We do not own any real property. We lease our Tampa corporate office, Puerto Rico office and Texas office. 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. Provider service, account management, and certain clinical functions are also performed in our Puerto Rico office. Our Texas office is primarily used for sales and marketing purposes. Future payments under noncancelable leases 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.
CompCare manages the delivery of a continuum of behavioral healthcare, substance abuse, and psychotropic drug management services to commercial, Medicare, Medicaid, and CHIP members on behalf of health plans. 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.
Effective January 13, 2012, we increased the number of authorized shares of our common stock that we may issue from 200,000,000 to 500,000,000, based on an affirmative vote by written consent of a majority of our shareholders held in November 2011.
On November 6, 2011, our Board of Directors approved the appointment of Robert R. Kulbick, age 63, to serve as President of the Company. Although Mr. Kulbick has not entered into a written employment agreement with the Company, it is intended that he will receive an initial salary of $300,000 per year. In connection with his hiring, Mr. Kulbick also received a stock option to purchase 300,000 shares of the Company’s common stock and a $50,000 signing bonus. Mr. Kulbick will report to the Chairman and Chief Executive Officer, Clark A. Marcus.
At-risk behavioral health contracts. Operating revenues from at-risk contracts increased by 49.3%, or $11.6 million, to $35.1 million for 2011 compared to $23.5 million for 2010. The increase is primarily attributable to the addition of two major customer contracts during the fourth quarter of 2010 that accounted for $16.8 million in revenue in 2011, as well as additional business from a previously existing customer of approximately $1.6 million. This was offset by the loss of two major customers that accounted for $6.3 million in 2010.
Other healthcare operating costs. Other healthcare operating costs, which consist of the costs of care administration, such as salaries, employee benefits and external medical case review fees, increased in 2011 by 46.1%, or approximately $2.7 million, due primarily to costs associated with contracts added in 2011. Other healthcare operating costs as a percentage of total operating revenues was 12.2% for 2011 compared to 16.8% for 2010 due to the benefit of economies of scale from higher operating revenues.
General and administrative expense. General and administrative expense decreased $0.6 million to $11.3 million in 2011 from $11.9 million in 2010 due primarily to a reduction of $1.5 million in salaries and benefits and a $0.7 million decrease in legal fees due to settled legal matters, offset by a $0.9 million increase in stock-based compensation expense. General and administrative expense as a percentage of total operating revenue decreased to 15.8% for 2011 from 33.8% for 2010 due to the benefits of economies of scale gained from higher operating revenue.
During 2011, net cash increased by $269,000. Company operations resulted in a net outflow of cash of approximately $4.0 million. Cash provided by financing activities consists primarily of approximately $1.0 million in net proceeds from the issuance of common stock, and approximately $4.0 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), and the expected continuing financial support from our major stockholders and bond holders, that we will be able to improve our cash flows and operating results and sustain current operations over the next year. 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, or that our stockholders and bond holders will continue to provide financial support. 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 plus the expected continued support of our major stockholders and bond holders will likely be sufficient to meet our current levels of operations. However, failure to obtain sufficient debt or equity financing, or any required support from our stockholders and bond holders, and, ultimately, to achieve profitable operations and positive cash flows from operations during 2012 would adversely affect our ability to achieve our business objectives and continue as a going concern.
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 uncertainty about the effects of prospective U.S. government action on healthcare all of which are likely to continue to have far-reaching effects on economic activity for an indeterminate period. The effects and probable duration of these conditions on our future operations and positive cash flows, including our ability to obtain continued support from our major stockholders and lenders, cannot be estimated at this time.
Sources of liquidity. Our primary source of liquidity on an on-going basis consists of the monthly capitation payments we receive from our clients for providing managed care services. Based on historical experience, there is considerable reliability to be expected from these continuing contracts. However, the expiration of existing contracts or commencement of new contracts may cause our operational cash flow to vary significantly.
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 are described below.
Preparation of our consolidated financial statements requires us to make significant estimates and judgments to develop the amounts reflected and disclosed in the consolidated financial statements. On an on-going basis, we evaluate the
Revenue recognition. The majority of our managed care activities are performed under at-risk arrangements pursuant to terms of agreements primarily with health plans to provide contracted behavioral healthcare and pharmacy management services to subscribing members. For the years ended December 31, 2011 and 2010, such agreements accounted for approximately 96%, or $68.4 million and 94%, or $32.9 million, respectively, of our revenue. Revenue under these agreements is earned continuously over time regardless of services actually provided and, therefore, is recognized monthly based on the number of qualified members. The information regarding qualified members is supplied by our clients, and we review member eligibility records and other reported information to verify its accuracy and determine the amount of revenue to be recognized. The remaining balance of our revenues is earned and recognized as services are delivered on a non-risk basis.
Reduction of prior year claims expense in 2010 was primarily due to the reversal of $1.4 million of claims expense for an expired contract due to a legal settlement.
Goodwill. We evaluate the amount of our goodwill at least annually, typically in the fourth quarter of our fiscal year. For 2011, we began our evaluation with a qualitative assessment of our managed care business, which is the reporting unit to which goodwill relates. Our assessment examined various indicators, primarily historical operating results, cash flows, and revenue trends, and resulted in a determination that it was more likely than not that our goodwill was impaired. To further confirm or invalidate this initial conclusion, we then proceeded to perform a quantitative analysis that calculates a fair value of the reporting unit which is then compared to the estimated fair values of our assets and liabilities. We used two methods to obtain a reporting unit fair value, a market approach and an income approach, with each heavily dependent upon management’s assumptions. The market approach calculates a fair value by multiplying the estimated value of our common stock by the quantity of shares outstanding. The income approach utilizes a discounted cash flow model to estimate the fair value of the reporting unit by discounting future cash flows derived from forecasted revenues, expenses, capital expenditures. The discount rate or weighted average cost of capital incorporates both market and company-specific risk premiums determined by management. We further reduced the initial result of the income approach by 50% to reflect our current financial uncertainty. We compared the estimates of the reporting unit’s fair value produced by the market approach and the income approach to the net estimated fair values of our assets and determined that the implied value of goodwill was in excess of our recorded amount of goodwill. Accordingly, management concluded there was no impairment adjustment required. To evaluate the sensitivity of our fair value calculations, we applied a hypothetical 10% decrease to the reporting unit fair values we initially calculated and again concluded that our goodwill is not impaired. If management’s estimates of common stock value, future earnings, cash flows, and discount rates differ significantly from those used in our calculations, future impairment charges to goodwill may be required.
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) and, to a lesser extent, uncertain income tax positions. See Note 9 to our consolidated financial statements.
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, 2011 and 2010, and the results of its operations and its cash flows for the two years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
We provide managed care services in the behavioral health, substance abuse, and psychotropic pharmacy management fields for commercial, Medicare, Medicaid and Children’s Health Insurance Program (“CHIP”) members primarily on behalf of health plans. We also provide behavioral pharmaceutical management services for two health plans 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 by unrelated vendors on a subcontract basis.
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, 2011 and 2010, such agreements accounted for 96%, or $68.4 million, and 94%, or $32.9 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 psychotropic 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 consolidated financial statements are prepared on the basis that the Company will continue its operations as a going concern. As a result of certain conditions described in Note 7, our ability to continue as a going concern will be dependent upon the success of management’s plans, as set forth also in Note 7, and is subject to significant uncertainty. Except for the consideration in determining the valuation allowance for deferred tax assets from net operating loss carryforwards (Note 9), the accompanying consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty.
Accrued claims payable includes 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 and estimated amounts for claims incurred but not yet reported (“IBNR”) to us. 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.
Revenue under our agreements to provide contracted behavioral healthcare and pharmacy management services to subscribing members is earned continuously regardless of services actually provided and, therefore, recognized monthly based on the number of qualified members. The information regarding qualified members is supplied by our clients, and we review member eligibility records and other reported information to verify its accuracy and determine the amount of revenue to be recognized. In some cases, we may adjust our monthly revenue periodically as claims data becomes available to permit a comparison of actual claims costs to targeted claims costs, for example, as a result of unforeseen variations in utilization. Similar to our other at-risk arrangements, pharmacy drug management revenue is recognized monthly as it is earned at a contracted rate per eligible member. All other service revenues are on a non-risk basis and earned and recognized as services are provided.
Costs of revenues consist of three major components: claims expense, pharmacy expense and healthcare operating expense. Claims 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.
We are subject to the income tax jurisdictions of the U.S., Puerto Rico and multiple state tax jurisdictions. However, our provisions for income taxes for 2011 and 2010 include only state income taxes (see Note 9).
We use a Black-Scholes valuation model to estimate the fair value of options and warrants on the measurement date and for determining the allocation of the relative values of debt and warrants. In applying the model, we use level 3 inputs, as defined by GAAP, consisting of historical data and management judgment to estimate the expected terms of the instruments. Expected volatility is based on the historical volatility of our traded stock. We do not expect to pay dividends for the period of the expected life of the instruments, and therefore we assume no expected dividend. The assumed risk-free rates used are based on the U.S. Treasury yield curve with the same expected terms as those of the equity instruments at the time of grant.
Property and equipment, net, consists of the following at December 31 (amounts in thousands):
Intangible assets other than goodwill are composed of our customer contracts, provider network, and accreditation. We use a straight-line method to amortize these assets over their estimated lives, which approximates three years. Annual amortization for 2011 and 2010 was $507,000, and the remaining balance will amortize in 2012.
Notes payable consists of the following as of December 31 (amounts in thousands):
(2) During 2011, each of these two notes was renewed for additional one-year terms. For the renewal of one note, we issued a three-year warrant for the purchase of 25,000 shares of our common stock at an exercise price of $0.25.
(4) In April 2011, we issued to a stockholder a $100,000 promissory note bearing interest at 24% per annum. At the loan’s maturity date in June it was renewed to October 2011 and was again renewed at the October maturity date until January 1, 2012. We made a principal payment of $10,000 in December 2011, and on January 3, 2012, renewed the note for another three month term at the same interest rate.
(5) In December 2011, we issued a $200,000 promissory note to an unrelated individual bearing interest at 14%. 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 maturity, we repaid $100,000 and executed a new note at 14% maturing April 30, 2012 for the remaining $100,000.
Long-term debt consists of the following as of December 31 (amounts in thousands):
(1) Represents our 7 1/2% convertible subordinated debentures that matured on April 15, 2010 and had not been repaid or exchanged for senior notes. These remaining outstanding debentures are convertible into 12,470 shares of common stock at a conversion price of $44.02 per share. Except for their classification among current liabilities, we are not able to estimate the financial effect resulting from the state of default with respect to the debentures held by the remaining bond holders (Note 7b).
(2) During 2010 and 2011 we issued senior promissory notes in exchange for certain of our subordinated debentures that had matured on April 15, 2010 but were not repaid. We also issued warrants to purchase our common stock in conjunction with the notes. The senior promissory notes bear interest at 10%, payable semiannually each April 15 and October 15 through April 15, 2012, the maturity date of the senior promissory notes. The warrants allow for the purchase of an aggregate of approximately 7.0 million shares of our common stock at an exercise price of $0.25 per share. All of the warrants have five year terms and are currently exercisable.
(5) In November 2011, we issued convertible promissory notes to one entity and one individual in exchange for aggregate proceeds of $700,000. The notes bear interest at the rate of 14% per annum, payable quarterly and the principal is due in May 2013. At any time during the term of the notes, the lenders may elect to convert the principal and unpaid interest to our common stock at an exercise price of $0.25 per share. The lenders also received warrants to purchase an aggregate of 350,000 shares of our common stock at $0.44 per share. The warrants, which were vested at issuance, have five year terms.
Future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more, consist of the following at December 31, 2011 (amounts in thousands):
At December 31, 2011, we had a working capital deficiency of approximately $25.2 million, including $ 2.5 million of debt currently in default, and a stockholders’ equity deficiency of approximately $16.7 million resulting from a history of operating losses. We expect that with our existing customer contracts, plus the addition of new contracts we are close to obtaining through our marketing efforts, the launch of our new pharmacy management programs, and the expected continuing financial support from our major stockholders and bond holders, that we will be able to improve our cash flows and operating results and sustain current operations over the next year. However, we do not currently maintain a line of credit or other financing arrangement with any financial institution and have not made any arrangements to obtain any additional financing but are looking at various alternative 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, or that we will be able to achieve profitable operations and positive operating cash flows in the near term. Although subject to the general economic conditions, risks and uncertainties discussed in the following paragraph, management believes that our current cash position plus the expected continued support of our major stockholders and bond holders will likely be sufficient to meet our current levels of operations, our ability to achieve our business objectives and continue as a going concern may be dependent upon the success of our plans to obtain sufficient debt or equity financing, and, ultimately, to achieve profitable operations and positive cash flows from operations during 2012.
(1) We currently provide mental health, substance abuse, and pharmacy prescription drugs management services to approximately 206,000 members of a health plan in Puerto Rico on an at-risk basis pursuant to a contract that began in September 2010. The contract accounted for 67.9%, or $48.4 million and 36.3%, or $12.8 million, of our revenues for the 2011 and 2010, respectively. The contract has an initial two-year term with provision for automatic renewals for additional one year terms unless either party provides 90 days prior written notice of its intention not to renew the agreement. The contract is cancellable by the plan after the first year with prior written notice subject to a calculated termination fee. On March 5, 2012, we entered into an amendment with the health plan to extend the contract term to December 31, 2012 and increase the rate for pharmacy management services by approximately 11% effective January 1, 2012. The loss of this customer, without replacement by new business, would adversely affect our future financial results, and cash flows and jeopardize our ability to continue as a going concern.
(1) We are subject to a pending judgment of damages to a former director of approximately $1.3 million, plus a court award to the same former director of $582,000 as reimbursement of legal fees and payment of interest on the pending judgment. The judgment and award are under appeal, and motions for reconsideration by the Company are pending.
(2) A subsidiary is subject to a suit for trademark infringement, among other things, in connection with its proposal to obtain a managed behavioral healthcare services contract in Puerto Rico. The complaint is seeking monetary damages in the amount of $600,000 and certain injunctive relief. We believe the suit is without merit and intend to vigorously defend ourselves against the allegations asserted.
(3) In addition, we and a former customer are being sued for damages of approximately $1.7 million for allegedly unpaid claims for behavioral health professional services rendered in, 2007 and 2008. We filed a counterclaim for breach of a settlement agreement that we believed resolved many of the claims that are the subject of the complaint, which we therefore, now believe is without merit and are vigorously opposing.
In accordance with the employment agreement between the Company and our CEO, Clark Marcus, we are obligated to pay to Mr. Marcus a total of approximately $8.3 million in base salary over the next five years. In addition, we will pay on his behalf approximately a total of $68,000 in health insurance premiums and $603,000 in life insurance premiums, also over the next five years. This compensation may, at our election, be accrued, in whole or in part, until such time as we receive financing and/or generate sufficient cash flows with which to pay Mr. Marcus his stated compensation, after the payment of our operating expenses.
In connection with an agreement with a new customer 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. 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 under the letter of credit.
Our Series C convertible preferred stock is the only class of preferred outstanding at December 31, 2011 and 2010. It 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 future dilutive issuances of common stock. Series C preferred shares vote with the common shares on an as-converted basis. The shares are nonparticipating except that dividends, when declared by our Board of Directors must be paid before any dividends are paid on our common stock. Other significant rights and preferences of the Series C preferred include:
A summary of warrants outstanding and exercisable as of December 31, 2011 follows:
In the event of a change of control (as defined in the warrants) of CompCare, the warrant holder will have the right to require us to redeem the warrant for an amount equal to the estimated fair value of the warrant determined using a Black-Scholes pricing model.
In addition, under our Non-employee Directors’ Stock Option Plan, we are authorized to issue non-qualified stock options to our non-employee directors for up to 1,000,000 common shares. Each non-qualified stock option is exercisable at a price equal to the average of the closing bid and asked prices of the common stock in the over-the-counter market for the most recent preceding day there was a sale of the stock prior to the grant date. Grants of options vest in accordance with vesting schedules established by our Board of Directors’ Compensation and Stock Option Committee. Upon joining our Board of Directors, directors receive an initial grant of 25,000 options. Annually, directors are granted 15,000 options on the date of our annual meeting. As of December 31, 2011, there were 776,668 shares available for option grants and 125,000 options outstanding under the non-qualified directors’ plan, 40,000 of which were exercisable.
The following table summarizes information about options granted, exercised, and vested as of December 31.
Significant related party transactions in addition to those discussed above are summarized below.
In connection with the employment agreement executed with our Chairman and CEO, we have deferred compensation payable of $500,000 included in accrued expenses as of December 31, 2011.
During 2011 and 2010, we recognized interest expense of approximately $0.7 million and $0.5 million, respectively, in connection with loans from major stockholders of the Company.
The effect of unusual items material to the fourth quarter of 2011 was an aggregate charge to operations of $2.6 million primarily from stock based compensation, with no tax effect.
On March 26, 2012, we received a letter from a customer terminating a contract effective July 1, 2012. The elimination of this contract slightly improves our prospects for future profitability.
Effective January 13, 2012, we increased the number of authorized shares of our common stock that we may issue from 200,000,000 to 500,000,000, based on an affirmative vote by written consent of a majority of our shareholders held in November 2011. We also increased the number of our common shares that we may issue under our 2009 Equity Compensation Plan from 10,000,000 to 50,000,000, effective with the same date.
On January 4, 2012, we issued 250 restricted shares of Series D Stock, par value $50 per share, to an officer and certain board members. As a condition for the grants, the recipients of the grants surrendered for cancellation all warrants for the purchase of up to 120 shares of such preferred stock. The granted Series D Stock will contain a ten-year vesting period but have the voting, dividend, liquidation and other rights of a share of Series D Stock effective from the date of grant. Upon the 10th anniversary of the grant date, each share of Series D Stock may be converted into 100,000 shares of our common stock, or an aggregate of 25,000,000 common shares.