Advanzeon Solutions, Inc. - Annual Report: 2008 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the calendar year ended December 31, 2008

Commission File Number 1-9927

COMPREHENSIVE CARE CORPORATION

(Exact name of Registrant as specified in its charter)

3405 W. Dr. Martin Luther King, Jr. Blvd, Suite 101

Tampa, Florida 33607

(Address of principal executive offices, zip code)

(813) 288-4808

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $0.01 per share

7 ¹/2 % Convertible Subordinated Debentures due 2010

(Title of class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  ¨    Accelerated Filer   ¨    Non-Accelerated Filer   x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of voting stock held by non-affiliates of the Registrant on June 30, 2008 was approximately $1,993,000 based on the closing price of $0.40 of the common stock on June 30, 2008, as reported on the Over-The-Counter Bulletin Board. This amount excludes approximately 2.8 million shares of common stock held by officers, directors, and persons owning 5% or more of our outstanding common stock. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

On March 23, 2009, the Registrant had 23,926,218 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None.

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PART I

CAUTIONARY STATEMENT FOR THE PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: Certain information included in this annual report and in our other reports, Securities and Exchange Commission (SEC) filings, statements, and presentations is forward looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements concerning the projected successful integration of the operations of Core Corporate Consulting Group, Inc. (“Core”) into CompCare’s business, the continuing success that Core is expected to have in marketing its products, the potential represented by ethnic markets and the overall performance of the healthcare market, our anticipated operating results, financial resources, increases in revenues, increased profitability, interest expense, predictions of anticipated health care costs, growth and expansion, and the ability to obtain new behavioral healthcare contracts. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed herein and in our other reports, SEC filings, statements, and presentations. These risks and uncertainties include, among others, changes in local, regional, and national economic and political conditions, the effect of governmental regulation, competitive market conditions, varying trends in member utilization, our ability to manage healthcare operating expenses, the profitability of our capitated contracts, cost of care, seasonality, the Company’s ability to obtain additional financing, our ability to renegotiate or extend expiring customer contracts, the risk that any definitive agreements or additional business will result from letters of intent entered into by us, and other risks detailed from time to time in our SEC reports.

OVERVIEW

Comprehensive Care Corporation (referred to herein as the “Company,” “CompCare,” “we,” “us” or “our”) is a Delaware corporation organized in 1969.

Primarily through Comprehensive Behavioral Care, Inc. (“CBC”), we provide managed care services in the behavioral health and psychiatric fields, which is our only operating segment. Recent federal and state legislation provides a new focus for CBC in specialty behavioral health care areas such as Autism Spectrum Disorders (“ASD”) and Attention Deficit Disorder (“ADD”). Additionally, CBC provides analytic services for its health plan customers to integrate medical claims data and pharmacy data into actionable information so patient care can be coordinated cost effectively. We coordinate and manage the delivery of a continuum of psychiatric and substance abuse services and products to:

on behalf of:

Our customer base includes both employers and health plans administering government-sponsored programs for Medicaid, Medicare, CHIP and commercial plans. We provide clinical services primarily by a contracted network of providers that include:

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The services provided through our provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), and inpatient and crises intervention services. We do not directly provide treatment or own any provider of treatment services.

We typically enter into contracts with our clients on an annual basis to provide managed behavioral healthcare and substance abuse services to our clients’ members. Our arrangements with our clients fall into two broad categories:

Under capitation arrangements, the number of covered members reported by our clients determines the amount of premiums we receive, which is independent of the cost of services rendered to members. The amount of premiums we receive for each member is fixed at the beginning of the contract term. These premiums may be subsequently adjusted, up or down, generally at the commencement of each renewal period.

The following table sets forth our operating revenue and covered lives, segregated by category, for the years ended December 31, 2008 and 2007, the seven months ended December 31, 2006, and for the fiscal year ended May 31, 2006:

Over the last several years, we have experienced a trend with our clients to contract for services more on a capitated basis than on a non-capitated basis. However, during 2008 the Company placed more focus on Administrative Services Only (“ASO”) contracts to obtain a better balance of risk and non-risk clients.

Our largest expense is the cost of behavioral health services that we provide, which is a function of 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 capitation arrangements. Providing services on a capitation basis exposes us to the risk that our contracts may ultimately be unprofitable if we are unable to anticipate or control healthcare costs. Estimation of healthcare operating expense is our most significant critical accounting estimate. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates.”

We manage programs through which services are provided to recipients in eight states and Puerto Rico. Our programs and services include:

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We provide prior and concurrent authorization for physician-prescribed psychotropic medications for a Medicaid health maintenance organization (“HMO”) in Michigan and a Medicare health plan in Puerto Rico. Members are generally directed to us by their employer, health plan, or physician and receive an initial authorization for an assessment. Based upon the physician’s initial assessment, a treatment plan is established for the member.

Our objective is to provide easily accessible, high quality behavioral healthcare services and products and to manage costs through measures such as the monitoring of hospital inpatient admissions and the review of authorizations for various types of outpatient therapy. Our goal is to combine access to quality behavioral healthcare services with effective management controls in order to ensure the most cost-effective use of healthcare resources.

RECENT DEVELOPMENTS

On January 20, 2009, we entered into an Agreement and Plan of Merger (the “Merger “) with Core, a privately held Delaware corporation. The Merger was accomplished by merging our wholly owned subsidiary, CompCare Acquisition, Inc., with and into Core, with Core continuing as the surviving corporation and becoming a wholly-owned direct subsidiary of CompCare. All 10,294,725 outstanding shares of Core’s Class A Common Stock were exchanged for 10,294,725 shares of CompCare common stock. Each outstanding share of Core’s Class B Common Stock was exchanged for newly designated CompCare Series B-1 Convertible Preferred Stock and Series B-2 Convertible Preferred Stock, which in aggregate are convertible into the equivalent of 11,801,250 common shares. As a result of the Merger, Core stockholders became the holders of 77% of the voting power of the Company. Core has a national presence in product sourcing and the direct response market. Core markets a variety of health related products, insurance, and discount plans through multiple distribution channels.

On January 20, 2009, Woodcliff Healthcare Investment Partners LLC (“Woodcliff”), a wholly-owned subsidiary of Hythiam, Inc. (“Hythiam”) and our then largest stockholder, entered into a Stock Purchase Agreement with Core and Hythiam, pursuant to which Core purchased all 14,400 shares of Series A Convertible Preferred Stock and all 1,739,130 shares of common stock of the Company owned by Woodcliff. The Series A Preferred Stock purchased by Core represented 100% of our outstanding shares of Series A Preferred Stock. Prior to the Merger, Core converted all of its Series A Preferred Stock into 4,553,136 shares of common stock of the Company.

On January 14, 2009, stockholders of record as of January 9, 2009 holding 58.2% of our outstanding voting capital stock took action by written consent approving the amendment and restatement of the Company’s Restated Certificate of Incorporation to increase the number of authorized shares of our common stock from 30,000,000 shares to 100,000,000 shares and to increase the number of authorized shares of our preferred stock from 60,000 shares to 1,000,000 shares.

On January 1, 2009, we began providing behavioral health services for approximately 173,000 Medicaid recipients under contracts with two affiliated health plans in the states of Michigan and Illinois. The contracts are expected to generate approximately $1.2 million in annual revenue and are for one-year terms with automatic one-year renewals.

As of December 31, 2008, we ceased providing behavioral health services to 278,000 Medicaid members of our major Indiana client, which had decided to manage its membership through its own provider delivery system. Revenues from this client accounted for $17.8 million, or 50.6%, and $15.0 million, or 40.2%, of our operating

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revenues for the years ended December 31, 2008 and 2007, respectively. In addition, our contract with a Maryland HMO covering approximately 11,000 Medicare members ended December 31, 2008. This contract accounted for $1.9 million, or 5.3%, and $1.3 million, or 3.6% of our operating revenues for the years ended December 31, 2008 and 2007, respectively.

In the summer of 2008 we formed a majority owned subsidiary, CompCare de Puerto Rico, Inc., with an island based provider delivery system. We began providing behavioral health services to approximately 9,000 members of a health plan located in Puerto Rico on December 1, 2008. Effective January 1, 2009, we also initiated pharmaceutical management services for the plan’s members. Services under the contract are expected to generate approximately $1.0 million of annual revenue. The contract is for a term of three years with automatic one-year renewals.

In October 2008 we were awarded Full Accreditation by the National Committee on Quality Assurance (“NCQA”). NCQA accreditation attests that we meet managed behavioral healthcare organization (“MBHO”) accreditation standards that govern quality improvement, utilization management, provider credentialing, members’ rights and responsibilities, and preventative care. These standards confirm that a MBHO maintains minimum quality requirements and seeks to improve the clinical care and services it provides. Full Accreditation is granted for a period of three years to those plans that meet the NCQA’s rigorous standards. We believe our NCQA accreditation is beneficial to our clients and their members we serve. Additionally, NCQA accreditation is required by several of our client contracts and is frequently an important consideration to our prospective clients.

SOURCES OF REVENUE

We provide managed behavioral healthcare and substance abuse services to recipients, primarily through subcontracts with HMOs, which have historically outsourced these functions to managed behavioral healthcare organizations like us. We generally receive a negotiated amount on a per-member, per-month or capitated basis in exchange for providing these services. We then contract directly with behavioral healthcare providers that receive a predetermined, fee-for-service rate or case rate. Our behavioral healthcare providers include:

As of December 31, 2008, we had approximately 18,000 behavioral healthcare practitioners in our network who are primarily located in the eight states and Puerto Rico in which we have principal contracts:

Under such full-risk capitation arrangements, our profit is a function of utilization and the amount of claims payments made to our network providers. We perform periodic reviews of our current client contracts to determine profitability. In the event a contract is not profitable, we may seek to revise the terms of the contract or to terminate the agreement in accordance with the specific contract terms.

During the year ended December 31, 2008, we provided services under capitated arrangements for Medicare patients in Connecticut, Maryland, Pennsylvania, and Puerto Rico; commercial patients in Georgia; Medicare, Medicaid, and commercial patients in Florida and Michigan; Medicaid and commercial patients in Indiana; Medicare and Medicaid patients in California; and Medicare, Medicaid, and CHIP patients in Texas.

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Our Medicare, Medicaid and CHIP contracts are subject to agreements with our HMO clients whose contracts with the various governmental agencies may be subject to renegotiation at the election of the specific agency.

Over eighty percent of our operating revenue is currently concentrated, and has been concentrated in past fiscal years, in contracts with four health plans to provide behavioral healthcare services under commercial, Medicare, Medicaid, and CHIP plans. The terms of each contract are generally for one-year periods and are automatically renewable for additional one-year periods unless terminated by either party. The loss of one or more of these clients, without replacement by new business, may adversely impact our financial results.

GROWTH STRATEGY

CBC is a leader in the MBHO field with years of experience serving public program health plans and unique innovative programs addressing ASD, ADD and pharmacy management. The continued consolidation of the behavioral health care market through the acquisition of MBHOs by health plans offers CBC opportunities and we have become one of the few MBHOs that are not owned by a health plan and thus remain independent to focus on many customers at once.

Our objective is to expand our presence in both existing and new managed behavioral healthcare markets by enhancing our product offerings, adjusting our client portfolio to better balance our risk-to-ASO ratio and identifying new business development partners. We have identified portions of our market to focus on health plans known as “safety net” plans, which serve populations that we believe need many of the services that we provide. We have expanded our specialty management products to include ASD, ADD, and pharmacy management for psychotropic medications. We provide data analytic services for health plan claims and pharmacy data to effectively integrate plan data so that actionable information can be utilized to address patient care.

We provide our core product, outsourced behavioral healthcare management, to health plans, government entities, and other entities. In addition, the Medicare market is growing rapidly with new Medicare Advantage Plans being approved by the Centers for Medicare and Medicaid Services (“CMS”). Persons over the age of 65 and younger persons who are deemed disabled are eligible to receive Medicare benefits. The shifting demographics of the U.S. population signal increasing Medicare enrollment as the baby boom generation ages. According to the U.S. government, Medicare expenditures are projected to double over the next decade to a cost of approximately $863 billion in the year 2016. Additionally, the passage of the recent economic stimulus legislation requires that mental health and substance abuse benefits be paid at the same level as medical benefits. Compliance is mandated by 2010 and is anticipated to generate additional business for MBHOs. Finally, 35 states are in various stages of legislating mandates, with 11 already having passed legislation, for the case management of Autism. Mental health expertise continues to be critical to successful management of healthcare costs, and of particular importance to managing the care of populations with specific needs and we are well positioned for the growth in this sector of the market.

Our acquisition of Core will enable us to expand our product offerings to include Core’s health-related products under its Medquip™ brand name, insurance and discounted health products branded as Core Advantage™, and durable health and non-health related goods. We will utilize traditional and non-traditional distribution channels focused on targeted markets, such as the uninsured, the underinsured, and underserved ethnic groups. We believe the customer base of each company will provide cross-selling opportunities leading potentially to greater revenue, and the ability of the combined companies to realize synergies that we anticipate will lead to greater profit margins.

PROVIDER NETWORK

Our managed behavioral healthcare services are provided by contracted providers, including behavioral healthcare professionals and facilities. Our behavioral healthcare professionals include a variety of specialized behavioral healthcare personnel, such as:

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The facilities we provide our services to include:

Outpatient providers include both individual practitioners, as well as individuals who are members of group practices or other licensed centers or programs. Outpatient providers typically execute contracts with us under which they are generally paid on a fee-for-service basis.

Our provider network also includes contractual arrangements with intensive outpatient facilities, partial hospitalization facilities, community health centers, and other community-based facilities. Our contracts with facilities are on a per diem or fee-for-service basis and, in some cases, on a “case rate” basis, whereby a fixed amount is paid irrespective of the amount of services provided.

COMPETITION

The behavioral healthcare industry is very competitive and provides products and services that are price sensitive. We believe that there are approximately 150 MBHOs providing services for an estimated 227 million covered lives in the United States. Competitors include both freestanding MBHOs as well as HMOs and insurers with internal behavioral health units or subsidiaries. Many of these competitors have revenues, financial resources, and membership substantially larger than ours. The extent of competition results in significant pricing pressures which limits our revenue growth. Accordingly, we expect our future growth to come mainly from additional contracts in different segments.

SEASONALITY OF BUSINESS

Historically, we have experienced increased member utilization during the months of March, April and May and consistently low utilization by members during the months of June, July, and August. Such variations in member utilization impact our costs of care during these months, generally having a positive impact on our gross margins and operating profits during the June through August period and a negative impact on our gross margins and operating profits during the months of March through May.

GOVERNMENT REGULATION

We are subject to extensive and evolving state and federal regulations relating to the nation’s mental health system, as well as changes in Medicaid and Medicare reimbursement that could have an effect on our profitability. These regulations range from licensure and compliance with regulations related to insurance companies and other risk-assuming entities, to licensure and compliance with regulations related to healthcare providers. These laws and regulations may vary considerably between states. As a result, we may be subject to the specific regulatory approach adopted by each state for regulation of managed care companies and for providers of behavioral healthcare treatment services. We hold licenses or certificates to perform utilization review and/or third party administrator (“TPA”) services in:

Some of the services provided by our managed behavioral healthcare subsidiaries may be subject to such licensing requirements in other states. There can be no assurance that additional utilization review or TPA licenses

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will not be required or, if required, that we will qualify to obtain or renew such licenses. In many states, entities that assume risk under contract with licensed insurance companies or health plans that retain ultimate financial responsibility have not been considered by state regulators to be conducting an insurance or HMO business. As a result, we have not sought licensure as either an insurer or HMO in certain states. If the regulatory positions of these states change, our business could be materially affected until such time as we meet the regulatory requirements. We cannot quantify the potential effects of additional regulation of the managed care industry, but such costs will have an adverse effect on future operations to the extent that they are not able to be recouped in future managed care contracts.

As of January 1, 2009, we managed approximately 805,000 lives in connection with behavioral and substance abuse services covered through Medicare, Medicaid and CHIP programs in Texas; Medicare and Medicaid in Florida, California, and Michigan; and Medicare in Connecticut and Puerto Rico. Any changes in Medicare, Medicaid or CHIP funding would ultimately affect our reimbursement and overall profitability.

We are subject to the requirements of the Health Insurance Portability and Accountability Act of 1996, or HIPAA. One of the purposes of HIPAA is to improve the efficiency and effectiveness of the healthcare system through standardization of the electronic data interchange of certain administrative and financial transactions and, also, to protect the security and privacy of protected health information. Entities subject to HIPAA include some healthcare providers and all healthcare plans.

ACCREDITATION

The National Committee on Quality Assurance provides information about the quality of national managed care plans to enable consumers to evaluate health plan performance. To develop standards that effectively evaluate the structure and function of medical and quality management systems in managed care organizations, NCQA has developed an extensive review and development process in conjunction with the managed care industry, healthcare purchasers, state regulators, and consumers. The Standards for Accreditation of MBHOs used by NCQA reviewers to evaluate an MBHO address the following areas: quality improvement, utilization management, credentialing, members’ rights and responsibilities, and preventative care. These standards validate that an MBHO is founded on principles of quality and is continuously improving the clinical care and services it provides. NCQA utilizes the Health Plan Employer Data and Information Set (“HEDIS”), which is a core set of performance measurements developed to respond to complex but clearly defined employer needs as standards for patient care and customer satisfaction.

In October 2008, we were awarded Full Accreditation by NCQA extending through September of 2011. Full Accreditation is granted for a period of three years to those plans that have, according to the NCQA, excellent programs for continuous quality improvement and that meet NCQA’s rigorous standards.

We believe our NCQA accreditation is beneficial to our clients and their members we serve. Additionally, NCQA accreditation is required by several of our client contracts and is frequently an important consideration to our prospective clients.

MANAGEMENT INFORMATION SYSTEMS

All of our health plans information technology and systems operate on a single platform. This approach avoids the costs associated with maintaining multiple systems and improves productivity. The open architecture of the systems gives us the ability to transfer data from other systems thereby facilitating the integration of new health plan business. We use our information system for claims processing, utilization management, reporting, cost trending, planning, and analysis. The system also supports member and provider service functions, including:

We have implemented significant enhancements to our existing healthcare information system with recently made available technology from our current vendor to best meet our future information system needs and

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comply with all HIPAA requirements. These enhancements include advanced software to facilitate patient case management and provide our healthcare providers with self-serve capabilities through the Internet. We expect all parties involved to benefit from the efficiencies of our improved information systems.

MARKETING AND SALES

Our marketing and sales efforts are led by our Chief Executive Officer and Senior Vice President of Business Development. In addition, we utilize consultants for direct sales to commercial, Medicaid, and Medicare prospective clients. We will continue to dedicate resources to expand our sales staff and marketing efforts as necessary.

CompCare’s sales strategy focuses on matching our solutions to the needs identified by our potential clients. Examples of developing customer solutions include our ASD, ADD, and pharmacy analytics programs that offer unique solutions for our customers. Sales are highly technical and complex, involving many stakeholders within an organization. The sales cycle is typically 12 to18 months. Sales leads may be generated by our business development staff, our operations staff, consultants, cold calls, prior business relationships, or recommendations from existing clients. We attend trade shows within geographic areas in which we conduct business and reach out to contacts known to us, our consultants, and our investors. Proposals in response to RFPs from prospective commercial and public sector clients are prepared by our sales staff and presented by our Chief Executive Officer and Senior Vice President of Business Development. In addition, we maintain permanent marketing outreach through our website, www.compcare.com.

ADMINISTRATION AND EMPLOYEES

Our executive and administrative offices are located in Tampa, Florida, where we maintain operations, business development, accounting, reporting and information systems, and provider and member service functions. Provider management, account management, and certain clinical and utilization management functions are also performed in our Texas office and by employees located in Michigan and Indiana. As of December 31, 2008, we employed 64 full-time and 10 part-time employees.

AVAILABLE INFORMATION

Our stockholder website is www.compcare-shareholders.com. We make available free of charge, through a link to the SEC Internet site, our annual, quarterly, and current reports, and any amendments to these reports, as well as any beneficial ownership reports of officers and directors filed electronically on Forms 3, 4, and 5. Information contained on our website or linked through our website is not part of this report on Form 10-K. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Additionally, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, which can be found at http://www.sec.gov.

CODE OF ETHICS

We have adopted a code of ethics applicable to all of our employees, including our principal executive officer, principal financial officer, principal accounting officer and persons performing similar functions. The text of this code of ethics can be found on our website at www.compcare-shareholders.com. We intend to post notice of any waiver from, or amendment to, any provision of our code of ethics on our website.

You should carefully consider and evaluate all of the information in this report, including the risk factors listed below. Risks and uncertainties in addition to those we describe below, that may not be presently known to us, or that we currently believe are immaterial, may also harm our business and operations. If any of these risks occur, our business, results of operations and financial condition could be harmed, the price of our common stock could decline, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this report.

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Risks related to our business

We may not be able to successfully implement our modified business strategy.

Our merger with Core in January 2009 will result in the addition of a variety of health related products to our currently offered managed behavioral healthcare services. We may not be successful in implementing a sales plan to effectively market the new products or the products may not generate the level of customer interest, and thus revenue and profit margins, that were anticipated at the time of the merger.

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We may not be able to accurately predict utilization of our full-risk contracts, which could result in contracts priced at levels insufficient to ensure profitability.

Managed care operations are at risk for costs incurred to provide agreed upon levels of service. Failure to anticipate or control costs could have material, adverse effects on our business. A very large percentage of our services are provided on a full-risk capitation basis, which exposes us to significant risk that contracts negotiated and entered into may ultimately be unprofitable if utilization levels require us to provide services at a cost in excess of the capitation rates we receive for the services.

Because providers are responsible for claims submission, the timing of which is uncertain, we must estimate the amount of claims incurred but not reported, and actual results may differ materially.

Our costs of care include estimated amounts for claims incurred but not reported, referred to as IBNR. The IBNR is estimated using an actuarial paid completion factor methodology and other statistical analyses that we continually review and adjust, if necessary, to reflect any change in the estimated liability. These estimates are subject to the effects of trends in utilization and other factors. Our estimates of IBNR may be inadequate in the future, which would negatively affect results of operations. Although considerable variability is inherent in such estimates, we believe that our unpaid claims liability is adequate. However, actual results may differ materially from the estimated amounts reported.

We may be subject to fines and penalties being assessed to us by our clients.

Many of our contracts contain provisions stating that if our clients are assessed penalties or fines by a regulatory agency due to our noncompliance with a contractual requirement, we will be responsible for paying the assessed fine or penalty. Though to date, no material fines have been assessed under such provisions, any future fines would have a negative impact on our results of operations.

A failure of our information systems would significantly impair our ability to serve our customers and manage our business.

An effective and secure information system, available at all times, is vital to our health plan customers and their members. We depend on our computer systems for significant service and management functions, such as providing membership verification, monitoring utilization, processing provider claims, and providing regulatory data and other client and managerial reports. Although our computer and communications hardware is protected by physical and software safeguards, it is still vulnerable to computer viruses, fire, storm, flood, power loss, telecommunications failures, physical or software break-ins, and similar events. We do not have 100% redundancy for all of our computer and telecommunications facilities. A catastrophic event could have a significant negative effect on our business, results of operations, and financial condition.

We also depend on a third-party provider of application services for our core business application. Any sustained disruption in their services to us would have a material effect on our business.

We are subject to intense competition that may prevent us from gaining new customers or pricing our contracts at levels to achieve sufficient gross margins to ensure profitability.

We are continually pursuing new business. Many of our competitors are significantly larger and better capitalized than us, and the smaller size and financial condition of our company has proved a deterrent to some prospective customers. Additionally, we will likely have difficulty in matching the financial resources expended on marketing characteristic of our competitors. As a result, we may not be able to successfully compete in our industry. Our major competitors include Magellan Health Services, United Behavioral Health, ValueOptions, and APS Healthcare.

We will require additional funding, and we cannot guarantee that we will find adequate sources of capital in the future or that we will be able to continue as a going concern.

We cannot assure you that our existing cash and cash equivalents will be sufficient to fund our business. We expect to obtain these funds from operating activities and financing activities that may include equity or debt financings, which could dilute stockholder ownership. We cannot provide assurance that additional funding will be available on acceptable terms, if at all.

Failure to achieve profitable operations and positive cash flows from operations during 2009 would adversely affect our ability to achieve our business objectives and may require us to raise additional funds that may include equity or debt financing. There can be no assurance as to the availability of needed funding and, if available, that the source of funds would be available on terms and conditions acceptable to us. The inability or failure to raise funds before our available cash is depleted will have a material adverse effect on our business and may raise doubt as to our ability to continue as a going concern.

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Our ability to utilize net operating loss carryforwards may be limited.

As of December 31, 2008, we had net operating loss carryforwards, or NOLs, of approximately $12.8 million for federal income tax purposes that will begin to expire in 2022. These NOLs may be used to offset future taxable income, to the extent we generate any taxable income, and thereby reduce or eliminate our future federal income taxes otherwise payable. Section 382 of the Internal Revenue Code imposes limitations on a corporation’s ability to utilize NOLs if it experiences an ownership change as defined in Section 382. In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percent over a three-year period. In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in the Internal Revenue Code. Any unused annual limitation may be carried over to later years. If so, the use of our NOLs, or a portion thereof, against our future taxable income may be subject to an annual limitation under Section 382, which may result in expiration of a portion of our NOLs before utilization.

We underwent such ownership changes in June 2005, January 2007, and January 2009. Any future ownership changes can impose the application of another Section 382 limitation on our federal NOLs and can reduce the amount of NOLs we can utilize in a year if the market value of our stock were to decline significantly prior to an ownership change. Such an event may have an adverse impact on our anticipated future cash flow.

Our sales cycle is long, which complicates our ability to predict our growth.

The sales and implementation process for our services is lengthy and requires our potential clients to commit time and other resources. Our sales cycle is unpredictable and has generally ranged from 12 to 18 months from our initial contact to an executed contract. Accordingly, it may be difficult to replace lost business quickly.

We are dependent on a limited number of customers, and a loss or reduction in business of any one could have a material adverse effect on our working capital and results of operations.

For the year ended December 31, 2008, we provided behavioral healthcare services to the members of four health plans under contracts that on a combined basis represented approximately 88% percent of our operating revenue. The loss of one or more of these clients, unless replaced by new business, would negatively affect our financial condition. During 2008, we experienced the loss of our Pennsylvania, Maryland, and Indiana major customers, which on a combined basis provided 68% of our operating revenue for fiscal 2008. As a result, we may experience lower operating margins and profitability. The terms of each contract are generally for one-year periods and are automatically renewable for additional one-year periods unless terminated by either party by giving the requisite written notice.

We may be unsuccessful in obtaining performance bonds or other security that is required by our existing or future clients, and consequently may lose clients.

Some of our clients may require us to maintain performance bonds, restricted cash accounts, or other security with respect to our obligations to pay IBNR claims and claims not yet processed and paid. Due to current market conditions, we may be unable to provide the security required by our client. This could result in the loss of a client or clients which would negatively affect our financial condition.

We are dependent on our provider network to provide services to our members.

We contract with providers as a means to assure access to behavioral health services for our members. Some providers could refuse to contract with us, demand higher payments, or take other actions which could result in higher healthcare operating expenses. In addition, certain providers may have significant market position, which could cause disruption to provider access in a particular geographic area for our members and affect our contractual requirements with our customers of maintaining an adequate network.

Claims brought against us may exceed our insurance coverage.

We maintain a program of insurance coverage against a broad range of risks related to our business. As part of this program of insurance, we are subject to certain deductibles and self-insured retentions. Our insurance may not be sufficient to cover all judgments, settlements, or costs relating to future claims, suits or complaints. Upon expiration of our insurance policies, sufficient insurance may not be available on favorable terms, if at all. If we are unable to secure adequate insurance in the future, this may have a material adverse effect on our profitability and financial condition.

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The Company may be unable to attract and retain qualified personnel.

The Company’s business is largely dependent on the skills, experience and performance of key members of the Company’s senior management team. The Company plans to increase its sales and marketing personnel, as well as enter into agreements with independent third-parties to sell products and services in order to grow revenue. The Company believes that its success depends largely on its ability to attract and retain highly skilled and qualified technical, managerial, and marketing personnel. The market for highly skilled sales, marketing and support personnel is highly competitive as a result of the limited availability of technically qualified personnel with the requisite understanding of the markets which the Company serves. The inability to hire or retain qualified personnel may hinder the Company’s ability to implement its business strategy and may harm its business.

The Company’s cash deposits exceed FDIC insured amounts.

The Company regularly maintains cash balances that exceed amounts covered FDIC. As of December 31, 2008, the Company had approximately $1.1 million in banking accounts. Should our bank cease operations, it would cause a significant disruption to the Company’s cash flow. The Company has recently opened new bank accounts at other banking institutions and began to spread its cash reserves in order to minimize any potential impact of a bank failure.

Our growth could strain our personnel and infrastructure resources, and if we are unable to implement appropriate controls and procedures to manage our growth, we may not be able to successfully implement our business plan.

Our expected growth in our operations will place a significant strain on our management, administrative, operational, and financial infrastructure. Our future success will depend in part upon the ability of our management to manage growth effectively. This may require us to hire and train additional personnel to manage our expanding operations. In addition, we will be required to continue to improve our operational, financial and management controls and our reporting systems and procedures. If we fail to successfully manage our growth, we may be unable to execute upon our business plan and our business and operations may be adversely impacted.

Risks related to our industry

Adverse conditions in the global economy could negatively affect our revenues and sources of liquidity.

The financial markets have been experiencing extreme disruption, including severely diminished liquidity and availability of credit, which could adversely affect our ability to raise additional capital. State and federal budgets could be adversely affected resulting in reduced payments to our clients for health care coverage programs, including Medicare, Medicaid, and CHIP, which in turn could result in lower revenues being paid to us and adversely affecting our results of operations.

Our existing and potential managed care clients operate in a highly competitive environment and may be subject to a higher rate of merger, acquisition, and regulation than in other industries.

We typically contract with small to medium sized HMOs that may be adversely affected by the continuing efforts of governmental and third-party payers to contain or reduce the costs of healthcare through various means. Our clients may also decide to manage the behavioral healthcare benefits “in-house” and, as a result, discontinue contracting with us. Additionally, our clients may be acquired by larger HMOs, in which case there can be no assurance that the acquiring company would renew our contract. The non-renewal of one or more contracts could adversely impact our business.

Many managed care companies, including nine of our existing clients, provide services to groups covered by Medicare, Medicaid and/or CHIP programs. Such federal and state controlled programs are susceptible to annual changes in reimbursement rates and eligibility requirements that could ultimately affect companies such as CompCare.

As of January 1, 2009, we managed approximately 805,000 lives in connection with behavioral and substance abuse services covered through Medicare, Medicaid and CHIP programs in Texas; Medicare and Medicaid in Florida, California and Michigan; and Medicare in Connecticut and Puerto Rico. Any changes in Medicare, Medicaid, and/or CHIP reimbursement could ultimately affect us through contract bidding and cost structures with the health plans first impacted by such changes. If we are unable to adapt to the differing needs of our Medicare members and the Medicare regulations, we may be unsuccessful in managing this line of business.

Temporary reductions in state funding have previously had a negative impact on us, and if implemented in the future, could have a material, adverse impact on our operations. In addition, states in which we operate may pass legislation that would reduce our revenue or increase our claims expense through changes in the reimbursement

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rates, changes in the benefit covered, or in the number of eligible participants. We may be unable to reduce our costs to a level that would allow us to maintain current gross margins specific to our Medicare, Medicaid and CHIP programs.

The industry is subject to extensive state and federal regulations, as well as diverse licensure requirements varying by state. Changes in regulations could affect the profitability of our contracts or our ability to retain clients or to gain new customers.

We are required to hold licenses or certificates to perform utilization review and/or TPA services in Connecticut, Florida, Georgia, Indiana, Illinois, Maryland, Michigan, Pennsylvania, and Texas. Additional utilization review or TPA licenses may be required in the future, and we may not qualify to obtain new licenses or renew existing licenses. In many states, entities that assume risk under contract with licensed insurance companies or health plans have not been considered by state regulators to be conducting an insurance or HMO business. As a result, we have not sought licensure as either an insurer or HMO in any state. If the regulatory positions of these states were to change, our business could be materially affected until such time as we are able to meet the regulatory requirements, if at all. Additionally, some states may decide to contract directly with companies such as ours for managed behavioral healthcare services, in which case they may also require us to maintain financial reserves or net worth requirements that we may not be able to meet. Currently, we cannot quantify the potential effects of additional regulation of the managed care industry, but such costs will have an adverse effect on future operations to the extent that they are not able to be recouped in future managed care contracts.

Healthcare reform can significantly reduce our revenues and profitability.

The U.S. Congress and certain state legislatures are considering legislation that, among other things, could limit funding to our clients. We cannot predict the effect of this legislation or other legislation that may be adopted by Congress or by the states. Such legislation, if implemented, could have a material, adverse effect on us.

We are subject to federal statutes prohibiting false claims.

The Federal False Claims Act imposes civil penalties for knowingly making or causing to be made false claims with respect to governmental programs, such as Medicare and Medicaid, for services not rendered, or for misrepresenting actual services rendered, in order to obtain higher reimbursement. While we do not directly provide services to beneficiaries of federally funded health programs and, accordingly, do not submit claims to the federal government, we do provide services to health plans that could become involved with false claims, which could include allegations against us as well.

Failure to adequately comply with HIPAA may result in penalties and loss of revenues.

We are subject to the requirements of HIPAA. The purpose of HIPAA is to improve the efficiency and effectiveness of the healthcare system through standardization of the electronic data interchange of certain administrative and financial transactions and to protect the security and privacy of protected health information. We have implemented policies and practices to achieve compliance with HIPAA, and believe we are fully compliant with all HIPAA regulations. However, any lack of compliance with HIPAA regulations may result in penalties and have a material adverse effect on our ability to retain our customers or to gain new business.

The managed care industry is subject to class action lawsuits and claims for professional liability that could increase our expenditures and have an adverse effect on our profitability and financial condition.

In recent years the managed care industry has been subject to a greater number of lawsuits and claims of professional liability alleging negligence in performing utilization review and other managed care activities and in the denial of payment for services. Such incidents may result in professional negligence or other claims against us causing us to incur fees and expend substantial resources in defense of such actions. Although we maintain professional liability insurance, there can be no assurance that future claims will not have a material effect on our profitability and financial position.

Risks related to our common and preferred stock

Our Series B-1 and Series B-2 Convertible Preferred shareholders have significant rights and preferences over the holders of our common stock.

The Core shareholders who received our Series B-1 and Series B-2 Convertible Preferred Stock as a result of our merger with Core on January 20, 2009 are entitled to receive dividends when declared by our Board of Directors. The payment of these dividends will take priority over any payment of dividends on our common stock. The holders of our Series B-1 and Series B-2 Convertible Preferred Stock will also 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. In addition, each Series is entitled to vote together with the holders of our common stock on an “as converted” basis.

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The holders of Series B-1 Convertible Preferred stock are entitled to convert into a designated number of shares of Series C Preferred Stock upon the filing of a Certificate of Designation and satisfaction of other conversion conditions. The holders of the Series C Preferred Stock, when outstanding, will have a claim against our assets senior to the claim of our common stock and the Series B-2 Convertible Preferred Stock. The aggregate amount of that senior claim will be approximately $3,600,000, which will increase thereafter if such preferred stock accrues dividends or if we issue additional shares of such preferred stock. The Series B-2 Convertible Preferred Stock is entitled to convert into common shares at a predetermined ratio after satisfaction of certain conversion conditions.

The holders of our Series B-1Convertible Preferred Stock have other rights and preferences, including the following:

These rights and preferences could adversely affect our ability to finance future operations, satisfy capital needs or engage in other business activities that may be in our interest.

The price of our common stock may be adversely affected by our small public capitalization.

The size of our public market capitalization is relatively small, and the volume of our shares that are traded is low. These factors could cause significant fluctuation in the trading of our stock, which may adversely affect the price of our common stock.

We may experience fluctuations in our quarterly operating results, which would cause our stock price to decline.

Our quarterly operating results have varied in the past and may fluctuate significantly in the future due to seasonal changes in utilization levels, changes in estimates regarding IBNR claims, the timing of implementation of new contracts, and enrollment changes. These factors may affect our quarterly and annual net revenue, expenses, and profitability in the future, and consequently we may fail to meet market expectations, causing our stock price to decline.

Shares reserved for future issuance upon the conversion of our preferred stock, subordinated debentures, options, warrants, and a convertible promissory note will cause dilution to our common stockholders.

As of December 31, 2008, 4,553,136 shares of our common stock were reserved for Series A Convertible Preferred Stock, 1,153,500 shares for outstanding options and warrants, 800,000 shares for a convertible promissory note, and 15,873 shares for our subordinated debenture. On January 20, 2009, the Series A Preferred Stock was converted to common stock, and Series B-1 and B-2 Convertible Preferred Stock were issued. Upon the satisfaction of certain conversion conditions, the Series B-1 Convertible Preferred Stock will have the ability to convert into Series C Preferred Stock, which will have the option to convert into 4,554,379 shares of common stock. The Series B-2 Convertible Preferred Stock is convertible into 7,246,871 shares of common stock once similar conversion conditions have been met. Our stockholders would experience further dilution of their investment upon conversion or exercise of these securities.

Errors in estimates may have a significant negative impact on our financial condition and results of operations.

Assumptions relating to certain business, accounting and financial estimates involve judgments that are difficult to predict accurately and are subject to many factors that can materially affect results. Budgeting and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our budgets which

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may in turn affect our results. In light of the factors that can materially affect the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved.

We incur costs as a result of being a publicly-traded company.

As a publicly-traded company, we incur legal, accounting, and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Securities Exchange Act of 1934, as amended (the Exchange Act), recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, and other rules implemented relatively recently by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

The Company may raise additional funds in the future through issuances of securities and such additional funding may be dilutive to stockholders or impose operational restrictions.

We may raise additional capital in the future to help fund acquisitions and our operations through sales of shares of our common stock or securities convertible into shares of our common stock, as well as issuances of debt. Such additional financing may be dilutive to our stockholders, and debt financing, if available, may involve restrictive covenants which may limit our operating flexibility. If additional capital is raised through the issuances of shares of our common stock or securities convertible into shares of our common stock, the percentage ownership of existing stockholders will be reduced. These stockholders may experience additional dilution in net book value per share and any additional equity securities may have rights, preferences and privileges senior to those of the holders of our common stock.

We are not subject to certain of the corporate governance provisions of the Sarbanes-Oxley Act of 2002 and, without voluntary compliance with such provisions, neither you nor the Company will receive the benefits and protections they were enacted to provide.

Since our common stock is not listed for trading on a national securities exchange, we are not subject to certain of the corporate governance rules established by the national securities exchanges pursuant to the Sarbanes-Oxley Act of 2002. These rules relate to independent director standards, director nomination procedures, audit and compensation committees standards, the use of an audit committee financial expert and the adoption of a code of ethics.

While we intend to file an application to have our securities listed for trading on a national securities exchange in the future that would require us to fully comply with those obligations, we cannot assure you that we will file such an application, that we will be able to satisfy applicable listing standards, or, if we do satisfy such standards, that we will be successful in receiving approval of our application by the governing body of the applicable national securities exchange.

Applicable SEC rules governing the trading of “penny stocks” may limit the trading and liquidity of our common stock which may affect the trading price of our common stock.

Our common stock is a “penny stock” as defined under Rule 3a51-1 of the Exchange Act and is accordingly subject to SEC rules and regulations that impose limitations upon the manner in which our common stock may be publicly traded. These regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser’s written agreement to a transaction prior to sale. These regulations may have the effect of limiting the trading activity of our common stock and reducing the liquidity of an investment in our common stock.

Our common share price may subject us to securities litigation.

The market for our common stock is characterized by significant price volatility when compared to other issuers, and we expect that our share price will continue to be volatile for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management’s attention and resources.

Our stock price may be volatile, which may result in losses to our shareholders.

The stock markets have experienced significant price and trading volume fluctuations, and the market prices of companies listed on the OTC Bulletin Board^® (OTCBB) have been volatile in the past and have experienced share price and trading volume changes. The trading price of our common stock is likely to be volatile and could fluctuate widely in response to many of the following factors, some of which are beyond our control:

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Domestic and international stock markets often experience significant price and volume fluctuations. These fluctuations, as well as general economic and political conditions unrelated to our performance, may adversely affect the price of our common stock.

We do not own any real property. We lease our corporate office and Texas office. The following table sets forth certain information regarding our leased properties as of December 31, 2008. 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 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. Our Indiana office, which was not subject to a written lease agreement, was closed in December 2008.

We and nine current and former board members were named as defendants in two class action lawsuits filed by two shareholders on January 23, 2007 and February 1, 2007, respectively, regarding a proposed merger between CompCare and Hythiam. On May 25, 2007, we mutually terminated the Agreement and Plan of Merger. The lawsuits were subsequently dismissed as moot, but requests for attorney fees by plaintiffs remained pending. On June 19, 2008, the Chancery Court awarded $325,000 in fees and expenses to plaintiff’s counsel. The award was paid in January 2009 from funds provided by a claim against our directors’ and officers’ insurance policy.

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PART II

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

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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.

The selected consolidated financial data that follows should be read in conjunction with the consolidated financial statements and accompanying notes appearing elsewhere in this report.

No dividends were paid during any of the periods presented above.

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This report includes forward-looking statements, the realization of which may be impacted by certain important factors discussed previously under Item 1A “Risk Factors.”

OVERVIEW

CompCare manages the delivery of a continuum of psychiatric and substance abuse services to commercial, Medicare, and Medicaid members on behalf of 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 employers and health plans that contract with governmental entities. Our clinical services are provided primarily by unrelated contracted providers on a fee for service or subcapitated basis.

In January 2008, CompCare appointed John Hill as its new Chief Executive Officer and President and charged him with the responsibility of improving CompCare’s financial performance. Following a review of operations and all client contracts, Mr. Hill formulated a plan to better streamline our processes and to focus on financial objectives. We quickly implemented the plan and CompCare began to re-organize its operations in the second quarter of 2008. We completed this restructuring in the fourth quarter of 2008. As a result of the automation of some manual processes, the streamlining of workflows, and improving the sales pipeline opportunities by hiring a Senior Vice President of Business Development, we expect much better operating results in 2009 as compared to 2008.

The reorganization plan also included a shift in the sales and marketing approach of the Company to improve margins. In concert with the addition of a Senior Vice President of Business Development, we began pursuing Administrative Services Only contracts and broadened our product offerings. The Company began utilizing consultants, association memberships, and endorsements to increase its market presence. ASO contracts are non-risk and provide management with more certainty in generating profits. We further expanded our product offering to include specialty case management services in areas such as Attention Deficit Disorder and Autism and an analytic service that provides our clients with actionable information so patients can be coordinated cost effectively. We expect these efforts to broaden our sales pipeline.

In the summer of 2008, we formed a majority owned subsidiary in Puerto Rico with an island based provider system. CompCare de Puerto Rico was awarded its first HMO contract in the fall and began providing mental health services in December. On January 1, 2009, CompCare de Puerto Rico added psychotropic drug management to that contract. With the new governmental administration in Puerto Rico, we believe that new opportunities will begin to appear and with our local partner, we are well positioned to grow our business.

On January 20, 2009, CompCare acquired Core. This acquisition dramatically expands CompCare’s marketing capabilities, both domestically and internationally, as well as providing CompCare with a substantially expanded product line to be marketed as companion products to its already existing line of healthcare offerings.

Core is a company specializing in the healthcare sector and is a national leader in product sourcing and the direct response market. Core markets a variety of health-related products under its Medquip™ brand name and insurance and discounted health products branded as Core Advantage™ through a multiple of distribution channels. In addition to traditional distribution channels, the Company directs its distribution into highly targeted ethnic markets. In particular, CompCare services Medicare/Medicaid and affordable healthcare solution market segments – segments that are all “booming” in this economic climate.

As a direct result of CompCare’s acquisition of Core, the Company can expect strong revenue growth and sustainable increased margins. All CompCare’s overheads are covered by its existing contracted revenues, thus all new sales generated by the Company will have a visible impact to the bottom line. In addition, CompCare’s existing back office and fulfillment capabilities will be able to easily support the additional sales.

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The following table sets forth our operating (loss) income for the years ended December 31, 2008 and 2007, the seven months ended December 31, 2006 and 2005 and the fiscal years ended May 31, 2006 and 2005 (amounts in thousands):

RESULTS OF OPERATIONS – YEAR ENDED DECEMBER 31, 2008 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2007.

The decrease in capitated contract revenue from $36.3 million to $34.1 million is primarily attributable to the loss of one client in Texas and two customers in Indiana, which accounted for approximately $5.7 million in revenue for the year ended December 31, 2007 compared to $37,000 for the year ended December 31, 2008. This was partially offset by additional business from existing clients in Indiana, Maryland, and Michigan, which contributed an additional $3.7 million. The decrease in non-capitated revenue is primarily attributable to the loss of business from customers in Indiana and Texas.

Claims expense on capitated contracts increased approximately $177,000, or 0.6%, for the year ended December 31, 2008 as compared to the year ended December 31, 2007. Claims expense as a percentage of capitated revenues increased from 83.5% for the year ended December 31, 2007 to 89.4% for the year ended December 31, 2008 due to a high medical loss ratio experienced with our major Indiana client. Other healthcare operating expenses, which are incurred to service both capitated and non-capitated contracts, decreased approximately $471,000, or 7.3%, due to staff decreases in response to the loss of revenues in Indiana and Pennsylvania. As a percentage of total revenue, other healthcare operating expenses decreased from 17.3% for the year ended December 31, 2007 to 17.1% for the year ended December 31, 2008.

General and administrative expenses decreased by $290,000, or 7.2%, for the year ended December 31, 2008 as compared to the year ended December 31, 2007. This decrease is primarily attributable to the $416,000 severance benefit of two years salary paid in 2007 to our former Chief Executive Officer upon her resignation pursuant to her employment agreement following the January 12, 2007 change in ownership of Woodcliff. General and administrative expense as a percentage of operating revenue decreased from 10.8% for the year ended December 31, 2007 to 10.6% for the year ended December 31, 2008.

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RESULTS OF OPERATIONS – SEVEN MONTHS ENDED DECEMBER 31, 2006 AS COMPARED TO THE SEVEN MONTHS ENDED DECEMBER 31, 2005.

The decrease in capitated contract revenue is primarily attributable to the termination of our Connecticut contract, the loss of which accounted for $3.4 million less revenue for the seven months ended December 31, 2006 versus 2005 and the termination of a Texas contract, the loss of which accounted for $3.2 million less revenue for the same periods. This was partially offset by additional business from existing clients in Pennsylvania, Texas, Michigan and Maryland. The decrease in non-capitated revenue is primarily attributable to the loss of a management services only customer in Michigan offset by additional business in Texas and Florida and a new client in Connecticut.

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.

General and administrative expenses decreased by $192,000, or 9.8%, for the seven months ended December 31, 2006 as compared to the seven months ended December 31, 2005. This decrease is primarily attributable to indirect costs of the June 2005 sale of Series A Preferred Stock, increased costs for marketing consultants engaged to obtain additional commercial business, and legal expenses associated with our 2005 Annual Meeting and changes to the corporate charter in the period ended December 31, 2005. General and administrative expense as a percentage of operating revenue increased from 12.8% for the period ended December 31, 2005 to 17.1% for the period ended December 31, 2006.

RESULTS OF OPERATIONS – FISCAL YEAR ENDED MAY 31, 2006 AS COMPARED TO THE FISCAL YEAR ENDED MAY 31, 2005.

Capitated contract revenues increased 4.5%, or approximately $1.0 million, to $23.0 million for the year ended May 31, 2006 compared to $22.0 million for the year ended May 31, 2005. This increase in revenue is primarily attributable to additional business from existing clients in Indiana and new customers in Pennsylvania and Maryland, but was partially offset by the termination of our Connecticut contract, the loss of which accounted for $1.9 million less revenue in fiscal 2006 than in fiscal 2005. Non-capitated revenue declined 62.2%, or $1.5 million, to $0.9 million for the fiscal year ended May 31, 2006, compared to $2.4 million for the fiscal year ended May 31, 2005. The decrease is primarily attributable to the loss of two management services only customers in Michigan and an ASO client in Texas.

Claims expense on capitated contracts decreased approximately $129,000, or 0.8%, for the fiscal year ended May 31, 2006 as compared to the fiscal year ended May 31, 2005. The reduction is due to decreased utilization of covered services. Claims expense as a percentage of capitated revenues decreased from 74.2% for the fiscal year ended May 31, 2005, to 70.5% for the fiscal year ended May 31, 2006. Other healthcare operating expenses, which are incurred to service both capitated and non-capitated contracts, decreased approximately $607,000, or 12.3%, for the fiscal year ended May 31, 2006 as compared to the fiscal year ended May 31, 2005, 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 decreased from 20.1% for fiscal 2005 to 18.0% for fiscal 2006.

General and administrative expenses increased by $238,000, or 7.7%, for the fiscal year ended May 31, 2006 as compared to the fiscal year ended May 31, 2005. This increase is primarily attributable to indirect costs of the June 2005 sale of Series A Preferred Stock, increased costs for marketing consultants engaged to obtain additional commercial business, and legal expenses associated with our 2005 Annual Meeting and changes to the corporate charter. General and administrative expense as a percentage of operating revenue increased from 12.6% for the fiscal year ended May 31, 2005 to 13.8% for the fiscal year ended May 31, 2006.

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EFFECTS OF INFLATION

To minimize the effect of inflation, some of our multi-year revenue contracts contain provisions for annual rate increases that average approximately three percent per year. Our largest expense, the cost of care provided by our contracted providers, is frequently tied to standard Medicaid, CHIP, and Medicare reimbursement rates set by governmental entities. To the extent these standard rates are periodically increased to reflect the effects of inflation, we may be adversely affected by rising prices, absent a sufficient compensating increase in our revenues.

SEASONALITY OF BUSINESS

Historically, we have experienced increased member utilization during the months of March, April and May, and consistently low utilization by members during the months of June, July, and August. Such variations in member utilization impact our costs of care during these months, generally having a positive impact on our gross margins and operating profits during the June through August period and a negative impact on our gross margins and operating profits during the months of March through May.

LIQUIDITY AND CAPITAL RESOURCES

During the year ended December 31, 2008, net cash and cash equivalents decreased by $5.2 million. Net cash used in operations totaled $5.5 million, attributable primarily to payment of claims on our Indiana, Pennsylvania, and Maryland contracts which have experienced high utilization of services by members. Approximately $1.5 million of the total cash usage was due to a timing difference in the monthly capitation remittance from our large Indiana client, which the Company received in January 2009. In addition, approximately $0.7 million in cash was used to pay accrued claims payable relating to three contracts that terminated during the quarter ended December 31, 2007, and $416,000 was used to make a contractually required severance payment to our former Chief Executive Officer. Cash used in investing activities is comprised of $48,000 in additions to property and equipment offset by $27,000 in proceeds from payments received on notes receivable. Cash provided by financing activities consists primarily of $158,000 in net proceeds from the issuance of common stock and $200,000 from the issuance of a convertible promissory note, providing additional funds for working capital purposes. Other cash flows from financing activities consist of repayment of debt of $55,000.

At December 31, 2008, we had $1.1 million in cash, a working capital deficit of $5.7 million, and a stockholders’ deficit of $9.2 million. To conserve cash during the third and fourth quarters of 2008, we instituted reductions in the usage of consultants and temporary employees and eliminated permanent staffing positions. In addition, we implemented a 10% salary reduction for employees at the vice president level and above and reduced outside directors’ fees by 10%. We also requested rate increases from several of our existing clients.

In January 2009, we underwent a merger with Core. As a combined company, we have been able to raise additional capital, as demonstrated in February 2009 with the infusion of $1.6 million in cash that will be used for working capital purposes and the reduction of accrued claims payable (see Note 19 “Subsequent Events” to the audited, consolidated financial statements included elsewhere in this report). We believe we will have access to additional capital in the future as well, if needed. We believe the addition of Core will increase our sales pipeline for selling opportunities and create additional distribution channels for products we can offer, from which we expect additional positive cash flow. Together with new managed behavioral healthcare business in Michigan and Puerto Rico, we believe we will generate sufficient working capital to sustain current operations and meet our current obligations during the next twelve months.

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 estimates.

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COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The following is a schedule at December 31, 2008 of our long-term contractual commitments, future minimum lease payments under non-cancelable operating lease arrangements, and other long-term obligations:

CRITICAL ACCOUNTING ESTIMATES

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make significant estimates and judgments to develop the amounts reflected and disclosed in the consolidated financial statements, most notably our estimate for claims incurred but not yet reported (“IBNR”). On an on-going basis, we evaluate the appropriateness of our estimates and we maintain a thorough process to review the application of our accounting policies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We believe our accounting policies specific to our revenue recognition, accrued claims payable and claims expense, premium deficiencies, goodwill and stock compensation expense involve our most significant judgments and estimates that are material to our consolidated financial statements (see Note 2 – “Summary of Significant Accounting Policies” to the audited, consolidated financial statements).

REVENUE RECOGNITION

We provide managed behavioral healthcare and substance abuse services to recipients, primarily through subcontracts with HMOs. Revenue under the vast majority of these agreements is earned and recognized monthly based on the number of covered members as reported to us by our clients regardless of whether services actually provided are lesser or greater than anticipated when we entered into such contracts (generally referred to as capitation arrangements). The information regarding the number of covered members is supplied by our clients and we review membership eligibility records and other reported information to verify its accuracy in calculating the amount of revenue to be recognized. Consequently, the vast majority of our revenue is determined by the monthly receipt of covered member information and the associated payment from the client, thereby removing uncertainty and precluding us from needing to make assumptions to estimate monthly revenue amounts.

We may experience adjustments to our revenues to reflect changes in the number and eligibility status of members subsequent to when revenue is recognized. Subsequent adjustments to our revenue have not been material in the past.

ACCRUED CLAIMS PAYABLE AND CLAIMS EXPENSE

Healthcare operating expenses are composed of claims expense and other healthcare operating 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.

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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. 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.

Accrued claims payable consists primarily of reserves established for reported claims and claims IBNR which are unpaid through the respective balance sheet dates. Our policy is to record management’s best estimate of IBNR. The IBNR liability is estimated monthly using an actuarial paid completion factor methodology and is continually reviewed and adjusted, if necessary, to reflect any change in the estimated liability as more information becomes available. In deriving a range of estimates, management considers qualitative factors, authorization information, and an actuarial model that incorporates past claims payment experience, enrollment data and key assumptions such as trends in healthcare costs and seasonality. The accrued claims payable ranges were between $6.4 and $6.9 million at December 31, 2008 and between $4.9 and $5.5 million at December 31, 2007. To determine the best estimates, management reviews 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, 2008 and 2007 were $6.8 million and $5.5 million, respectively. Approximately $3.4 million of the $6.8 million accrued claims payable balance at December 31, 2008 is attributable to our major Indiana Medicaid client. We have used the same methodology and assumptions for estimating the IBNR portion of the accrued claims liability for the last three periods.

The following table provides a reconciliation of the beginning and ending balance of accrued claims payable for the years ended December 31, 2008 and 2007 and the seven months ended December 31, 2006:

Changes in prior year claims expense were primarily due to changes in utilization patterns and changes in claim submission timeframes by providers. Management considers these changes in claims expenses to be immaterial when compared to the total claims expenses incurred in prior years.

Accrued claims payable at December 31, 2008, 2007 and 2006 is comprised of approximately $1.6 million, $1.1 million and $0.7 million, respectively, of submitted and approved claims which had not yet been paid, and $5.2 million, $4.4 million and $2.0 million for IBNR claims, respectively.

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Many aspects of our business are not predictable with consistency, and therefore, estimating IBNR claims involves a significant amount of management judgment. Actual claims incurred could differ from the estimated accrued claims payable amount presented. The following are factors that would have an impact on our future operations and financial condition:

A 5% increase in assumed healthcare cost trends from those used in our calculations of IBNR at December 31, 2008 could increase our claims expense by approximately $127,000 as illustrated in the table below:

PREMIUM DEFICIENCIES

We accrue losses under our capitated 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 specific contract basis taking into consideration such factors as future contractual revenue, projected future healthcare and maintenance costs, and each contract’s specific terms related to future revenue increases as compared to expected increases in healthcare costs. The projected future healthcare and maintenance costs are estimated based on historical trends and our estimate of future cost increases.

At any time prior to the end of a contract or contract renewal, if a capitated contract is not meeting its financial goals, 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.

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, 2008, we believe no contract loss reserve for future periods is necessary. At December 31, 2008 and 2007, no contract loss reserve for future periods was necessary.

GOODWILL

We evaluate at least annually the amount of our recorded goodwill by performing impairment tests that compare the carrying amount to an estimated fair value. Management considers both the income and market approaches in the fair value determination. In estimating the fair value under the income approach, management makes its best assumptions regarding future cash flows and applies a discount rate to the cash flows to yield a present, fair value of equity. The market approach is based primarily on reference to transactions including the Company’s common stock and the quoted market prices of the Company’s common stock. As a result of such tests, management believes there is no material risk of loss from impairment of goodwill. However, actual results may differ significantly from management’s assumptions, resulting in a potentially adverse impact to our consolidated financial statements.

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STOCK COMPENSATION EXPENSE

We issue stock-based awards to our employees and members of our Board of Directors. Effective June 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment” and elected to apply the modified-prospective method to measure compensation cost for stock options at fair value on the grant date and recognize compensation cost on a straight-line basis over the service period for those options expected to vest. We use the Black-Scholes option pricing model, which requires certain variables for input to calculate the fair value of a stock award on the grant date. These variables include the expected volatility of our stock price, award exercise behaviors, the risk free interest rate, and expected dividends. We use significant judgment in estimating expected volatility of the stock, exercise behavior and forfeiture rates.

Expected Volatility

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.

Expected Term

A variety of factors are considered in determining the expected term of options granted. Options granted are grouped by their homogeneity based on the optionees’ position, whether managerial or clerical, and length of service and turnover rate. Where possible, we analyze exercise and post-vesting termination behavior. For any group without sufficient information, we estimate the expected term of the options granted by averaging the vesting term and the contractual term of the options.

Expected Forfeiture Rate

We generally separate our option awards into two groups: employee and non-employee awards. The historical data of each group are analyzed independently to estimate the forfeiture rate of options at the time of grant. These estimates are revised in subsequent periods if actual forfeitures differ from estimated forfeitures.

RECENT ACCOUNTING PRONOUNCEMENTS

Effective June 1, 2006, we adopted the fair value recognition provisions of SFAS 123R, as previously discussed in “Critical Accounting Estimates” immediately preceding.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) 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. We adopted FIN 48 effective January 1, 2007 with no impact on our consolidated financial statements.

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 have adopted this statement and incorporated its requirements into our disclosures and periodic tests of impairment of carrying values.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides that companies may elect to measure many financial instruments and certain other items at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period. The election, called the “fair value option,” will enable some companies to reduce the variability in reported earnings caused by measuring related assets and liabilities differently. SFAS 159 is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2007. SFAS 159 did not have a significant impact on our consolidated financial statements.

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In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) replaces SFAS No. 141, “Business Combinations,” but retains the requirement that the purchase method of accounting for acquisitions be used for all business combinations. SFAS 141(R) expands on the disclosures previously required by SFAS 141, better defines the acquirer and the acquisition date in a business combination, and establishes principles for recognizing and measuring the assets acquired (including goodwill), the liabilities assumed and any non-controlling interests in the acquired business. SFAS 141(R) also requires an acquirer to record an adjustment to income tax expense for changes in valuation allowances or uncertain tax positions related to an acquired business. SFAS 141(R) is effective for all business combinations with an acquisition date in the first annual period following December 15, 2008; early adoption is not permitted. We will adopt this statement as of January 1, 2009. We are currently evaluating the impact SFAS 141(R) will have on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 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. SFAS 160 also changes the manner in which the net income of the subsidiary is reported and disclosed in the controlling company’s income statement. SFAS 160 also establishes guidelines for accounting for changes in ownership percentages and for deconsolidation. SFAS 160 is effective for financial statements for fiscal years beginning on or after December 1, 2008 and interim periods within those years. The adoption of SFAS 160 is not expected to have a material impact on our financial statements.

LEGAL PROCEEDINGS

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this report, we are not currently involved in any legal proceeding that we believe would have a material adverse effect on our business, financial condition or operating results.

While we currently have market risk sensitive instruments, we have no significant exposure to changing interest rates as the interest rate on our long-term debt is fixed. Additionally, we do not use derivative financial instruments for investment or trading purposes and our investments are generally limited to cash deposits.

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Index to Consolidated Financial Statements

Years Ended December 31, 2008 and 2007,

Seven Months Ended December 31, 2006, and

Fiscal Year Ended May 31, 2006

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Comprehensive Care Corporation

We have audited the accompanying consolidated balance sheets of Comprehensive Care Corporation and Subsidiaries as of December 31, 2008 and 2007 and the related consolidated statements of operations, stockholders’ deficit and cash flows for the years ended December 31, 2008 and 2007, the seven months ended December 31, 2006, and the fiscal year ended May 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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, 2008 and 2007 and the consolidated results of their operations and their cash flows for the years ended December 31, 2008 and 2007, the seven months ended December 31, 2006, and the fiscal year ended May 31, 2006, in conformity with U.S. generally accepted accounting principles.

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CONSOLIDATED BALANCE SHEETS