We do not own any real property. We lease our corporate office and regional offices. The following table sets forth certain information regarding our leased properties as of December 31, 2006. The Texas lease is a full service lease under which we bear only those costs of operations and property taxes exceeding the base-year expenses. The Florida lease is a sublease for which the monthly base rent covers all services and property taxes. 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.
(1) Beginning in November 2006, and in connection with a contract that started January 1, 2007 to service approximately 250,000 members of an Indiana health plan (see “Recent Developments”), we have rented office space within the Indianapolis offices of the client at the rate of $2,200 per month. We expect to rent such space, which is not subject to a written lease agreement, for a time period at least equivalent to the initial two-year term of the contract.
Prior to fiscal 1993, we principally engaged in the ownership, operation, and management of psychiatric and substance abuse programs in Company owned, leased, or unaffiliated hospitals. During fiscal 1999, we completed our plan to dispose of our hospital business segment. Fiscal 2004 results include a $387,000 charge related to such discontinued operations (see Note 10 - “Discontinued Operations” to the audited, consolidated financial statements).
Fiscal 2003 results include a $7.7 million, non-operating gain related to a settlement with the Internal Revenue Service (IRS). Additionally, fiscal 2003 results include a $470,000 gain included in discontinued operations, related to the settlement of one matter, covering our fiscal years 1983 through 1986, involving Medi-Cal reimbursements paid to Brea Neuropsychiatric Hospital, a facility we owned until its disposal in fiscal year 1991.
This report on includes forward-looking statements, the realization of which may be impacted by certain important factors discussed previously under Item 1A “Risk Factors - Important Factors Related to Forward-Looking Statements and Associated Risks.”
We manage the delivery of a continuum of psychiatric and substance abuse services to commercial, Medicare, and Medicaid members on behalf of employers, health plans, government organizations, third-party claims administrators, and commercial and other group purchasers of behavioral healthcare services. 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 or subcapitated basis.
Claims expense on capitated contracts decreased approximately $3.2 million or 30.0% for the seven months ended December 31, 2006 as compared to the seven months ended December 31, 2005. The reduction is due to the
loss of capitated revenue as mentioned above. Claims expense as a percentage of capitated revenues increased from 74.0% for the period ended December 31, 2005 to 77.1% for the period ended December 31, 2006. Other healthcare operating expenses, which are incurred to service both capitated and non-capitated contracts, decreased approximately $456,000, or 17.6%, due to staff reductions in response to the loss of revenues in Michigan, Connecticut and Texas. As a percentage of total revenue, other healthcare operating expenses increased from 17.0% for the period ended December 31, 2005 to 20.7% for the period ended December 31, 2006.
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 $2.7 million accrued claims payable amount reported as of December 31, 2006.
Healthcare operating expenses are composed of claims expense and other healthcare expenses. Claims expense includes amounts paid to hospitals, physician groups and other licensed behavioral healthcare professionals. Other healthcare operating expenses include items such as information systems, provider contracting, case management and quality assurance, attributable to both capitated and non-capitated contracts.
The cost of behavioral health services is recognized in the period in which an eligible member actually receives services and includes an estimate of IBNR (as defined below). We contract with various healthcare providers including hospitals, physician groups and other managed care organizations 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 (1) the member is eligible to receive such services, (2) the service provided is medically necessary and is covered by the benefit plan’s certificate of coverage, and (3) the service has been authorized by one of our employees. If all of these requirements are met, the claim is entered into our claims system for payment and the associated cost of behavioral health services is recognized. If the claim is denied, the service provider is notified and has appeal rights under their contract with us.
utilization statistics, authorized healthcare service data, calculated completion factors and other data available at and subsequent to the balance sheet dates. The best estimates at December 31, 2006, May 31, 2006 and 2005 were $2.7 million, $2.8 million and $3.7 million respectively. We have used the same methodology and assumptions for estimating the IBNR portion of the accrued claims liability for the last three years.
Accrued claims payable at December 31, 2006 and May 31, 2006 and 2005 comprises approximately $0.7 million, $1.1 million and $1.8 million, respectively, of submitted and approved claims which had not yet been paid, and $2.0 million, $1.7 million and $1.9 million for IBNR claims, respectively.
A 5% increase in assumed healthcare cost trends from those used in our calculations of IBNR at December 31, 2006 could increase our claims expense by approximately $80,000 as illustrated in the table below:
At any time prior to the end of a contract or contract renewal, if a capitated 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, we 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.
We estimate the volatility of the share price by using historical data of our traded stock in combination with our expectation of the extent of fluctuation in future stock prices. We believe our historical volatility is more representative of future stock price volatility and as such it has been given greater weight in estimating future volatility.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the statement to determine what, if any, impact it will have on our consolidated financial statements.
From time to time, we may be party to, and our property may be subject to, ordinary, routine litigation incidental to our business. Claims may exceed insurance policy limits and we may have exposure to a liability that is not covered by insurance. Management is not aware of any such lawsuits that could have a material adverse impact on our consolidated financial statements.
Consolidated Statements of Stockholders’ Deficit, Seven Months Ended December 31, 2006 and 2005, and Years Ended May 31, 2006, 2005, and 2004
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, 2006, May 31, 2006, and May 31, 2005, and the consolidated results of their operations and their cash flows for the seven months ended December 31, 2006, and the years ended May 31, 2006, 2005 and 2004, in conformity with U.S. generally accepted accounting principles.
See accompanying report of independent registered public accounting firm and notes to the consolidated financial statements.
NOTE 1 - DESCRIPTION OF THE COMPANY’S BUSINESS AND BASIS OF PRESENTATION
Comprehensive Care Corporation (the “Company” or “CompCare”) is a Delaware Corporation organized in 1969. Unless the context otherwise requires, all references to the “Company” include Comprehensive Behavioral Care, Inc. (“CBC”) and subsidiary corporations. The Company, primarily through its wholly owned subsidiary, CBC, provides managed care services in the behavioral health and psychiatric fields, which is its only operating segment. The Company manages the delivery of a continuum of psychiatric and substance abuse services to commercial, Medicare, Medicaid and CHIP members on behalf of employers, health plans, government organizations, third-party claims administrators, and commercial and other group purchasers of behavioral healthcare services. The Company also provides prior and concurrent authorization for physician-prescribed psychotropic medications for a major Medicaid HMO in Indiana and Michigan. The managed care operations include administrative service agreements, fee-for-service agreements, and capitation contracts. The customer base for its services includes both private and governmental entities. The Company’s services are provided primarily by unrelated vendors on a subcontract basis.
The Company’s Board of Directors approved on May 21, 2007 a change in the Company’s fiscal year end from May 31 to December 31, effective December 31, 2006. The purpose of the change is to align the Company’s fiscal year end with that of Hythiam, which purchased a majority controlling interest in the Company through its purchase of Woodcliff in January 2007 (see Note 20, “Subsequent Events”). In addition, a calendar year end will coincide with that of a new client that is estimated to provide approximately 41% of our annual revenues during the 2007 calendar year. The seven months ended December 31, 2006 is the Company’s transition period. The Company’s new fiscal year began January 1, 2007 and will end December 31, 2007.
The Company’s 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 capitation arrangements). The information regarding qualified participants is supplied by the Company’s clients and the Company reviews membership eligibility records and other reported information to verify its accuracy to determine the amount of revenue to be recognized. Such agreements accounted for 95.3%, or $9.8 million, of revenue for the seven months ended December 31, 2006 and 95.7%, or $14.6 million, of revenue for the seven months ended December 31, 2005. For the fiscal years ended May 31, 2006, 2005, and 2004 such agreements accounted for 96.2%, or $23.0 million, 90.2%, or $22.1 million, and 85.5%, or $23.6 million respectively. The remaining balance of the Company’s revenues is earned on a fee-for-service basis and is recognized as services are rendered.
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 the Company’s claims system for payment.
At December 31, 2006 and May 31, 2006, cash in excess of daily requirements was invested in short-term, overnight investments. Such investments totaled $1.7 million and $1.0 million, respectively, and are included in cash and cash equivalents in the accompanying consolidated balance sheets. At May 31, 2005, cash and cash equivalents consisted entirely of funds on deposit in savings and checking accounts at major financial institutions.
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 3 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 $62,000 and $51,000 for the seven months ended December 31, 2006 and 2005, respectively. For the fiscal years ended May 31, 2006, 2005 and 2004, depreciation and amortization expense was $87,000, $96,000, and $107,000, respectively.
The accrued claims payable liability represents the estimated ultimate net amounts owed for all behavioral healthcare services provided through the respective balance sheet dates, including estimated amounts for claims incurred but not yet reported (“IBNR”) to the Company. The unpaid claims liability is estimated using an actuarial paid completion factor methodology and other statistical analyses and is continually reviewed and adjusted, if necessary, to reflect any change in the estimated liability. These estimates are subject to the effects of trends in utilization and other factors. However, actual claims incurred could differ from the estimated accrued claims payable amount reported. Although considerable variability is inherent in such estimates, management believes that the unpaid claims liability is adequate.
In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes. FIN 48 requires that companies recognize in the consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007, the beginning of its 2007 fiscal year, with no impact on its consolidated financial statements.
The Company issues stock options to its employees and non-employee directors (“optionees”) allowing optionees to purchase the Company’s common stock pursuant to shareholder approved stock option plans. Prior to June 1, 2006, as permitted by SFAS No. 148, “Accounting for Stock-Based Compensation-Transitional Disclosure,” the Company elected to follow Accounting Principles Board Opinion No. 25, (“APB 25”) “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock options. Under APB 25, in the event that the exercise price of the Company’s employee stock options is less than the market price of the underlying stock on the date of grant, compensation expense is recognized. Because all options granted under the Company’s employee stock option plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost was reflected in net (loss) income.
For cash and cash equivalents, marketable securities, restricted cash, and note receivable, the carrying amount approximates fair value. For long-term debt, the fair value is based on the estimated market price for the convertible debentures on the last day of the interim period and fiscal year.
During the seven months ended December 31, 2006, cash and cash equivalents increased by $80,000. Net cash used by continuing operations amounted to $539,000. Cash used in investing activities totaled $113,000, which is composed primarily of $160,000 in additions to property and equipment offset by $35,000 in proceeds from a property insurance claim. Cash provided by financing activities consists primarily of $785,000 in net proceeds from the exercise of a Put Option to Woodcliff in exchange for 1,739,130 shares of our common stock in October of 2006. At December 31, 2006, cash and cash equivalents amounted to $5.5 million. Management believes the Company has sufficient working capital to sustain current operations and meet the Company’s current obligations during the next twelve months.
The Company’s revenue can be segregated into the following significant categories (amounts in thousands):
(3) During its fiscal year ended May 31, 2006, the Company began providing behavioral health services to the members of a Medicare Advantage HMO in the states of Maryland, Pennsylvania, and Texas. Revenues under the contracts accounted for $2.0 million, or 19.6%, $1.1 million, or 6.9%, and $2.3 million, or 9.5% of the Company’s revenues for the seven months ended December 31, 2006 and 2005, and the fiscal year ended May 31, 2006, respectively. The contracts are for an initial one-year term with automatic annual renewals unless either party provides notice of cancellation at least 90 days prior to the expiration of the then current terms.
In general, the Company’s contracts with its customers are typically for initial one-year terms, with automatic annual extensions. Such contracts generally provide for cancellation by either party with 60 to 90 days written notice.
Accounts Receivable of $170,000 at December 31, 2006, $153,000 at May 31, 2006, and $113,000 at May 31, 2005 consists of trade receivables resulting from services rendered under managed care capitation contracts. The following table summarizes changes in the Company’s allowance for doubtful accounts for the seven months ended December 31, 2006, and the fiscal years ended May 31, 2006 and 2005:
(b) Excludes $153,000 at December 31, 2006, $89,000 at May 31, 2006, and $9,000 at May 31, 2005 of recoveries from accounts previously written off.
Recoveries are reflected on the Company’s consolidated statements of operations as a reduction to the provision for doubtful accounts.
Results for the fiscal year ended May 31, 2004 include a change in estimate resulting in a $387,000 charge recorded in August 2003 related to hospital operations disposed of in prior years, which is included under discontinued operations in the accompanying consolidated financial statements. The charge primarily relates to settlement of the Company’s Fiscal 1999 Medicare cost report for its Aurora, Colorado facility that was sold by the Company during fiscal 1999. The settlement required the Company to repay $400,000 specific to fiscal 1999, less approximately $106,000 in Medicare refunds that were due the Company in connection with its fiscal 1995 and 1996 Medicare cost report settlements for this same Aurora, Colorado hospital. The debt was satisfied by means of an installment payment plan, under which the final payment was made during fiscal 2006.
Future minimum lease payments under the capital leases are as follows:
At December 31, 2006, the Company’s federal net operating loss carryforwards total approximately $4.4 million resulting from losses incurred in the years ended May 31, 2002 through December 31, 2006, which expire in years 2022 through 2026. 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. In June 2005, the Company completed a private placement transaction, which constituted a “change of ownership” under IRS Section 382 rules. As a result, the Company’s ability to use its net operating losses incurred prior to June 14, 2005 is limited to approximately $400,000 per year, with any unused portion to be carried forward to the following year. The Company may be subject to further limitation in the event that the Company issues or agrees to issue substantial amounts of additional equity.
The company is 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 fix 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.
Authorized shares of common stock reserved for possible issuance for convertible debentures, convertible preferred stock, stock options, and warrants are as follows at December 31, 2006:
(b) The Series A Convertible Preferred Stock is convertible into 4,235,328 shares of common stock at a conversion rate of 294.12 common shares for each preferred share.
(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 $.25 to $4.00.
(d) Warrants to purchase common stock of the Company have been issued to certain individuals or vendors in exchange for consulting services. All such warrants were issued in lieu of cash compensation and have five-year terms with exercise prices ranging from $1.09 to $5.00.
The Company issues stock options to its employees and non-employee directors (“optionees”) allowing optionees to purchase the Company’s common stock pursuant to shareholder-approved stock option plans. The Company currently has two active incentive plans, the 1995 Incentive Plan and the 2002 Incentive Plan (collectively, the “Plans”), that provide for the granting of stock options, stock appreciation rights, limited stock appreciation rights, and restricted stock grants to eligible employees and consultants to the Company. Grants issued under the Plans may qualify as incentive stock options (“ISOs”) under Section 422A of the Internal Revenue Code. Options for ISOs may be granted for terms of up to ten years and are generally exercisable in cumulative increments of 50% each six months. Options for non-statutory stock options (“NSOs”) may be granted for terms of up to 13 years. The exercise price for ISOs must equal or exceed the fair market value of the shares on the date of grant, and 65% in the case of other options. The Plans also provide for the full vesting of all outstanding options under certain change of control events. The maximum number of shares authorized for issuance is 1,000,000 under the 2002 Incentive Plan and 1,000,000 under the 1995 Incentive Plan. As of December 31, 2006, under the
Stock options were granted to board of director members and certain employees during the seven months ended December 31, 2006 and 2005 and fiscal years ended May 31, 2006, 2005 and 2004. Options exercised during the seven months ended December 31, 2006 and 2005 and fiscal years ended May 31, 2006, 2005, and 2004 were 0, 255,833, 282,166, 116,500 and 16,500 respectively. Total intrinsic value of exercised options during the seven months ended December 31, 2006 and 2005 and fiscal years ended May 31, 2006, 2005, and 2004 was $0, $375,087, $411,009, $91,166 and $21,655 respectively.
attributable to stock-based compensation expense recorded during the seven months ended December 31, 2006. This benefit was fully offset by a valuation allowance of the same amount due to the likelihood of future realization.
The following table lists the assumptions utilized in applying the Black-Scholes valuation model. The Company uses historical data to estimate the expected term of the option. Expected volatility is based on the historical volatility of the Company’s traded stock. The Company has not declared dividends in the past nor does it expect to do so in the near future, and as such it assumes no expected dividend. The risk-free rate is based on the U.S. Treasury yield curve with the same expected term as that of the option at the time of grant.
A summary of the Company’s stock option activity and related information for the fiscal years ended May 31 and the seven months ended December 31, 2006 is as follows:
A summary of options outstanding and exercisable as of December 31, 2006 is as follows:
The Company leases certain office space and equipment. The Texas office lease contains escalation clauses based on the Consumer Price Index and provisions for payment of real estate taxes, insurance, and maintenance and repair expenses. Total rental expense for all operating leases was $210,000 and $261,000 for the seven months ended December 31, 2006 and 2005, respectively. For the fiscal years ended May 31, 2006, 2005, and 2004, total rental expense was $0.5 million, $0.6 million, and $0.6 million, respectively.
The above does not include rent payments related to the Company’s use of space within the offices of its major Indiana client, which is not subject to a written lease agreement.
(1) In connection with the Company’s new Indiana contract that started January 1, 2007, the Company is required to maintain a performance bond in the amount of $1,000,000. In addition, a $25,000 performance bond is maintained in relation to a Third Party Administrator license in Maryland.
(3) The Company is actively marketing eye care memberships it acquired in November 2004. As of December 31, 2006 none of the memberships had been sold. At May 31, 2006, the Company recorded a valuation reserve of 50%, or $62,500, to reduce the carrying value of the memberships to management’s best estimate of recoverable value. Our marketing efforts have continued during calendar 2007 but have yet to result in sales of the memberships. At May 31, 2007, a further valuation reserve was recorded to reduce the remaining carrying value to zero.
In August 2005, the Company’s principal operating subsidiary, CBC, entered into a marketing agreement with Health Alliance Network, Inc. (“HAN”) whereby CBC appointed HAN as its primary representative and marketing agent for commercial business. Two shareholders of HAN held membership interests in Woodcliff, the owner of a controlling interest in the Company. On January 12, 2007, the members of Woodcliff sold 100% of their outstanding membership interests in Woodcliff to Hythiam, as described in Note 20, “Subsequent Events.” For the seven months ended December 31, 2006 and the year ended May 31, 2006, CBC paid HAN $33,000 and $229,000, respectively, under this agreement.
(a) Includes a $150,000 recovery of an account written off in 1999.
(b) Includes recognition of $250,000 of insurance policy proceeds due the Company.
(f) Includes an $88,000 expense reimbursement received from one former client.
On January 1, 2007, we began providing behavioral healthcare services to approximately 250,000 Medicaid recipients in Indiana. The contract is estimated to generate approximately $14 million to $15 million in annual revenues, or approximately 41% of our anticipated annual revenues of between $35 million and $36 million.
On January 12, 2007, the members of Woodcliff sold their outstanding membership interests in Woodcliff to Hythiam. Woodcliff owns 1,739,130 shares of the Company’s common stock acquired in October 2006 and 14,400 shares of the Company’s Series A Convertible Preferred Stock acquired in June 2005, the conversion of which would result in Woodcliff owning a majority interest in the Company. By virtue of Woodcliff’s preferred stock ownership, it is entitled to significant control provisions, including the right to designate a majority of the directors on the Company’s Board. Three board members resigned following Hythiam’s acquisition, resulting in the write-off in January 2007 of approximately $106,000 in prepaid directors’ fees. In addition, the acquisition by Hythiam of the Woodcliff membership interests constitutes a “change of control” pursuant to the terms of the Company’s employment agreement with its Chief Executive Officer (“CEO”), which would entitle the CEO to be paid a severance benefit equal to twenty-four months base salary totaling $410,000 if she elects to terminate, at her sole discretion, her employment at any time within one year following the change in control.
On January 18, 2007, the Company entered into an Agreement and Plan of Merger with Hythiam, whereby the Company would merge with a newly formed, wholly-owned subsidiary of Hythiam, with the Company surviving the merger as a wholly-owned subsidiary of Hythiam. On May 25, 2007, we mutually terminated the merger.