necessary.
This report includes forward-looking statements, the realization of which may be affected by certain important factors discussed previously above under Item 1A, “Risk Factors.”
CompCare manages the delivery of a continuum of behavioral healthcare, substance abuse, and drug management services for commercial, Medicare, Medicaid, and CHIP members on behalf of health plans. It also provides these services to employees of self-insured companies and members of unions. Our managed care operations include at-risk contracts, administrative service agreements, and fee-for-service agreements. The customer base for our services is primarily health plans that contract with governmental entities. Our clinical services are provided by unrelated contracted providers on a fee for service or subcapitated basis.
ASO arrangements where we manage behavioral healthcare programs or perform various managed care services, such as clinical care management, provider network development, and claims processing without assuming financial risk for member behavioral healthcare costs.
Our largest expense is the cost of behavioral health services and pharmacy drugs that we provide, which is based primarily on our arrangements with healthcare providers. Since we are subject to increases in healthcare operating expenses based on an increase in the number and frequency of our members seeking behavioral care services, our profitability depends on our ability to predict and effectively manage healthcare operating expenses in relation to the fixed premiums we receive under at-risk arrangements. Providing services on an at-risk basis exposes us to the risk that our contracts may ultimately be unprofitable if we are unable to control or otherwise anticipate healthcare costs. Accrued claims payable and claims expense are our most critical accounting estimates. See “Critical Accounting Policies and Estimates” below.
analytic services for medical and pharmacy claims for medical integration of behavioral and medical care coordination;
On December 31, 2012, the contract with our major Puerto Rico client expired and was not renewed. Under the contract, we provided services on an at-risk basis to approximately 220,000 Medicare members. The contract accounted for 82.5%, or $56.1 million, and 67.9%, or $48.4 million, of our revenues for the years ended December 31, 2012 and 2011, respectively.
On March 15, 2013, we executed an agreement with a creditor to modify the terms of a previously matured but unpaid promissory note in the amount of $1.4 million. Under the modified terms of the note, the maturity date was extended from February 28, 2013 to January 31, 2014 and the conversion price at which the note may be converted into our common stock was reduced to $0.125 from $0.25. In addition, the exercise price of a warrant to purchase our common stock issued in conjunction with the note was reset from $0.44 to $0.22. We also assigned certain receivables and a potential arbitration recovery to the creditor as a source of future repayment of a second loan from the creditor in the amount of $625,000 maturing May 14, 2013 and a $75,000 loan from an individual related to the creditor also due on May 14, 2013. Any proceeds remaining from the assigned receivables and potential recovery after repayment of the aforementioned loans will be used to reduce the principal of the $1.4 million loan, but not in excess of $300,000.
Revenues: Total managed care revenues decreased 3.3%, or approximately $2.3 million, for 2012 compared to 2011. We experienced increases and decreases in the various categories of such revenues as follows:
ASO contracts: Revenue from ASO contracts increased by 4.7%, or approximately $0.1 million, to $2.9 million for the year December 31, 2012, due primarily to $0.5 million of additional revenue from the expansion of business of previously existing ASO customers, offset by loss of contracts of $0.4 million for 2012 as compared to 2011.
Pharmacy management contracts: Pharmacy revenue increased by 18.2%, or approximately $6.0 million, to $39.4 million for 2012 from approximately $33.3 million for 2011 primarily due to a 6.5% increase in membership and a 11% contract rate increase effective January 1, 2012 from our major customer in Puerto Rico (which was discontinued for 2013).
Costs of revenues: Total costs of revenues decreased approximately 23.0%, or $16.4 million, in 2012 as compared to 2011 for reasons set forth in the following four paragraphs.
Pharmacy drug costs: Pharmacy costs decreased by 18.5%, or approximately $6.3 million, to $27.6 million for 2012 as compared to $33.9 million for 2011. The decrease is attributable to a $4.0 million resolution of a contract interpretation dispute with our major customer in Puerto Rico relating to the removal of non-psychotropic drugs charged to us by the health plan’s pharmacy benefit manager and the effect of the lower cost of a recently available generic version of a highly prescribed drug. The decrease was offset by higher drug costs attributable to greater drug utilization accompanying a 6.5% increase in membership. Pharmacy costs as a percentage of pharmacy revenue decreased from 101.8% for 2011 to 70.2% for 2012, due to an increase in the contract rate effective January 1, 2012 for our major customer in Puerto Rico (which was discontinued in 2013), the aforementioned $4.0 million adjustment and decrease in the cost of the highly prescribed drug.
Other healthcare operating expenses: Other healthcare operating expenses are for administration, such as salaries, employee benefits and external medical case review fees, decreased $1.9 million to $6.7 million for 2012, as compared to $8.7 million for 2011. The decrease is primarily attributable to salary reductions and cost savings from employee reductions in 2012. Total healthcare costs as a percentage of total operating revenue decreased to 9.8% for 2012 compared to 12.2% for 2011.
General and administrative expense: General and administrative expense decreased by 40.0%, or approximately $4.5 million, to $6.8 million for 2012 as compared to 2011. The decrease was primarily attributable to a reduction in legal expense due to adjustments of an estimated legal settlement provision, lower equity compensation expense, and cost savings from employee reductions in 2012. As a percentage of total operating revenue, general and administrative expense decreased to 9.8% for 2012 compared to 15.8% for 2011 due to the aforementioned.
Interest expense: Interest expense, excluding amortization of debt discount, increased by approximately 37.6%, or approximately $414,000, for 2012 as compared to 2011 due to an increase in the weighted average amount of debt outstanding to approximately $9.2 million during 2012, from $6.5 million for 2011 net of a decline in the average effective interest rate, excluding amortization of debt discount, for 2012, to approximately 16.4% from 16.9% for 2011, which was the result of adding $3.5 million in debt at 14% during the third quarter of 2011.
During 2012, net cash increased by $88,000. Company operations resulted in a net inflow of cash of approximately $0.3 million. Cash used in financing activities consists primarily of approximately $0.1 million in proceeds from the issuance of note obligations, offset by approximately $0.4 million in debt repayments.
We expect that with our existing customer contracts, plus the addition of new contracts we are close to obtaining through our marketing efforts, including the launch of our new pharmacy management programs (see GROWTH STRATEGY under Item 1, above), that we will be able to sustain current operations over the near term. We are looking at various alternative or additional sources of financing if operations cannot support our ongoing plan. Nevertheless, there can be no assurance that we will be able to find such financing in amounts or on terms acceptable to us, if at all. Although subject to the risks and uncertainties discussed previously in Item 1A “Risk Factors” and in the following paragraph, management believes that our current cash position will likely be sufficient to meet our current levels of operations in the short term. However, failure to obtain sufficient debt or equity financing, and, ultimately, to achieve profitable operations and positive cash flows from operations during 2013 would adversely affect our ability to achieve our business objectives and continue as a going concern.
Our ability to continue to borrow funds on an unsecured or secured basis is unknown, as well as our ability to sell our common stock in private placements. There are no present plans in place for a public registration of any of our securities. With the exception of contracted maturities of debt, there are no other known future liquidity commitments or events.
Our external sources of funds consist primarily of borrowings, and the use and sale of our unregistered common stock as a form of liquidity. Each is described below.
A further source of liquidity via borrowing is the renegotiation of a portion of our convertible subordinated debentures that were due in full on April 15, 2010. We were not able to repay the debentures on the due date, but as of December 31, 2012, have converted approximately $1.8 million, or 76%, of the outstanding debentures to three-year senior promissory notes with a fixed interest rate of 14%. In connection with issuing the senior promissory notes, we also issued warrants to purchase an aggregate of approximately seven million shares of our common stock, each exercisable at a price of $0.25 and with a five year term.
Our business model does not require us to make extensive investments in or use of capital resources.
As of December 31, 2012 and 2011, the Company did not have any off-balance sheet arrangements.
Changes in the number of employee plan members due to economic factors;
We compared the estimate of the reporting unit’s fair value produced by the income approach to the net estimated fair values of our assets and determined that the implied value of goodwill was less than our recorded amount of goodwill. The amount of the adjustment required to our goodwill was calculated at that time to be 100% of the recorded balance. Accordingly, management recorded an impairment charge of approximately $12.2 million in December 2012. The goodwill impairment was a result of the expiration on December 31, 2012 of the contract with our client MMM Healthcare, Inc. and its corporate affiliate PMC Medicare Choice, Inc. which accounted for 81.5%, or $56.1 million, of our revenues for the twelve months ended December 31, 2012.
Income taxes. Computing our provision for income taxes involves significant judgment and estimates particularly in relation to the determination of a valuation allowance for deferred tax assets (primarily from net operating loss carryforwards). See Note 9 to our consolidated financial statements.
We estimate the risk-free interest rate by reference to the interest rate for a U.S. Treasury constant maturity security with the same estimated term as the stock based award being issued.
Consolidated Statements of Operations, Years Ended December 31, 2012 and 2011
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Comprehensive Care Corporation and Subsidiaries as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the two years in the period ended December 31, 2012 in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 2 and 7 to the consolidated financial statements, the Company has suffered recurring losses from operations and has not generated sufficient cash flows from operations to fund its working capital requirements. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Notes 2 and 7. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The majority of our managed care activities are performed under at-risk arrangements pursuant to terms of agreements with health plans to provide contracted behavioral healthcare and pharmacy services to subscribing members. For the years ended December 31, 2012 and 2011, such agreements accounted for 96%, or $66.0 million, and 96%, or $68.4 million, respectively, of our revenue. We include cost sharing/cost savings provisions in certain agreements with health plans whereby we share in the additional cost or cost savings when comparing actual claims costs to the estimated claims costs incorporated into the contract’s pricing. 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.
We also manage the drug benefit under certain behavioral health contracts for certain health plans’ subscribing members and are responsible for the cost of drugs dispensed. In accordance with the contracts, the health plan’s pharmacy benefit manager (“PBM”) performs drug price negotiation and claims adjudication.
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates that affect the reported amounts. Actual results could differ from these estimates. Estimates involved in the determination of an allowance for doubtful accounts receivable and accrued claims payable, including incurred but not reported, are considered by management as particularly susceptible to material change in the next year. Other significant estimates relate to stock-based compensation, valuation of goodwill, warrants and beneficial conversion features.
Accrued claims payable includes estimated claims incurred but not yet reported (“IBNR”) to us, and any provisions for losses under our managed care contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. We perform this loss accrual analysis on a contract-by-contract basis taking into consideration such factors as future contractual revenue, estimated future healthcare and maintenance costs, and each contract’s specific terms related to future revenue increases as compared to expected increases in healthcare costs. Future healthcare and maintenance costs are estimated based on historical trends and expected future cost increases.
Generally, we have the ability to cancel a managed care contract with 60 to 120 days’ written notice or to request a renegotiation of terms under certain circumstances, if the contract is not meeting our financial goals. Prior to a cancellation, we typically submit a request for a rate increase accompanied by supporting utilization data. Although historically, our clients have been generally receptive to such requests, no assurance can be given that such requests will be fulfilled in our favor in the future. If a rate increase is not granted, we have the ability, in some cases, to terminate the contract and thereby limit our exposure to risk.
We perform quarterly reviews of our portfolio of contracts for the purpose of identifying loss contracts (as defined in Accounting Standards Codification (“ASC”) 944-60, “Premium Deficiency and Loss Recognition”) and to develop a contract loss allowance, if applicable, for succeeding periods. At December 31, 2012, no contract loss allowance for future periods was deemed necessary.
We also incur pharmacy costs under contracts pursuant to which we manage the drug benefit. Pharmacy costs are recognized in the period in which an eligible member actually receives medications. The health plan’s PBM periodically reports the cost of drugs used, which is subtracted from our pharmacy management premium to yield a net payment to us or payment to the health plan, depending on actual drug usage. Healthcare operating expenses are any expenses associated with care administration, which are recognized in the period that they incur.
Management has evaluated our tax positions taken or to be taken on income tax returns that remain subject to examination (i.e., tax years 2008 and thereafter federally), and has concluded that there have been no uncertain tax positions (as defined in GAAP) taken that require recognition or disclosure in the consolidated financial statements. In the event of any income tax-related interest or penalties are incurred, they would be included in general and administrative expense.
(3) Represents a zero-coupon convertible promissory note issued in February 2010 for net proceeds of $200,000 in cash. The note came due and was renewed several times since origination. The noteholder may elect to convert all or a portion of the face value of the note into our common stock at $0.25 per share. The current note has a maturity date of May 31, 2013.
(5) Issued in December 2011, the note and any unpaid interest thereon may be converted at any time during its term into our common stock at $0.25 per share. At its original maturity in January 2012, we effectively reissued the note in the amount of $100,000 on similar terms. The reissued note matured April 30, 2012, but was renewed on a quarterly basis thereafter such that the current note is now due April 30, 2013.
(7) This convertible promissory note dated June 4, 2010 to a major stockholder matured June 4, 2011, but was not repaid and is in default. Interest at 24%, payable quarterly, is also in arrears. The principal and accrued but unpaid interest may be converted at any time prior to maturity into our common stock at a conversion price of $0.25 per share. In conjunction with the loan, the noteholder received warrants to purchase an aggregate of 1,000,000 shares of our common stock at $0.25 per share. The warrants were vested upon issuance and have a five-year term. While waiting for a resolution of the arrearage with the noteholder, we continue to accrue interest at the rate of 24%. As of December 31, 2012, interest of approximately $1,259,000 was due and is included in other accrued expenses. For 2012 and 2011, we recognized approximately $480,000 and $648,000 of related party interest expense on this obligation.
(2) Represents a 10% senior promissory note that was not repaid on its maturity date of April 15, 2012. Due to a lack of contact from the holder, we were not able to modify this note to a 14% senior promissory note due April 15, 2013.
We lease certain office space and equipment under operating leases expiring in 2013 and 2014. The Tampa office lease contains an annual escalation clause and a provision for payment of real estate taxes, insurance, and maintenance and repair expenses. Total rental expense for all operating leases was approximately $622,000 and $642,000, respectively, for 2012 and 2011.
The United States and other parts of the world have been experiencing a severe and widespread recession accompanied by, among other things, instability in the financial markets and reduced credit availability, and political uncertainty in the U.S. about the effects on healthcare of recent and prospective government action, all of which are likely to continue to have far-
reaching effects on economic activity for an indeterminate period. The probable duration and effects of these conditions on our future operations and cash flows, including our ability to obtain continued support from our major stockholders and creditors cannot be estimated at this time.
We occasionally carry cash on deposit with financial institutions in excess of federally-insured limits, and the risk of losses related to such concentrations may be significant as a result of economic conditions discussed in the foregoing paragraph. The extent of a loss to be sustained as a result of uninsured deposits in the event of a future failure of a financial institution, if any, however, is not subject to estimation at this time.
(3) We are in arbitration with a former health plan client in Missouri relating to its allegation that we breached our obligation to pay claims submitted to us for payment. The arbitration is underway but has not yet progressed significantly.
(4) A group of health care providers in the state of Louisiana has filed suit against us claiming breach of contract in that we failed to pay claims submitted to us for payment. The litigation is currently in the discovery stage.
We have a single-employer defined contribution employee retirement plan qualified under Section 401(k) of the Internal Revenue Code, for the benefit of our eligible employees. Matching contributions are made only at management’s discretion and were none in 2012 and 2011.
In the event Mr. Marcus’ employment is terminated without cause, or Mr. Marcus voluntarily terminates his employment within one year following a change in control, if any, we will be obligated to pay to Mr. Marcus any accrued but unpaid bonuses and the total compensation that would have been paid to him for five full years following the date of termination. In connection with this employment agreement, we have deferred compensation payable of $740,000 and $350,000 included in accrued expenses as of December 31, 2012 and 2011, respectively.
In connection with our former major contract to provide mental health, substance abuse and pharmacy prescription drugs management services in Puerto Rico, we obtained a letter of credit from a bank for $4,000,000 to assure the customer of our compliance with our obligations under the agreement. The letter of credit extends past the expiration date of the contract, decreasing at the rate of $666,667 monthly until the letter’s termination on June 30, 2013. Under such agreement, the customer may draw on all or part of the letter of credit under certain defined circumstances. Collateral for the letter of credit was provided by a major stockholder of the Company. If the client draws upon the letter of credit, we may become liable to the major stockholder for the amount of collateral accessed by the bank to fulfill its obligations thereunder.
Our Series C preferred stock is currently convertible into common stock at the rate of approximately 316.28 common shares for each share of Series C preferred, adjustable for any dilutive issuances of common occurring in the future. Series C preferred shares vote with the common stockholders on an as-converted basis. The shares are nonparticipating except that dividends, when declared by our Board of Directors on the common stock, must be paid on the Series C stock on an as-converted basis before any dividends are paid on our common stock. The Series C is also cumulative with respect to dividends on common stock and junior series of preferred stock. Other significant rights and preferences of the Series C preferred include:
the right to vote as a separate class to appoint five directors of the Company, and
liquidation preferences, whereby the Series C holders have a claim against our assets senior to the claim of the holders of our common stock in the event of our liquidation, dissolution or winding-up (the value of the liquidation preference is $250 per share, or approximately $2.6 million at December 31, 2012 and 2011).
The following table summarizes information about warrants granted, reclassified and vested during 2012 and 2011:
We recognized approximately $2,000 and $1.7 million of compensation costs during 2012 and 2011, respectively. Total unrecognized compensation costs related to warrants as of December 31, 2012 and 2011 was approximately $1,000 and $283,000, which is expected to be recognized over a weighted-average period of 12 and 31 months. As a result of employee and director resignations prior to the vesting dates of their warrants, we derecognized compensation costs of approximately $25,000 and accordingly reversed its corresponding tax benefits and valuation allowance of approximately $6,000 during 2012.
A summary of warrants outstanding and exercisable as of December 31, 2012 follows:
A summary of our common stock option activity and related information for 2012 and 2011 follows:
At December 31, 2012, we have federal net operating loss (“NOL”) carryforwards totaling approximately $33.7 million, of which approximately $29.5 million is subject to Internal Revenue Code (“IRC”) Section 382 limitations (currently approximating $635,000 per year) as a result of previous changes in control. The NOLs will expire in 2022 through 2031. We are particularly vulnerable to additional changes in control in the near term due to probable future equity dilution or possible takeover because of low common stock trading prices resulting in further loss of our ability to utilize the remaining carryforwards under IRC Section 382. Primarily based on the foregoing and other facts and circumstances discussed in Note 7b, management has determined that realization of tax benefits from our NOLs and other deferred tax assets is not more likely than not at this time and, accordingly has provided an effective 100% valuation allowance at December 31, 2012 and 2011. Deferred income tax assets and liabilities at December 31, are as follows (amounts in thousands):
The effect of unusual items material to the fourth quarter of 2012 was an aggregate non-cash charge to operations of approximately $12.2 million as a result of writing off goodwill.
Other than the events discussed elsewhere above, no events were identified by management that in our opinion require accounting recognition or disclosure in these financial statements.