Ontrak, Inc. - Annual Report: 2008 (Form 10-K)
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
Fiscal Year Ended December 31, 2008
Commission
File Number 001-31932
_______________________
HYTHIAM,
INC.
(Exact
name of registrant as specified in its charter)
_______________________
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Delaware
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88-0464853
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(State
or other jurisdiction of incorporation)
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(I.R.S.
Employer Identification Number)
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11150
Santa Monica Boulevard, Suite 1500
Los
Angeles, California 90025
(Address
of principal executive offices, including zip code)
(310) 444-4300
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
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Common Stock, $0.0001 par
value
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NASDAQ Global
Market
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|
(Title
of each class)
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(Name
of each exchange on which
registered)
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Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
|
Yes o
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No
þ
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Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
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Yes o
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No
þ
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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 þ
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No
o
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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 the Form 10-K or any amendment to
this Form 10-K. þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller reporting company.
See definitions of ‘‘accelerated filer,” “large accelerated filer,’’ and
“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large
accelerated filer o
|
Accelerated
filer þ
|
Non-accelerated
filer o
|
Smaller
reporting company o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
|
Yes o
|
No
þ
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As of
June 30, 2008, the aggregate market value of the common stock held by
non-affiliates of the registrant was $95,234,000 based on the $2.42 closing
price on the NASDAQ Global Market on that date. This amount excludes the value
of $36,743,000 shares of common stock directly or indirectly held by the
registrant’s affiliates.
As of
March 26, 2009, there were 55,074,047 shares of the registrant’s common
stock outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the registrant’s proxy statement for its 2008 annual meeting of
stockholders, scheduled for June 19, 2009, are incorporated by reference
into Part III of this report.
HYTHIAM, INC.
Form 10-K
Annual Report
For
The Fiscal Year Ended December 31, 2008
TABLE OF
CONTENTS
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PART
I
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Forward-Looking
Statements
This
report contains forward-looking statements that involve risks and uncertainties.
Our actual results may differ materially from those discussed due to factors
such as, among others, limited operating history, difficulty in developing,
exploiting and protecting proprietary technologies, intense competition and
substantial regulation in the healthcare industry. Additional information
concerning factors that could cause or contribute to such differences can be
found in the following discussion, as well as in Item 1.A Risk Factors and Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM
1. BUSINESS
Overview
We are a
healthcare services management company, providing through our Catasys™
subsidiary behavioral health management services for substance abuse to
health plans. Catasys is focused on offering integrated substance
dependence solutions, including our patented PROMETA®
Treatment Program, for alcoholism and stimulant dependence. The PROMETA
Treatment Program, which integrates behavioral, nutritional, and medical
components, is also available on a private-pay basis through licensed treatment
providers and company managed treatment centers that offer the PROMETA Treatment
Program, as well as other treatments for substance dependencies. We also
research, develop, license and commercialize innovative and proprietary
physiological, nutritional, and behavioral treatment
programs.
In
January 2009, we sold our interest in Comprehensive Care Corporation (CompCare),
a behavioral health managed care company, in which we had acquired a majority
controlling interest in January 2007. Additionally, we entered into
an administrative services only (ASO) agreement with CompCare to provide
administrative services including case management and authorization services in
support of autism and attention deficit hyperactivity disorder (ADHD) specialty
behavioral health products that will be offered through Catasys. As
part of our effort to develop additional specialty behavioral health products
for Catasys, we are continuing to focus on smaller populations that incur
disproportionately higher costs, and that payors have difficulty
addressing.
Catasys’s
integrated substance dependence solution combines innovative medical and
psychosocial treatments with elements of traditional disease management and
ongoing member support to help organizations treat and manage substance
dependent populations to impact both the medical and behavioral health costs
associated with substance dependence and the related
co-morbidities.
Our
unique PROMETA Treatment Program is designed for use by health care providers
seeking to treat individuals diagnosed with dependencies to alcohol, cocaine or
methamphetamine, as well as combinations of these drugs. The PROMETA
Treatment Program includes nutritional supplements, FDA-approved oral and IV
medications used off-label and separately administered in a unique dosing
algorithm, as well as psychosocial or other recovery-oriented therapy chosen by
the patient and his or her treatment provider. As a result, our PROMETA
Treatment Program represents an innovative approach to managing substance
dependence designed to address physiological, nutritional and psychosocial
aspects of the disease, and are thereby intended to offer patients an
opportunity to achieve sustained recovery.
We have
been unprofitable since our inception in 2003 and expect to continue to incur
operating losses for at least the next twelve months. However, we
believe our operating losses will decrease and we will achieve positive cash
flows within the next two years as we begin to sign contracts with managed care
organizations for our Catasys products and the number of covered lives
increases. Accordingly, our historical operations and financial
information are not necessarily indicative of future operating results,
financial condition or ability to operate profitably as a commercial
enterprise.
We
believe that our business and operations as outlined above are in substantial
compliance with applicable laws and regulations. However, the healthcare
industry is highly regulated, and the criteria are often vague and subject to
change and interpretation by various federal and state legislatures, courts,
enforcement and regulatory
authorities.
Additional clinical studies are underway to evaluate our PROMETA Treatment
Program and confirm initial studies and reports from physicians using them
in their practices. The medications used in the PROMETA Treatment Program are
FDA approved for uses other than treating dependence on alcohol, cocaine or
methamphetamine. Therefore, the risks and benefits of using those medications to
treat dependence on those substances have not been evaluated by the FDA, which
may not find them to be sufficiently safe or effective. We do not manufacture,
distribute or sell any medications and have no relationship with any
manufacturers or distributors of medications used in the PROMETA Treatment
Program. Only a treating physician can determine if the PROMETA Treatment
Program is appropriate for any individual patient. Our future prospects are
subject to the legal, regulatory, commercial and scientific risks outlined above
and in Item 1.A Risk Factors.
Substance
Dependence as a Disease
Scientific
research indicates that not only can drugs interfere with normal brain
functioning, but they can also have long-lasting effects that persist even after
the drug is no longer being used. Data indicates that at some point changes may
occur in the brain that can turn drug and alcohol abuse into substance
dependence—a chronic, relapsing and sometimes fatal disease. Those dependent on
drugs may suffer from compulsive drug craving and usage and be unable to stop
drug use or remain drug abstinent without effective treatment. Professional
medical treatment is often necessary to end this physiologically-based
compulsive behavior. We believe that addressing the physiological basis of
substance dependence as part of an integrated treatment program will improve
clinical outcomes, reduce the cost of treating dependence, and reduce the cost
to society by decreasing related criminality and violence, therefore mitigating
the costs associated with high risk behavior.
Alcohol
The
Centers for Disease Control and Prevention rank alcohol as the number three
preventable cause of death in the United States, with 85,000 deaths annually.
According to NIAAA, 47.5% of all deaths due to liver cirrhosis are alcohol
related, with most of these deaths occurring in people 40 to 65 years old. One
study found that 20-37% of all emergency room trauma cases involve alcohol use
(Roizen, J., Alcohol and Trauma, 1988). Another found that 46% of asymptomatic
alcoholic men exhibited evidence of cardiomyopathy (Rubin, E., The Effects of
Alcoholism on Skeletal and Cardiac Muscle, 1989).
The
consequences of alcoholism and alcohol abuse affect most American families. One
study estimated that 20-25% of all injury-related hospital admissions are the
result of alcoholism or alcohol problems (Waller J., Diagnosis of Alcoholism in
the Injured Patient, 1988). According to a 2003 report by the National
Commission Against Drunk Driving, over 250,000 Americans were injured in
alcohol-related traffic crashes, resulting in 17,000 fatalities in 2002.
According to a 2005 report by the National Highway Traffic Safety
Administration, alcohol-related motor vehicle crashes accounted for 39% of all
traffic fatalities in 2004.
Methamphetamine
According
to a National Institute on Drug Abuse (NIDA) report “Methamphetamine: Abuse and
Addiction” (January 2002), the effects of methamphetamine use can include memory
loss, aggression, psychotic behavior, and heart and brain damage.
Methamphetamine is highly addictive and users trying to abstain from use may
suffer withdrawal symptoms that include depression, anxiety, fatigue, paranoia,
aggression, and intense cravings for the drug. Chronic methamphetamine use can
cause violent behavior, anxiety, confusion, and insomnia. Users can also exhibit
psychotic behavior including auditory hallucinations, mood disturbances,
delusions, and paranoia, possibly resulting in homicidal or suicidal thoughts.
According to NIDA’s report “Methamphetamine Abuse Linked to Long-Term Damage to
Brain Cells” (March 2000), use of methamphetamine can cause damage to the brain
that is still detectable months after the use of the drug. The damage to the
brain caused by methamphetamine use appears similar to damage caused by
Alzheimer’s disease, stroke and epilepsy.
Cocaine
and Crack Cocaine
Cocaine
and crack cocaine use are societal problems that place a heavy load upon our
criminal justice system. According to a Bureau of Justice Statistics Bulletin,
“Prisoners in 2006,” published in December 2007, 53% of the 176,000 federal
prisoners and 20% of the 1.3 million state prisoners were convicted of drug
offenses. The National Institute of Justice reports that over 30% of all
arrestees in 2003 tested positive for crack or powder cocaine.
The
consequences of cocaine and crack use extend beyond the criminal justice system.
NIDA reports the medical complications of cocaine use can include heart
arrhythmias and heart attacks, chest pain, respiratory failure, strokes,
seizures and headaches, as well as abdominal pain and nausea. NIDA also notes
that there have been no medications available to treat cocaine
dependence.
Our
Market
Substance
Dependence
Substance
dependence is a worldwide problem with prevalence rates continuing to rise
despite the efforts by national and local health authorities to curtail its
growth. Substance dependence disorders affect many people and have wide-ranging
social consequences. In 2007, an estimated 22.3 million Americans aged 12 and
older were classified with substance dependence or abuse, of which only 2.4
million received treatment at a specialty substance abuse facility, according to
the National Survey on Drug Use and Health published by the Substance Abuse and
Mental Health Services Administration (SAMHSA), an agency of the U.S. Department
of Health and Human Services. Furthermore, according to the survey,
approximately 13 million Americans age 12 and older are reported as having tried
methamphetamine, and, according to its 2006 survey, the percentage of
methamphetamine use characterized as abuse or dependence increased 57% from 2002
to 2005. Findings from the Treatment Episode Data Set (TEDS) Highlights – 2006
published by SAMHSA’s Office of Applied Studies show that the proportion of
admissions for primary abuse of methamphetamine as a percent of substance abuse
treatment admissions increased from 2.5% in 1996 to 8.3% in 2006.
Summarizing
data from the Office of National Drug Control Policy (ONDCP) and the National
Institute on Alcohol Abuse and Alcoholism (NIAAA), the economic cost of alcohol
and drug abuse exceeds $365 billion annually in the U.S., including $42 billion
in healthcare costs and approximately $262 billion in productivity losses.
Despite these staggering figures, it is a testament to the unmet need in the
market that only a small percentage of those who need treatment actually receive
help. Traditional treatment methods are often not particularly effective,
especially when it comes to those who are dependent on stimulants.
There are
over 13,000 facilities reporting to SAMHSA that provide substance dependence
treatment on an inpatient or outpatient basis. Historically, the disease of
substance dependence has been treated primarily through behavioral intervention,
with fairly high relapse rates. SAMHSA’s TEDS 2005 report states that in 2005
only 71% of those treated for alcoholism and 57% of those treated for cocaine
completed detoxification, and that alcohol and cocaine outpatient treatment
completion rates were only 47% and 24%, respectively.
The
stigma of substance abuse, with its lack of effective treatment options and high
cost, has meant that few if any healthcare plans, third-party payors or
employers know how to grapple with this significant health issue. This
leaves a largely untreated or under-treated substance dependent population for a
payor. Impediments to treatment are often the result of behavioral health
units being carved out of the medical division of commercial healthcare plans,
thereby creating a non-integrated treatment approach.
Pharmacological
options for alcohol dependence exist and a number of pharmaceutical companies
have introduced or announced drugs to treat alcohol dependence. These drugs may
require chronic or long-term administration. In addition, several of these drugs
are generally not used until the patient has already achieved abstinence, are
generally administered on a chronic or long-term continuing basis, and do not
represent an integrated treatment approach to addiction. We believe PROMETA can
be used at various stages of recovery, including initiation of abstinence and
during early recovery, and can also complement other existing treatments. As
such, our treatment programs offer a potentially valuable alternative or
addition to traditional treatment methods.
It is
commonly reported that addiction to methamphetamine is an epidemic rapidly
spreading throughout the United States. Methamphetamine addicts are
highly resistant to treatment and, even after intervention, relapse at very high
rates. Methamphetamine use is also spreading to the
workplace. A study funded by the Wal-Mart Foundation in 2004
determined that each methamphetamine-using employee costs his or her employer
$47,500 per year in terms of lost productivity, absenteeism, higher healthcare
costs and higher workers’ compensation costs. For city, state and
county governments and their taxpayers, methamphetamine abuse causes legal,
medical, environmental and social problems. A study entitled “The Criminal
Effect of Meth on Communities” conducted in 2005 by the National Association of
Counties, which surveyed 500 counties in 45 states, reported that 58%
of
counties
surveyed reported methamphetamine as their largest drug problem, with 87%
reporting increases in arrests involving methamphetamine starting three years
earlier. Cocaine was reported as the number one drug problem in 19% of the
counties. There are currently no generally accepted medical treatments for
cocaine or methamphetamine dependence.
The true
impact of substance dependence is often under-identified by organizations that
provide healthcare benefits. The reality is that substance dependent
individuals:
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Are
prevalent in any organization
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Cost
health plans a disproportionate amount of
money
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Stay
in health plans comparably as long as members without substance
dependence
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Have
higher rates of absenteeism and lower rates of
productivity
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Who
have co-morbid medical conditions incur increased costs for the treatment
of these conditions compared to a non-substance dependent
population
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When
considering substance dependence-related costs, many organizations only look at
direct treatment costs–usually behavioral claims. The reality is that
substance dependent individuals generally have overall poorer health and lower
compliance, which leads to more expensive treatment for related, and even
seemingly unrelated, co-occurring medical conditions. In fact, of total
healthcare claims costs associated with substance dependence populations, only
6% are behavioral health, while 94% are medical claims, according to our
research.
Currently,
there are approximately 191 million lives in the United States covered by
various managed care programs, including Preferred Provider Organizations
(PPOs), Health Maintenance Organizations (HMOs), self-insured employers and
managed Medicare/Medicaid programs. Each year, approximately
1.93% of commercial plan members will have a substance dependence diagnosis, and
that figure may be lesser or greater for specific plans depending on the health
plan demographics and location. A smaller, high-cost subset of this
population drives the majority of the claims costs for the overall substance
dependent population. For commercial members with substance
dependence and a total annual claims cost of at least $7,500, the average annual
per member claims cost is $25,500, compared to an average of $3,250 for a
commercial non-substance dependent member, according to our
research.
In
October 2008, the Wellstone and Domenici Mental Health Parity and Addiction
Equity Act was passed as part of the nation’s Troubled Assets Relief Program
(TARP) financial bail-out package. The bill requires that behavioral
coverage be no less favorable than medical coverage, which is expected to
increase utilization of mental health services, causing health plans’ costs to
rise. The impact on commercial plans with high-cost substance
dependent members will be significant. The increased costs will be
most acute for members who recur frequently throughout the health plan system
and whose substance dependence increases the cost of any co-existing
disorders. We expect that this parity bill and the continuing
difficult economic environment will heighten commercial plans’ interest in
programs that can lower their cost and increase their interest in seeking
solutions.
Autism
and ADHD
The
Autism Society of America estimates that 1 in 150 children are autistic, and
with growth rates of 10-17% per year and annual direct treatment costs of up to
$50,000 per child, autism is one of the fastest-growing developmental
disabilities. A recent study indicated that the economic costs
associated with autism are approximately $35 billion dollars annually, and do
not include the myriad challenges that parents encounter in helping their child
cope with the condition. Autistic children typically struggle with
social interaction, display difficulty in communication and may demonstrate
repetitive behaviors or focus on obsessive interests. Many health
care professionals and organizations focused on autism awareness recommend
early, individualized intervention to treat autism. Parents of
autistic children may be presented with numerous treatment alternatives from
speech therapy to self-help services. Because autism is so unique, it
typically requires a care plan tailored to a child’s specific needs, and parents
are often seeking guidance on where to begin and how to access
services.
The
recently passed federal parity law is also expected to have a significant impact
on health plans currently mandated to provide autism
coverage. Numerous well-funded organizations are lobbying to expand
autism coverage mandates throughout all 50 states. The anticipated
cost increases due to parity and state mandated coverage are creating a need for
health plans to focus on managing autism and other costly disorders by launching
cost-effective and integrated medical and behavioral programs that improve
patient care.
ADHD is
typically characterized by an individual’s inattention and
hyperactivity-impulsivity, and diagnosis of ADHD usually involves a
comprehensive and thorough evaluation conducted by trained professionals using
accepted diagnostic interview techniques. Treatment pathways include
support and education of parents, behavioral therapy and pharmacological
treatment—primarily psychostimulants. Health plans currently spend
substantial amounts on pharmaceutical costs, and would significantly benefit
from care management programs that improve patient care and help control
costs.
Our
Solution: Catasys and the PROMETA Treatment Program
We are in
a position to respond to a largely unmet need in the healthcare industry by
offering an innovative and integrated substance dependence treatment solution in
an effort to reduce overall medical costs, improve clinical outcomes and improve
quality of care for patients. People suffering from alcohol and drug
dependence have a clinical disease, but are often characterized as having a
social disorder or a lack of self-discipline. In this context,
traditional treatment approaches have generally focused on the psychosocial
aspect of the disease. While we recognize the psychological approach
to substance dependence treatment is important, we believe that a more
comprehensive approach to this multi-factorial disease should be addressed as
part of an integrated treatment approach intended to provide patients with an
improved chance for recovery. We believe our integrated approach
offers patients a better opportunity to achieve their individual recovery
goals.
Current
research indicates that substance dependence is associated with altered cortical
activity and changes in neurotransmitter function in the specific areas of the
brain which are critical to normal brain function. Moreover, changes in the
neurochemistry of the brain may underlie the hallmarks of substance dependence,
including tolerance, withdrawal symptoms, craving, decrease in cognitive
function and propensity for relapse. Our Catasys and PROMETA Treatment Program
for substance dependence include medically directed and supervised treatments,
prescription medications and nutritional supplements, combined with psychosocial
or other recovery-oriented therapy and patient coaching. We provide a
proprietary integrated treatment program to medical professionals who exercise
their discretion and judgment in the specific implementation of treatment
programs tailored to individual patient needs.
Under our
Catasys offering, we work with health plans and employers using our model to
customize our program to meet a plan’s need on pricing—either a case rate per
patient or a per-member, per-month fee. Our Catasys substance
dependence program is designed for increased enrollment, longer retention and
better health outcomes so we can help payors improve member care and achieve
lower costs, and help employers and organized labor reduce medical costs,
absenteeism and job-related injuries in the workplace, thereby improving
productivity.
Our
proprietary PROMETA Treatment Program combines a medical treatment
approach—addressing the physiological aspects of addiction—with a behavioral
treatment program, including wellness and psychosocial support, and also
includes nutritional aspects. This unique regimen allows us to offer a
more comprehensive way to manage a broader array of aspects of substance
dependence and achieve higher success rates than traditional
approaches.
Catasys™
Our
Catasys integrated substance dependence solution combines innovative medical and
psychosocial treatments with elements of traditional disease management and
ongoing member support to help organizations treat and manage substance
dependent populations, and is designed to lower both the medical and behavioral
health costs associated with substance dependence, and the related
co-morbidities. We believe the benefits of Catasys include improved
clinical outcomes and decreased costs for the payor, and improved quality of
life and productivity for the member.
We
believe Catasys is the only program of its kind dedicated exclusively to
chemical dependence. The Catasys substance dependence program was developed by
addiction experts with years of clinical experience in the substance dependence
field. This experience has helped to form a key area of expertise that sets
Catasys apart from other solutions: member engagement.
Our
Catasys integrated substance dependence program includes the following
components: Member identification, enrollment/referral, provider
network, outpatient medical treatment, outpatient psychosocial treatment, care
coaching, reporting and IT platform.
We target
substance dependence members who incur significant costs and may be appropriate
for enrollment into Catasys. We then enroll targeted members into the
Catasys program through consumer marketing research, mailings, email and
telephonic outreach, for example. After enrollment/referral, we
optimize patient outcomes through a specially trained sub-network of providers,
utilizing integrated treatment modalities. Outpatient medical
treatment follows, where we utilize the most advanced pharmacologic treatments
(primarily PROMETA Treatment Program for alcohol and stimulant dependence and
SUBOXONE® for
opioid dependence) in order to provide more immediate and sustained
results. This is paired with outpatient psychosocial treatment where
we utilize our proprietary psychosocial model, Relapse Prevention Program (RPP),
in order to enhance the neurophysiologic effect gained from the medical
treatment by helping members develop improved coping skills and a recovery
support network. Throughout the treatment process, our care coaches
work directly with members to keep them engaged in treatment by proactively
supporting members to enhance motivation, minimize lapses and enable lifestyle
modifications consistent with the recovery goals. We also link
providers and care coaches to member information through our IT platform,
enabling each provider to assist in providing the best possible care. At
treatment end, we will provide outcomes reporting on clinical and financial
metrics to our customers to demonstrate the extent of the program’s
value.
PROMETA
Treatment Program
Our
PROMETA Treatment Program is an integrated, physician-based outpatient addiction
treatment program that combines three components–medical treatment, nutritional
support and psychosocial therapy–all critical in helping people address
addiction to alcohol and stimulants (e.g. cocaine and methamphetamine). The
program is designed to help relieve cravings, restore nutritional balance and
initiate counseling.
There are
two PROMETA treatments:
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PROMETA
for alcohol dependence
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PROMETA
for stimulant dependence (or combination alcohol/stimulant
dependence)
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Historically,
the disease of addiction has been treated primarily through behavioral
intervention, with fairly high relapse rates. We believe the PROMETA Treatment
Program offers an advantage to traditional alternatives because it provides a
treatment methodology that is discreet and only mildly sedating, and can be
initiated in only three days, with a two-day follow-up treatment three weeks
later for addictive stimulants. The initiation of treatment under PROMETA
involves the oral and intravenous administration of pharmaceuticals in a
medically directed and supervised setting. The medications used in the PROMETA
Treatment Program have been approved by the Food and Drug Administration (FDA)
for uses other than treatment of substance dependence. Treatment generally takes
place on an outpatient basis at a properly equipped outpatient setting or
clinic, or at a hospital or other in-patient facility, by physicians and
healthcare providers who have licensed the rights to use our PROMETA Treatment
Program. Following the initial treatment, our treatment program provides that
patients receive one month of prescription medication, nutritional supplements,
nutritional guidelines designed to assist in recovery, and individualized
psychosocial or other recovery-oriented therapy chosen by the patient in
conjunction with their treatment provider. The PROMETA Treatment Program for
stimulant dependence provides for a second, two-day administration at the
facility, which takes place about three weeks after initiation of treatment. The
medical treatment is followed by continuing care, such as individual or group
counseling, as a key part of recovery.
We
believe the short initial treatment period when using our PROMETA Treatment
Program is a major advantage over traditional inpatient detoxification
treatments and residential treatment programs, which typically consist of up to
28 days of combined inpatient detoxification and recovery in a rehabilitation or
residential treatment
center.
Treatment with PROMETA does not require an extensive stay at an inpatient
facility. Rather, the PROMETA Treatment Program offers the convenience of a
three-day treatment (for addictive stimulants, there is a two-day follow-up
treatment three weeks later) and can be administered on an outpatient basis. The
outpatient nature of the treatment provides the opportunity for the care to be
provided in a discreet manner and without long periods away from home or work.
This is particularly relevant since results from the National Survey on Drug Use
and Health – 2007 reported that approximately 75% of adults using illicit drugs
in 2007 were employed, and loss of time from work can be a significant deterrent
to seeking treatment.
The
PROMETA Treatment Program provides for:
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A
comprehensive physical examination, including specific laboratory tests,
prior to initiation of treatment by the treating physician, to determine
if the patient is appropriate for
PROMETA.
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Prescription
medications delivered in a unique dosing algorithm administered in a
physician-supervised setting. The initial treatment occurs during three
consecutive daily visits of about two hours each. For addictive
stimulants, there is a two-day follow-up treatment three weeks
later.
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A
nutritional plan and recommendations, designed to help facilitate and
maintain the other aspects of
recovery.
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One
month of prescription at-home medications and nutritional supplements and
education following the initial
treatment.
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Individualized
group or individual professional psychosocial counseling, or other
recovery oriented counseling.
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Initial
results indicate that the PROMETA Treatment Program may be associated with
higher initial completion rates than conventional treatments, improved cognitive
function, and reduced physical cravings which can be a major factor in relapse,
thus allowing patients to more meaningfully engage in counseling or other forms
of psychosocial therapy. These initial conclusions have been reported in the
treatment of over 3,200 patients at licensed sites, commercial pilots and in
research studies being conducted to study our treatment programs. They may not
be confirmed by additional double-blind, placebo-controlled research studies,
and may not be indicative of the long-term future performance of our treatment
programs.
We
believe the PROMETA Treatment Program may offer an advantage to traditional
alternatives for several reasons:
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By
first addressing the physiologic components of the disease, substance
dependent patients may have a better opportunity to address the behavioral
and environmental components, enabling them to progress through the
various stages of recovery
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The
PROMETA Treatment Program is designed to address a spectrum of patient
needs, including physiological, nutritional and psychological elements in
an integrated way
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The
PROMETA Treatment Program includes medically directed and supervised
procedures designed to address neurochemical imbalances in the brain that
may be caused or worsened by substance dependence. The rationale for this
approach is that by addressing the underlying physiological balance
thought to be disrupted by substance dependence, dependent persons may be
better able to address the behavioral/psychological and environmental
components of their disease
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Treatment
using the PROMETA Treatment Program generally can be performed on an
outpatient basis and does not require long periods away from home or
work
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The
PROMETA Treatment Program may be initiated at various stages of recovery,
including initiation of abstinence and during early recovery, and can
complement other treatment
modalities
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Additionally,
we provide training, education and other administrative services to assist
physicians, healthcare providers and treatment centers with staff education,
marketing and administrative support.
Treatment
with PROMETA is not appropriate for everyone. PROMETA is not designed for use
with those diagnosed with dependence to opiates, benzodiazepines, or addictive
substances other than alcohol or stimulants. The PROMETA-treating physician must
make the treatment decision for each individual patient regarding the
appropriateness of using the PROMETA Treatment Program during the various stages
of recovery.
Our
Strategy
Our
business strategy is to provide quality integrated medical and behavioral
programs to help organizations treat and manage substance dependent populations
to impact both the medical and behavioral health costs associated with
substance-dependence and the related co-morbidities. We intend to grow our
business through increased adoption of our Catasys integrated substance
dependence solutions, and our autism and ADHD solutions, by managed care health
plans, employers, unions and other third-party payors. We also intend to grow
our business through increased utilization of our PROMETA Treatment Program from
within existing and new licensees and managed treatment centers.
Key elements of our business
strategy include:
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Providing
our Catasys integrated substance dependence solutions to managed care
health plans for reimbursement on a case rate or monthly
fee
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Educating
third party payors on the disproportionately high cost of their substance
dependent population
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Demonstrating
the potential for improved clinical outcomes and reduced cost associated
with using our Catasys programs with key managed care and other
third-party payors
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Launching
other specialty behavioral health products and programs, including Autism
and ADHD, that can leverage our existing infrastructure and sales
force
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Further
validation of the benefits of the PROMETA Treatment Program through the
pending clinical studies by leading research institutions and preeminent
researchers in the field of alcohol and substance
abuse
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As an
early entrant into offering integrated medical and behavioral programs for
substance dependence, and one of the first to offer autism and ADHD specialty
programs, Catasys will be well positioned to address increasing market
demand. Our Catasys products will help fill the gap that exists
today: a lack of programs that focus on smaller populations with
disproportionately higher costs, and that improve patient care while controlling
overall treatment costs.
Catasys
– Integrated Substance Dependence Solutions
There are
currently approximately 191 million lives in the United States covered by
various managed care programs, including PPOs, HMOs, self-insured employers and
managed Medicare/Medicaid programs. We believe our greatest opportunities for
growth are in this market segment.
Our
proprietary Catasys integrated substance dependence solutions are designed to
improve treatment outcomes and lower the utilization of medical and behavioral
health plan services by high utilizers and high risk enrollees. Our
Catasys substance dependence programs include medical (including
the PROMETA Treatment Program) and proprietary psychosocial interventions
and the use of our PROMETA Treatment Program, a proprietary information
technology platform and database, clinical algorithms, psychosocial programs and
integrated case management and care coaching services.
Another
important aspect of the Catasys program is that the program is flexible and can
be altered in a modular way to enable us to partner with payors to meet their
needs. As a service delivery model, the Catasys program can be
expanded to include other medical interventions for addiction such as
buprenorphine for opiate dependent
patients.
In this way Catasys can work with payors to identify, engage, and treat
medically and behaviorally a broader spectrum of patients struggling with
substance dependence in a way that improves outcomes and thereby lowers
costs.
Our
proposed value proposition to our customers includes the following
benefits:
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Specific
programs aimed at addressing high-cost conditions by improving patient
care and reducing overall medical costs can benefit health plans that do
not have or do not wish to dedicate the capacity, ability or focus to
develop these programs internally
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Increased
worker productivity, by reducing workplace absenteeism, compensation
claims, and job related injuries
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Decreased
emergency room and inpatient
utilization
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Decreased
readmission rates
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Healthcare
cost savings (including medical, behavioral and
pharmaceutical)
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Catasys
– Autism and ADHD Specialty Programs
Autism
and ADHD are high cost conditions impacting both behavioral and medical costs
for those states in which coverage is mandated and would benefit from better
coordination and management through specialty programs that more rigorously
apply evidence based practices and specialty specific provider
sub-networks. These conditions require greater depth and higher
intensity case management than many conditions, have significant medical cost
implications, and would be augmented by programs specifically designed to manage
the disorders. Our Catasys specialty programs delivered in
conjunction with CompCare under an ASO agreement will help patients reduce
hurdles to obtaining appropriate care, and provide them with greater access to a
variety of public and private services available in their
communities.
In
completing development of our new autism and ADHD programs, Catasys will be able
to leverage its existing infrastructure and expertise, such as product
development, sales, marketing and clinical components, to incorporate these
programs and pursue both commercial and government opportunities. The
new products are expected to be particularly relevant because of the recently
passed Wellstone and Domenici Mental Health Parity and Addiction Equity Act, and
because several states currently have some level of mandated autism coverage
with additional states to add coverage soon. These new specialty
behavioral health products and programs fit within our strategy of offering
programs that address smaller populations with disproportionately higher costs
for health plans. Specific programs aimed at addressing high-cost
conditions by improving patient care and reducing overall medical costs can
benefit health plans that do not have or do not wish to dedicate the capacity or
focus to develop programs internally.
Managed
Medical Practices and Treatment Centers
Under the
terms of full business service management agreements with medical professional
corporations and treatment centers, we manage their business components and
license to them the PROMETA Treatment Program and use of our PROMETA trademark
in exchange for management and licensing fees. These treatment centers offer the
PROMETA Treatment Program for dependencies on alcohol, cocaine and
methamphetamines, and also offer medical interventions for other substance
dependencies. Under generally accepted accounting principles (GAAP), the
revenues and expenses of such managed treatment centers are included in our
consolidated financial statements. We currently manage two such treatment
centers, the PROMETA Center in Santa Monica, California, and the Murray Hill
Recovery Center in Dallas, Texas.
Self-pay
Patients – Licensees
A
significant source of our revenues to date has been from license fees derived
from the licensing of our PROMETA Treatment Program to physicians and other
licensed treatment providers. Although we plan to continue to provide
such services to our existing licensees for the treatment of substance
dependencies using our PROMETA
Treatment
Program, we do not expect to significantly invest in or expand this line of
business at this time. Accordingly, in 2008 we significantly reduced our
resources in each market area to more closely match our resources and
expenditures with revenues from our licensees in each market.
International
Operations
In 2007,
we expanded our operations into Europe, with our Swiss foreign subsidiary
commencing operations in the first quarter of 2007. However, in 2008 we
decided to substantially curtail our foreign operations to reduce costs and
focus on our Catasys offering.
Clinical
Data from Research Studies
There are
several research studies evaluating treatment with the PROMETA Treatment
Program, conducted by leading research institutions and preeminent researchers
in the field of alcohol and substance abuse. In 2007, three studies by industry
thought leaders were completed. Dr. Harold C. Urschel III conducted a
randomized, double-blind, placebo-controlled methamphetamine study, preceded by
an open-label methamphetamine study, the results of which were peer-reviewed and
published in July 2007. Dr. Urschel’s double-blind placebo-controlled
study showed that the pharmacological component of the PROMETA Treatment Program
versus placebo had a statistically significant reduction of cravings for
methamphetamine. This data further validates our PROMETA Treatment Program
with respect to reducing cravings and improving retention by also allowing
recipients to engage more actively in psychosocial counseling, thereby improving
treatment outcomes.
Both the
peer-reviewed published study and the top-line data from the double-blind,
placebo-controlled study indicate that the PROMETA Treatment Program appears to
reduce cravings for methamphetamine. We are not aware of any other published
study showing such results. Moreover, no patients have reported any major
adverse events or had to discontinue the treatment due to side
effects.
At the
Cedars-Sinai Medical Center in Los Angeles, Dr. Jeffrey Wilkins concluded a
30-subject, open-label, single-site alcohol study with a 16-week follow-up that
showed a substantial reduction in cravings and use among subjects treated with
the medical portion and nutritional elements of the PROMETA Treatment
Program. The study also showed that subjects with measurable
neurocognitive deficits at baseline showed significant improvement by week 2,
and all but one of the subjects tested normal at week 16.
Drug
treatment experts agree that minimizing cravings is critical to supporting
recovery, and that decreased cravings are an important indicator of treatment
success. Published clinical research has shown that cravings are a key cause of
continued drug use and relapse for those patients trying to end drug use. In a
study titled “Craving predicts use during treatment for methamphetamine
dependence: a prospective, repeated-measures, within-subject analysis,”
published in Drug and Alcohol Dependence in 2001, it was shown that among the
test population, craving scores that preceded use were 2.7 times higher than
craving scores that preceded abstinence. This confirms the long-held conviction
among clinicians that cravings drive substance dependent individuals to continue
to use, even when they truly desire to stop.
In Drug
and Alcohol Dependence, Hartz et al. cited leading addiction experts’ view of
the role that cravings play in the disease. These experts agreed on the critical
importance of addressing cravings in treatment. Dr. Charles O’Brien from the
University of Pennsylvania stated, “Cravings is viewed by many as the primary
symptom motivating drug use and the appropriate target of behavioral
interventions.” Robinson and Berridge refer to cravings and subsequent relapse
as, “the defining characteristics of addiction.”
Additionally,
in the Journal of Substance Abuse Treatment, Dackis et al. concluded, “Although
patients cite many reasons why they use cocaine, the feeling states of craving
and euphoria are the primary reinforcers of the addiction.”
Studies
funded by our unrestricted grants that are completed, pending or underway
include:
Completed
studies:
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A
135-subject randomized, double-blind, placebo-controlled study of the
PROMETA Treatment Program’s acute effects on cravings and cognition in
methamphetamine dependent subjects designed and supervised by Harold
Urschel, M.D., completed in October 2007. Top line results showed a
statistically significant reduction in cravings versus placebo. The
results of this study were presented at College on Problems of Drug
Dependence (CPDD) conference in June 2006 and have been submitted for
publication.
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A
50-subject open-label study of the physiological component of the PROMETA
Treatment Program for methamphetamine dependence conducted by Dr. Urschel
that was completed in 2006, in which it was reported that more than 80% of
study participants experienced a significant clinical benefit—measured
through decrease in cravings, reduction of methamphetamine use and
treatment retention—after treatment, with no adverse events. The results
of this study were reported in October 2007 in a peer-reviewed journal,
Mayo Clinic Proceedings.
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A
60–subject, randomized, double-blind, placebo-controlled study of the
PROMETA Treatment Program for the initiation and extension of abstinence
of alcoholism conducted by Raymond Anton, M.D., at Medical University of
South Carolina. Initial results of the study were presented at the
Research Society on Alcoholism conference in Washington, DC, in July 2008,
which showed that patients demonstrating relatively more symptoms of
substance dependence withdrawal had a significant response to PROMETA
and
during the follow up 8 week period, though not statistically significant,
the higher withdrawal PROMETA subjects continued to be superior for end
points that included percent days abstinent and craving, when compared to
placebo. For patients demonstrating lower withdrawal symptoms,
PROMETA had no effect or a lesser response compared to placebo subjects,
who fared better in the study. Additionally, during the
treatment phase and at the end of the study the data demonstrated that
those patients with higher withdrawal symptoms had a significant
difference on the measures of percent days abstinent and cravings, as
compared to patients with lower withdrawal symptoms, which provides
substantial clarity on which patients may benefit from PROMETA.
This study has been submitted for
publication.
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A
30-subject open label randomized controlled study of the PROMETA Treatment
Program in the treatment of alcohol dependence conducted by Jeffery
Wilkins, M.D., at Cedars-Sinai Medical Center in Los Angeles completed in
August 2007. Top line results reported at 30 days showed a 94% decrease in
median cravings and an 82% reduction in mean percentage of total drinking
days. The results of this study were presented at the Research Society on
Alcoholism conference in July 2007.
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In
2008, Sheryl Smith, Ph.D., a leading researcher in the field of
neurosteroids, presented data further supporting a mechanism of action
underlying our PROMETA Treatment Program at the 2008 Society for
Neuroscience annual meeting in Washington, D.C. The study focused on
methamphetamine dependent rats and highlighted a methamphetamine induced
increase in the alpha-4 and delta subunit expression of the GABA receptor
that has been associated with states of hyper-excitability and anxiety.
Receptor dysregulation of the alpha-4 subunit has previously been
associated with alcohol, methamphetamine and neurosteroid withdrawal. The
current study shows that a component of the PROMETA Treatment Program
reverses the increase in both alpha-4 and delta subunit expression in
chronic methamphetamine treated
rats.
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A 120-subject
randomized, double-blind, placebo-controlled study of the PROMETA
Treatment Program’s acute and immediate effects on cravings and cognition
in alcohol dependent subjects was completed in January 2009. The
study was designed and supervised by alcoholism researcher, Joseph R.
Volpicelli, M.D., Ph.D., at the Institute of Addiction Medicine in
Philadelphia. This
study demonstrated that for patients with lower symptoms of withdrawal and
a clinical history of alcohol withdrawal symptoms, when treated with
PROMETA experienced a statistically significant decrease in alcohol
craving and alcohol consumption during the active treatment phase, as
compared to
placebo.
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Ongoing
studies:
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120-subject
multi-site, randomized, double-blind, placebo-controlled study of the
PROMETA Treatment Program for the treatment of methamphetamine dependence
being conducted by Walter Ling, M.D., of
UCLA.
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We
believe additional positive results from published studies of our PROMETA
Treatment Program will enhance our efforts to increase third-party reimbursement
for providers using our treatment programs.
In a step
to further ensure the integrity of the clinical data, the independent physicians
who are conducting clinical trials of the PROMETA Treatment Program own their
study data and have complete control over the resulting data.
Additionally,
we are a pioneering company in exploring and identifying the role GABA
dysregulation plays in addiction as well as in generalizable anxiety
disorders. We believe that in the wake of many articles recently published
about the association between addiction and anxiety, as well as the growing
recognition by the scientific community of the GABA system’s part in it, this
essential and pioneering premise is being affirmed. With this mounting
body of evidence and our growing intellectual property estate, we firmly believe
that we will bring substantial and increasing value to the life sciences and
pharmaceutical fields. Our entirely distinct applications for composition
of matter and use patents for various treatment approaches for multiple CNS
indications, in which GABA receptor dysregulation may serve as the critical
pathology, have significant clinical implications.
Our
Operations
Healthcare
Services
To date,
a substantial portion of our healthcare services revenues has been derived from
license fees for the use of the PROMETA Treatment Program in treating self-pay
patients, and consolidation of self-pay patient revenues from our managed
treatment centers. We commenced operations in July 2003 and signed our first
licensing and administrative services agreement in November 2003. Under our
licensing agreements, we provide physicians and other licensed treatment
providers access to our PROMETA Treatment Program, education and training in the
implementation and use of the licensed technology and marketing support. We
receive a fee for the licensed technology and related services, generally on a
per patient basis. As of December 31, 2008, we had active licensing
agreements with physicians, hospitals and treatment providers for 84 sites
throughout the United States. However, we streamlined our operations
during 2008 to increase our focus on Catasys integrated substance dependence
solutions, significantly reducing our field and regional sales personnel. We
will continue to enter into agreements on a selective basis with additional
healthcare providers to increase the availability of the PROMETA Treatment
Program, but only in markets where we are presently operating or where such
sites will provide support for our Catasys products. Revenues are
generally related to the number of patients treated, and key indicators of our
financial performance for the PROMETA Treatment Program will be the number of
facilities and healthcare providers that license our technology, and the number
of patients that are treated by those providers using our PROMETA Treatment
Program. Since July 2003, over 3,200 patients have completed treatment using our
PROMETA Treatment Program at our licensed sites, and in commercial pilots and
research studies being conducted to study our treatment programs.
We
currently manage two treatment centers under our licensing agreements, located
in Santa Monica, California (dba The PROMETA Center, Inc.) and Dallas, Texas
(Murray Hill Recovery, LLC), whose revenues and expenses are included in our
consolidated financial statements.
In 2007
and 2008, we developed and operationalized our Catasys integrated substance
dependence solutions for third-party payors. We believe that our Catasys
offerings will address the largest segment of the healthcare market for
substance dependence.
We do not
operate our own healthcare facilities, employ our own treating physicians or
provide medical advice or treatment to patients. We provide services, which
assist health plans to manage their substance dependence populations, and access
to tools that physicians may use to treat their patients as they determine
appropriate. The hospitals, licensed healthcare facilities, and physicians that
contract for the use of our technology own their facilities or professional
licenses, and control and are responsible for the clinical activities provided
on their premises. Patients receive medical care in accordance with orders from
their attending physicians. Physicians with license rights to use the
PROMETA Treatment Program exercise their independent medical judgment in
determining the use and specific application of our treatment programs, and the
appropriate course of care for each patient. Following the medical portion of
the treatment procedure, physicians, local clinics and healthcare providers
specializing in drug abuse treatment administer and provide the psychosocial
component of the PROMETA Treatment Program.
Behavioral
Health Managed Care Services
All of
our behavioral health managed care service revenues have been derived from the
operations of our consolidated subsidiary, CompCare, in which we acquired a
majority controlling interest on January 12, 2007. In January 2009,
we sold our interest in CompCare.
Competition
Healthcare
Services
Catasys
Our
Catasys products primarily focus on substance dependence and are marketed
to health plans, employers and unions who have members or employees with
coverage for such medical and behavioral diseases. While we believe our products
and services are unique, we operate in highly competitive markets. We compete
with other healthcare management service organizations and disease management
companies, including managed behavioral health organizations (MBHOs), HMOs,
PPOs, third-party administrators and other specialty healthcare and managed care
companies. Most of our competitors are significantly larger and have greater
financial, marketing and other resources than us. In addition, customers that
are managed care companies may seek to provide similar specialty healthcare
services directly to their members, rather than by contracting with us for such
services. Behavioral health conditions, including substance
dependence, are typically managed for insurance companies by internal or
third-party (MBHO), frequently under capitated arrangements. Under
such arrangements, MBHOs are paid a fixed monthly fee and must pay providers for
provided services, which gives such entities an incentive to decrease cost and
utilization of services by members. We compete to differentiate our
integrated program for high utilizing substance dependence members from the
population of utilization management programs that MBHOs
offer.
We
believe that our ability to offer customers a comprehensive and integrated
substance dependence solution, including the utilization of innovative medical
and psychosocial treatments, and our unique technology platform will enable us
to compete effectively. However, there can be no assurance that we
will not encounter more effective competition in the future, which would limit
our ability to maintain or increase our business.
PROMETA
Treatment Program
Our
PROMETA Treatment Program focuses on providing licensing, administrative and
management services to licensees that administer PROMETA and other treatment
programs, including medical practices and treatment centers that are licensed
and managed by us. We compete with many types of substance dependence
treatment
methods,
treatment facilities and other service providers. Conventional forms of
treatment for alcohol dependence are usually divided into phases:
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Detoxification,
which is typically conducted in medically directed and supervised
environments
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Rehabilitation,
which is often conducted through short- or long-term therapeutic
facilities or programs, most of which do not offer medical management
options
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Relapse
prevention/aftercare that is provided via structured outpatient treatment
programs.
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Most
medically managed treatments require long-term usage of pharmaceuticals,
resulting in low patient compliance. Conventional forms of treatment for
stimulant dependence generally consist only of relapse prevention (psychosocial
and recovery oriented therapy), conducted through therapeutic
programs. Regardless of the approach, there is great variability in
the duration of treatment procedures, level of medical supervision, price to the
patients, and success rates.
One
currently accepted practice for detoxifying patients from dependence on alcohol
consists of heavily sedating the patient at an inpatient hospital facility for a
period of three to five days. Due to the heavy sedation, the patient may
need to be observed for an additional five to seven days. This procedure, while
medically necessary to prevent severe complications, e.g. seizures or delirium
tremens when withdrawing these patients from alcohol, does not consistently
relieve the patient’s cravings or otherwise attempt to address the long term
recovery of the patient. Further, the drugs typically used during this procedure
(the most commonly utilized medications are Valium® (diazepam), Ativan®
(lorazepam), and Xanax® (alprazolam)) can be addictive, and/or require a
time-intensive dose tapering and washout period, and/or cause side
effects.
While
withdrawal from cocaine or methamphetamine dependence is not considered to be
life threatening, withdrawal symptoms can be extremely unpleasant and may lead
to repeated relapses and treatment failures. Detoxification procedures typically
involve the use of sedatives to assist patients through this difficult period.
Following treatment, however, environmentally “cue induced” cravings are
especially pronounced and may re-occur for months to years.
Treatment
Programs
There are
over 13,000 facilities reporting to the SAMHSA that provide substance
dependence treatment on an inpatient or outpatient basis. Well-known examples of
residential treatment programs include the Betty Ford Center®, Caron
Foundation®, Hazelden® and Sierra Tucson®. In addition, individual physicians
may provide substance dependence treatment in the course of their
practices. There appears to be no readily available reliable information
about the success rates of these programs, nor agreed upon standards of how
outcomes should be measured (e.g. self-reported abstinence or reduction in days
of heavy drinking). Many of these traditional treatment programs have
established name recognition, and their treatments may be covered in large part
by insurance or other third party payors. To date, treatments using our PROMETA
Treatment Program have generally not been covered by insurance, and patients
treated with the PROMETA Treatment Program have been substantially self-pay
patients.
Traditional
treatment approaches for substance dependence focus mainly on group therapy,
abstinence and behavioral modification, while the disease’s underlying
physiology and pathology is rarely addressed, resulting in fairly high relapse
rates. Currently, therapies are beginning to target brain receptors thought to
play a central role in the disease process. We believe that our PROMETA
Treatment Program offers an improvement to traditional treatments because the
integrated PROMETA Treatment Program is designed to target the pathophysiology
induced by chronic use of alcohol or other drugs in addition to nutritional and
psychosocial aspects of substance dependence. The abnormalities in
brain function induced by chronic substance dependence may take weeks to years
of drug abstinence to return to normal function, if at all. We believe the
PROMETA Treatment Program offers an advantage to traditional alternatives
because it provides an integrated treatment methodology that is discreet, mildly
sedating and can be initiated in only three days, with a second two-day
treatment three weeks later for addictive stimulants. Our PROMETA Treatment
Program also provides for one month of prescription medication and nutritional
supplements, integrated with psychosocial or other recovery-oriented
therapy.
We
further believe the short initial outpatient treatment period when using our
PROMETA Treatment Program is a major advantage over traditional inpatient
treatments and residential treatment programs, which typically consist of
approximately 15 to 28 days of combined inpatient detoxification and
recovery in a rehabilitation or residential treatment center. The PROMETA
Treatment Program does not require an extensive stay at an inpatient facility.
Rather, the treatment program offers the convenience of a three day treatment
(addictive stimulants require a second two-day treatment three weeks later) and
can generally be administered on an outpatient basis. This is particularly
relevant since approximately 75% of adults classified with dependence or abuse
are employed, and loss of time from work can be a major deterrent for seeking
treatment. Moreover, we believe the PROMETA Treatment Program can be
used at various stages of recovery, including initiation of abstinence and
during early recovery, and can complement other forms of alcohol and drug abuse
treatments. As such, our treatment program offers a potentially valuable
alternative or addition to traditional behavioral or pharmacotherapy
treatments.
Treatment
Medications
There are
currently no generally accepted medical treatments for methamphetamine
dependence. Anti-depressants and dopamine agonists have been investigated as
possible maintenance therapies, but none have been FDA approved or are generally
accepted for medical practice.
Several
classes of pharmaceutical agents have been investigated as potential maintenance
agents (e.g., anti-depressants and dopamine agonists) for cocaine dependence;
however, none are FDA approved for treatment of cocaine dependence or generally
accepted widely in medical practice. Their effects are variable in terms of
providing symptomatic relief, and many of the agents may cause side effects or
may not be well tolerated by patients.
There are
a number of companies developing or marketing medications for reducing craving
in the treatment of alcoholism. Currently available medications
include:
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The
addiction medication naltrexone, an opiate receptor antagonist, is
marketed by a number of generic pharmaceutical companies as well as under
the trade names ReVia®
and Depade®,
for treatment of alcohol
dependence;
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VIVITROL®,
an extended release formulation of naltrexone manufactured by Alkermes, is
administered via monthly injections for the treatment of alcohol
dependence in patients who are able to abstain from drinking in an
outpatient setting, and are not actively drinking prior to treatment
initiation. Alkermes reported that in clinical trials, when used in
combination with psychosocial support, VIVITROL was shown to reduce the
number of drinking days and heavy drinking days and to prolong abstinence
in patients who abstained from alcohol the week prior to starting
treatment;
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Campral®
Delayed-Release Tablets (acamprosate calcium), an NMDA receptor antagonist
taken two to three times per day on a chronic or long-term basis and
marketed by Forest Laboratories. Clinical studies supported the
effectiveness in the maintenance of abstinence for alcohol-dependent
patients who had undergone inpatient detoxification and were already
abstinent from alcohol;
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Many
medications marketed to treat alcohol or drug dependence are not administered
until the patient is already abstinent or require long-term chronic
administration and. As noted above, we believe the PROMETA Treatment Program
represents an approach to treatment that includes medical, nutritional and
psychosocial components that can be used at various stages of recovery,
including initiation of abstinence and during early recovery, and can complement
other existing treatments. As such, our treatment programs offer a potentially
valuable addition to traditional medical treatment. Moreover, because treatment
with the PROMETA Treatment Program is an integrated treatment, we do not view
the current medical therapies as directly competitive and in some cases may be
used in conjunction with our treatment programs. We also believe, based on the
limited initial results discussed above, that treatment using our treatment
programs may have higher completion rates, greater compliance, reduction or
elimination of cravings and potentially lower relapse rates.
Behavioral
Health Managed Care Services
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 191 million covered lives in the United
States. CompCare’s competitors include both freestanding MBHOs as well as
managed care companies with internal behavioral health units or subsidiaries.
Most of these competitors have revenues and financial resources substantially
larger than CompCare. In January 2009, we sold our interest in
CompCare.
Development
of Our Technology
Much of
our proprietary, patented and patent–pending, substance dependence technology
known as the PROMETA Treatment Program, was developed by Dr. Juan José
Legarda, a European scientist educated at University of London who has spent
most of his professional career conducting research related to substance abuse.
In 2002, Dr. Legarda filed Patent Cooperation Treaty
(PCT) applications in Spain to protect treatment programs that he developed
for dependencies to alcohol and cocaine. We acquired the rights to these patent
filings in March 2003 through a technology purchase and license agreement with
Dr. Legarda’s company, Tratamientos Avanzados de la Adiccion S.L., to which
we pay a royalty of three percent of the amount the patient pays for treatment
using our treatment programs. After acquiring these rights, we filed
U.S. patent applications and other national phase patent applications based
on the PCT filings, as well as provisional U.S. patent applications to
protect aspects of additional treatment programs for alcohol, cocaine and other
addictive stimulants.
We have
two issued U.S. patents, one relating to the treatment of cocaine dependency
with our PROMETA Treatment Program and one relating to our PROMETA Treatment
Program for the treatment of certain symptoms associated with alcohol
dependence. We have also received allowances, issuances or notices
that patent grants are intended for our core intellectual property for the
treatment of alcohol and/or stimulant dependence in Canada, Mexico, Switzerland,
Australia, New Zealand, Singapore, South Africa, Russia, Turkey, South Korea,
Hong Kong and the European Union.
Once
patents are issued, they generally will expire 20 years from the dates of
original filing. Our two issued U.S. patents will expire in 2021.
Proprietary
Rights and Licensing
Our
success depends in large part on our ability to protect our proprietary
technology and operate without infringing on the proprietary rights of others.
We rely on a combination of patent, trademark, trade secret and copyright laws
and contractual restrictions to protect the proprietary aspects of our
technology. Our branded trade names include the following:
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Hythiam®
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PROMETA®
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Catasys™
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The
Science of Recovery®
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We impose
restrictions in our license agreements on our customers’ rights to utilize and
disclose our technology. We also seek to protect our intellectual property by
generally requiring employees and consultants with access to our proprietary
information to execute confidentiality agreements and by restricting access to
our proprietary information. We require that, as a condition of their
employment, employees assign to us their interests in inventions, original works
of authorship, copyrights and similar intellectual property rights conceived or
developed by them during their employment with us.
Our
Management Team
The
following table sets forth information regarding our executive
officers:
|
Name
|
Position
|
Age
|
|
Terren
S. Peizer
|
Chief
Executive Officer
|
49
|
|
Richard
A. Anderson
|
President
and Chief Operating Officer
|
39
|
|
Christopher
S. Hassan
|
Chief
Strategy Officer
|
48
|
|
Maurice
S. Hebert
|
Chief
Financial Officer
|
46
|
Terren S. Peizer is the
founder of our company and has served as our chief executive officer and
chairman of our Board of Directors since our inception in February
2003. Mr. Peizer has served on the board of Xcorporeal, Inc. since
August 2007 and was executive chairman until October 2008. Mr. Peizer also
served as chief executive officer of Clearant, Inc., a company which he founded
in April 1999 to develop and commercialize a universal pathogen
inactivation technology, until October 2003. He served as chairman of its
Board of Directors from April 1999 to October 2004 and as a director
until February 2005. From February 1997 to February 1999,
Mr. Peizer served as president and vice chairman of Hollis-Eden
Pharmaceuticals, Inc., a NASDAQ Global Market listed company. In addition, from
June 1999 through May 2003 he was a director, and from June 1999
through December 2000 he was chairman of the board, of supercomputer
designer and builder Cray Inc., a NASDAQ Global Market company. Since August
2006, he has served as chairman of the board of Xcorporeal, Inc., an American
Stock Exchange listed company. Mr. Peizer has been the largest beneficial
stockholder and has held various senior executive positions with several
technology and biotech companies. He has assisted companies by assembling
management teams, boards of directors and scientific advisory boards,
formulating business and financial strategies, and investor relations.
Mr. Peizer has a background in venture capital, investing, mergers and
acquisitions, corporate finance, and previously held senior executive positions
with the investment banking firms Goldman Sachs, First Boston and Drexel Burnham
Lambert. He received his B.S.E. in Finance from The Wharton School of Finance
and Commerce.
Richard A. Anderson has more
than fifteen years of experience in business development, strategic planning and
financial management. He has served as a director since July 2003 and an officer
since April 2005. He was the chief financial officer of Clearant, Inc. from
November 1999 until March 2005, and served as a director from
November 1999 to March 2006. Mr. Anderson was previously
with PriceWaterhouseCoopers, LLP, for seven years, most recently a director and
founding member of PriceWaterhouseCoopers Los Angeles Office Transaction Support
Group, where he was involved in operational and financial due diligence,
valuations and structuring for high technology companies. He received a B.A. in
Business Economics from University of California, Santa Barbara.
Christopher S. Hassan is a
senior healthcare executive who, prior to joining us in July 2006, served
as vice president, sales for Reckitt Benckiser Pharmaceuticals since
October 2003. From 2000 to October 2002, he served as director of
sales, North America for Drugabuse Sciences, Inc. a bio-pharmaceutical company.
From 1996 to 2000, Mr. Hassan served as area business manager for
Parke-Davis/Pfizer. From 1989 to 1996 he served as district sales manager for
Bayer Pharmaceuticals. Mr. Hassan received a B.B.A. in Accounting from
University of Texas, Austin.
Maurice S. Hebert has
served as our chief financial officer since November 2008. From
October 2006 to October 2008, Mr. Hebert served as our vice president and
corporate controller and from February 2007, as our principal accounting
officer. Mr. Hebert has 23 years of experience as a financial
executive, including 14 years within the insurance and managed care
industries. From April 2005 to October 2006, Mr. Hebert served
as corporate controller and principal accounting officer at Health Net, Inc. in
Woodland Hills, CA. From October 2003 to April 2005, he was with Safeco
Corporation (Insurance) in Seattle, WA, most recently as senior vice president
& controller and principal accounting officer. From 1993 to 2003, Mr. Hebert
was with AIG SunAmerica in Woodland Hills, CA, most recently as vice president
& controller-Life Insurance Companies. Mr. Hebert received a B.S. in
Accounting from Louisiana State University.
Financial
Information about Segments
We have
conducted our operations through two business segments: healthcare services and
behavioral health managed care services. Our healthcare services segment
provides our Catasys integrated substance dependence, autism and ADHD solutions
to health plans, employers and unions through a network of licensed and company
managed healthcare providers, and provides licensing, administrative and
management services to licensees that administer
PROMETA and other treatment programs, including managed treatment centers that
are licensed and/or managed by us. Our behavioral health managed care services
segment, comprised entirely of the operations of our consolidated subsidiary,
CompCare, provides managed care services in the behavioral health, psychiatric
and substance abuse fields. A majority of our consolidated revenues and assets
are earned or located within the United States.
In
January 2009, we disposed of our entire interest in CompCare, and as a
result we will have only one reporting segment, healthcare
services.
Employees
As of
December 31, 2008, we and our consolidated managed treatment centers
employed 81 persons, and our consolidated subsidiary, CompCare, employed 74
persons. We are not a party to any labor agreements and none of our
employees are represented by a labor union.
Our
Offices
We are
incorporated under the laws of the State of Delaware. Our principal executive
offices are located at 11150 Santa Monica Boulevard, Suite 1500, Los
Angeles, California 90025 and our telephone number is
(310) 444-4300.
Company
Information
We make
our annual reports on Form 10-K, our proxy statement, our quarterly reports on
Form 10-Q, our current reports on Form 8-K, and any amendments to these reports
available free of charge through links on our corporate website as soon as
reasonably practicable after such reports are filed with, or furnished to, the
Securities and Exchange Commission (SEC). Our corporate website is located on
the Internet at http://www.hythiam.com. These reports are not part of this
report or incorporated by reference herein. 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.
ITEM 1A. RISK FACTORS
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 occurs, 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.
Risks
related to our business
We
have a limited operating history, expect to continue to incur operating losses
and may be unable to obtain additional financing, causing our independent
auditors to express substantial doubt about our ability to continue as a going
concern
We have
been unprofitable since our inception in 2003 and expect to continue to incur
substantial additional operating losses and negative cash flow from operations
for at least the next twelve months. As of December 31, 2008,
these conditions raised substantial doubt as to our ability to continue as a
going concern. At December 31, 2008, cash, cash equivalents and current
marketable securities amounted to $11.0 million, of which $1.1 million related
to CompCare, which was sold in January 2009. At that date, we had a working
capital deficit of approximately $11.5 million, of which $5.7 million is related
to CompCare. During the year ended December 31, 2008, our cash and cash
equivalents used in operating activities amounted to $29.4 million, of which
$5.5 million related to CompCare. Although we have recently taken actions to
decrease expenses, increase revenues and obtain additional financing, there can
be no assurance that we will be successful in our efforts. We may not be
successful in raising necessary funds on acceptable terms or at all, and we may
not be able to offset this by sufficient reductions in expenses and increases in
revenue. If this occurs, we may be unable to meet our cash obligations as they
become due and we may be required to further delay or reduce operating expenses
and curtail our operations, which would have a material adverse effect on us.
We
may fail to successfully manage and maintain the growth of our business, which
could adversely affect our results of operations, financial condition and
business
Continued
expansion could put significant strain on our management, operational and
financial resources. The need to comply with the rules and regulations of the
SEC and The NASDAQ Global Market will continue to place significant demands on
our financial and accounting staff, financial, accounting and information
systems, and our internal controls and procedures, any of which may not be
adequate to support our anticipated growth. We may not be able to effectively
hire, train, retain, motivate and manage required personnel. Our failure to
manage growth effectively could limit our ability to satisfy our reporting
obligations, or achieve our marketing, commercialization and financial
goals. Recent actions to reduce costs and streamline our operations,
as well as planned future cost reductions, could place further demands on our
personnel, which could hinder our ability to effectively execute on our business
strategies.
We
will need additional funding, and we cannot guarantee that we will find adequate
sources of capital in the future.
We have
incurred negative cash flows from operations since inception and have expended,
and expect to continue to expend, substantial funds to grow our business. We
currently estimate that our existing cash, cash equivalents and marketable
securities will not be sufficient to fund our operating expenses and capital
requirements for at least the next twelve months. We will require
additional funds before we achieve positive cash flows and we may never become
cash flow positive.
If we
raise additional funds by issuing equity securities, such financing will result
in further dilution to our stockholders. Any equity securities issued also may
provide for rights, preferences or privileges senior to those of holders of our
common stock. If we raise additional funds by issuing additional debt
securities, these debt securities would have rights, preferences and privileges
senior to those of holders of our common stock, and the terms of the debt
securities issued could impose significant restrictions on our operations. If we
raise additional funds through collaborations and licensing arrangements, we
might be required to relinquish significant rights to our technology or
products, or to grant licenses on terms that are not favorable to
us.
We do not
know whether additional financing will be available on commercially acceptable
terms when needed. If adequate funds are not available or are not available on
commercially acceptable terms, we may need to downsize or halt our operations
and may be unable to continue developing our products.
Our
investments in auction-rate securities are subject to risks which may cause
losses and affect the liquidity of these investments.
As of
December 31, 2008 our total investment in auction-rate securities (ARS) was
$11.5 million. Since February 13, 2008, auctions for these securities have
failed, meaning the parties desiring to sell securities could not be matched
with an adequate number of buyers, resulting in our having to continue to hold
these securities. Although the securities are Aaa/AAA rated and
collateralized by portfolios of student loans guaranteed by the U.S. government,
based on current market conditions it is likely that auctions will continue to
be unsuccessful in the short-term, limiting the liquidity of these investments
until the auction succeeds, the issuer calls the securities, or they
mature. The remaining maturity periods range from nineteen to thirty-eight
years. As a result, our ability to liquidate our investment and fully recover
the carrying value of our investment in the near term may be limited or not
exist. In December 2008, we utilized a third-party valuation firm to
assist us with determining the fair market value of our ARS which was estimated
to be $10.1 million, representing an estimated decline in value of $1.4
million.
In making
our determination whether losses are considered to be “other-than-temporary”
declines in value, we consider the following factors at each quarter-end
reporting period:
|
●
|
How
long and by how much the fair value of the ARS securities have been below
cost
|
|
●
|
The
financial condition of the issuers
|
|
●
|
Any
downgrades of the securities by rating
agencies
|
|
●
|
Default
on interest or other terms
|
|
●
|
Our
intent & ability to hold the ARS long enough for them to recover their
value
|
We
determined that the loss in the fair value of our ARS investments was
“other-than-temporary,” in connection with our year end
assessment. Accordingly, we recognized an other-than-temporary loss
in non-operating expenses of approximately $1.4 million in December
2008. These securities will be analyzed each reporting period
for additional other-than-temporary impairment factors. Due to the
current uncertainty in the credit markets and the terms of a Rights offering
with UBS, that we accepted in November 2008, we have classified the fair value
of our ARS as long-term assets as of December 31, 2008.
In May
2008, our investment portfolio manager, UBS AG (UBS), provided us with a demand
margin loan facility, allowing us to borrow up to 50% of the market value of the
ARS, as determined by UBS. The margin loan facility is collateralized by the
ARS. In October 2008, UBS made a “rights” offering to its clients,
pursuant to which we are entitled to sell to UBS all auction-rate securities
held by us in our UBS account. The rights permit us to require UBS to purchase
our ARS for a price equal to original par value plus any accrued but unpaid
interest beginning on June 30, 2010 and ending on July 2, 2012 if the
securities are not earlier redeemed or sold. As part of the offering, UBS would
provide us a line of credit equal to 75% of the market value of the ARS until
they are purchased by UBS. The line of credit has certain restrictions
described in the prospectus. We accepted this offer on November 6,
2008. As of December 31, 2008, the outstanding balance on our line of
credit was 5.7 million. The potential lack of liquidity on these
investments may affect our ability to execute our current business plan, based
on our expected operating cash flows and our other sources of cash, and may
require us to sell them before we are able to sell them to UBS pursuant to the
Rights offering or before they recover in value.
Our
treatment programs may not be as effective as we believe them to be, which could
limit our revenues and adversely affect our business
Our
belief in the efficacy of our Catasys solution and PROMETA Treatment Program is
based on a limited number of studies and commercial pilots that have been
conducted to date and our initial experience with a relatively small number of
patients. Such results may not be statistically significant, have not been
subjected to close scientific scrutiny, and may not be indicative of the
long-term future performance and safety of treatment with our programs.
Controlled scientific studies, including those that have been announced and
planned for the future, may yield results that are unfavorable or demonstrate
that treatment with our programs is not clinically effective or safe. If the
initially indicated results cannot be successfully replicated or maintained over
time, utilization of our programs could decline substantially.
Our
Catasys Program or PROMETA Treatment Program may not become widely accepted,
which could limit our growth
Further
marketplace acceptance of our treatment programs may largely depend upon
healthcare providers’ and third-party payors’ interpretation of our limited
data, the results of pending studies, or upon reviews and reports that may be
given by independent researchers. In the event such research does not establish
our treatment programs to be safe and effective, it is unlikely we will be able
to achieve widespread market acceptance.
Disappointing
results for our PROMETA Treatment Program, or failure to attain our publicly
disclosed milestones, could adversely affect market acceptance and have a
material adverse effect on our stock price
There are
a number of studies, evaluations and pilot programs currently in progress that
are evaluating our PROMETA Treatment Program, and we expect results of many to
become available throughout the remainder of 2009. Disappointing
results, later-than-expected press release announcements or termination of
evaluations or pilot programs could have a material adverse effect on the
commercial acceptance of the PROMETA Treatment Program, our stock price and on
our results of operations. In addition, announcements regarding
results, or anticipation of results, may increase volatility in our stock price.
On October 24, 2007, the Pierce County Council in the State of Washington voted
to end funding for PROMETA. This announcement had an immediate negative effect
on our stock price, and we are unable to assess the long-term impact on our
business as a result of these and similar types of events. In
addition to numerous upcoming milestones, from time to time we provide financial
guidance and other forecasts to the market. While we believe that the
assumptions underlying projections and forecasts we make publicly available are
reasonable, projections and forecasts are inherently subject to numerous risks
and uncertainties. Any failure to achieve milestones, or to do so in
a timely manner, or to achieve publicly announced guidance and forecasts, could
have a material adverse effect on our results of operations and the price of our
common stock.
Our
industry is highly competitive, and we may not be able to compete
successfully
The
healthcare business, in general, and the substance dependence treatment business
in particular, are highly competitive. We compete with many types of substance
dependence treatment methods, treatment facilities and other service providers,
many of whom are more established and better funded than we are. Many of these
other treatment methods and facilities are well established in the same markets
we target, have substantial sales volume, and are provided and marketed by
companies with much greater financial resources, facilities, organization,
reputation and experience than we have. The historical focus on the use of
psychological or behavioral therapies, as opposed to medical or physiological
treatments for substance dependence, may create further resistance to
penetrating the substance dependence treatment market.
There are
a number of companies developing or marketing medications for reducing craving
in the treatment of alcoholism, including:
|
●
|
the
addiction medication naltrexone, an opiate receptor antagonist, is
marketed by a number of generic pharmaceutical companies as well as under
the trade name ReVia®,
for treatment of alcohol
dependence;
|
|
●
|
VIVITROL®,
an extended release formulation of naltrexone manufactured by Alkermes, is
intended to be administered by a physician via monthly injections for the
treatment of alcohol dependence in patients who are able to abstain from
drinking in an outpatient setting and are not actively drinking prior to
treatment initiation. Alkermes reported that in clinical trials, when used
in combination with psychosocial support, VIVITROL was shown to reduce the
number of drinking days and heavy drinking days and to prolong abstinence
in patients who abstained from alcohol the week prior to starting
treatment;
|
|
●
|
Campral®
Delayed-Release Tablets (acamprosate calcium), an NMDA receptor antagonist
taken two to three times per day on a chronic or long-term basis and
marketed by Forest Laboratories. Clinical studies supported the
effectiveness in the maintenance of abstinence for alcohol-dependent
patients who had undergone inpatient detoxification and were already
abstinent from alcohol;
|
|
●
|
Topiramate
(Topamax), a drug manufactured by Ortho-McNeill Jannssen, which is
approved for the treatment of seizures. A multi-site clinical trial
reported in October 2007 found that tropiramate significantly reduced
heavy drinking days in alcohol-dependent
individuals.
|
Our
competitors may develop and introduce new processes and products that are equal
or superior to our programs in treating alcohol and substance dependencies.
Accordingly, we may be adversely affected by any new processes and technology
developed by our competitors.
There are
approximately 13,000 facilities reporting to the Substance Abuse and Mental
Health Services Administration that provide substance abuse treatment on an
inpatient or outpatient basis. Well known examples of residential treatment
programs include the Betty Ford Center®, Caron Foundation®, Hazelden® and Sierra
Tucson®. In addition, individual physicians may provide substance dependence
treatment in the course of their practices. While we believe our products
and services are unique, we operate in highly competitive markets. We compete
with other healthcare management service organizations and disease management
companies, including MBHOs, HMOs, PPOs, third-party administrators and other
specialty healthcare and managed care companies. Most of our competitors are
significantly larger and have greater financial, marketing and other resources
than us. We believe that our ability to offer customers a
comprehensive and integrated substance dependence solution, including the
utilization of innovative medical and psychosocial treatments, and our unique
technology platform will enable us to compete effectively. However,
there can be no assurance that we will not encounter more effective competition
in the future, which would limit our ability to maintain or increase our
business.
We
depend on key personnel, the loss of which could impact the ability to manage
our business
Our
future success depends on the performance of our senior management, in
particular our Chairman and Chief Executive Officer, Terren S. Peizer,
President, Richard A. Anderson, Christopher S. Hassan, Chief Strategy Officer
and Maurice S. Hebert, Chief Financial Officer. Messrs. Peizer, Anderson, Hassan
and Hebert are each a party to employment agreements which, subject to
termination for cause or good reason, have various remaining terms with
renewable options.
The loss
of the services of any key member of management could have a material adverse
effect on our ability to manage our business.
We
may be subject to future litigation, which could result in substantial
liabilities that may exceed our insurance coverage
All
significant medical treatments and procedures, including treatment utilizing our
programs, involve the risk of serious injury or death. Even under proper medical
supervision, withdrawal from alcohol may cause severe physical reactions. While
we have not been the subject of any such claims, our business entails an
inherent risk of claims for personal injuries and substantial damage awards. We
cannot control whether individual physicians will apply the appropriate standard
of care, or conform to our treatment programs in determining how to treat their
patients. While our agreements typically require physicians to indemnify us for
their negligence, there can be no assurance they will be willing and financially
able to do so if claims are made. In addition, our license agreements require us
to indemnify physicians, hospitals or their affiliates for losses resulting from
our negligence.
We
currently have insurance coverage for up to $5 million per year, in the
aggregate, for personal injury claims. Hythiam maintains directors’ and
officers’ liability insurance coverage, subject to a self insured retention of
between $0 to $250,000 per claim. We may not be able to maintain
adequate liability insurance at acceptable costs or on favorable terms. We
expect that liability insurance will be more difficult to obtain and that
premiums will increase over time and as the volume of patients treated with our
programs increases. In the event of litigation, we may sustain significant
damages or settlement expense (regardless of a claim's merit), litigation
expense and significant harm to our reputation.
If
government and third-party payors fail to provide coverage and adequate payment
rates for treatment using our treatment programs, our revenue and prospects for
profitability will be harmed
Our
future revenue growth will depend in part upon the availability of reimbursement
for treatment or other forums of payment for using our programs from third-party
payors such as government health programs including Medicare and Medicaid,
managed care providers, private health insurers and other organizations. To
date, we have received an insignificant amount of revenue from our Catasys
substance dependence programs from governmental payors, managed care
organizations and other third-party payors, and acceptance of our Catasys
substance dependence programs is important to the future prospects of our
business. In addition, third-party payors are increasingly attempting to contain
healthcare costs, and may not cover or provide adequate payment for treatment
using our programs. Adequate third-party reimbursement might not be available to
enable us to realize an appropriate return on investment in research and product
development, and the lack of such reimbursement could have a material adverse
effect on our operations and could adversely affect our revenues and
earnings.
We
may not be able to achieve promised savings for our Catasys contracts, which
could result in pricing levels insuffiicient to cover our costs or ensure
profitability
We
anticipate that many or all of our Catasys contracts will be based upon
anticipated or guaranteed levels of savings for our customers or meeting other
operational metrics. If we are unable to achieve the promised savings or
operational metrics, we may be required to refund from the amount of fees paid
to us any difference between savings that were guaranteed and the savings, if
any, that were actually achieved. Accordingly, during or at the end of the
contract terms, we may be required to refund some or all of the fees paid for
our services. This exposes us to significant risk that contracts
negotiated and entered into may ultimately be unprofitable. In
addition, managed care operations are at risk for costs incurred to provide
agreed upon services under our program.Failure to anticipate or control
costs therefore could have material, adverse effects on our
business.
Our international operations may
be subject to foreign regulation, and the success of our foreign operations will
depend on many factors
The
criteria of foreign laws, regulations and requirements are often vague and
subject to change and interpretation. Our international operations may become
the subject of foreign regulatory, civil, criminal or other investigations or
proceedings, and our interpretations of applicable laws and regulations may be
challenged. The defense of any such challenge could result in substantial cost
and a diversion of management’s time and attention, regardless of whether it
ultimately is successful. If we fail to comply with any applicable international
laws, or a determination is made that we have failed to comply with these laws,
our financial condition and results of operations, including our domestic
operations, could be adversely affected.
In
addition, the private pay healthcare system in Europe is not as developed as in
the U.S and as a result it may be more difficult to convince patients in these
countries to pay substantial amounts for treatment. We will be reliant on
relationships that we establish with local companies, thought leaders and
governments. There can be no
assurance we will be able
to establish these relationships, maintain them or that the partners will retain
their influence in the market. It may take longer than we expect to commence
operations or to operate our business at profitable levels as we do not have the
established relationships and or knowledge of the regulations and business
practices in the markets we are in or entering.
Our ability to utilize net operating loss carryforwards may be limited
In 2008,
we significantly reduced our operations and presence in Europe in order to
reduce costs and better focus our efforts on pursuing U.S.-based business
strategies.
Our ability to utilize net operating loss carryforwards may be limited
As of
December 31, 2008, we had net operating loss carryforwards (NOLs) of
approximately $126.4 million for federal income tax purposes that will begin to
expire in 2023. 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. We may be found to have experienced
an ownership change under Section 382 as a result of events in the past or the
issuance of shares of common stock upon a conversion of notes, or a combination
thereof. 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.
Risks
related to our intellectual property
We
may not be able to adequately protect the proprietary PROMETA Treatment Program
which is important to our business
We
consider the protection of our proprietary PROMETA Treatment Program to be
critical to our business prospects. We obtained the rights to some of our most
significant PROMETA technologies through an agreement that is subject to a
number of conditions and restrictions, and a breach or termination of that
agreement or the bankruptcy of any party to that agreement could significantly
impact our ability to use and develop our technologies. While we have
two issued U.S. patents, one relating to the treatment of cocaine dependency
with our PROMETA Treatment Program and one relating to our PROMETA Treatment
Program for the treatment of certain symptoms associated with alcohol
dependency, we currently have no issued U.S. patents covering our PROMETA
Treatment Program for the treatment of methamphetamine dependency. The patent
applications we have licensed or filed may not issue as patents, and any issued
patents may be too narrow in scope to provide us with a competitive advantage.
Our patent position is uncertain and includes complex factual and legal issues,
including the existence of prior art that may preclude or limit the scope of
patent protection. Issued patents will generally expire twenty years after their
priority date. Our two issued U.S. patents will expire in 2021.
Further, our patents and pending applications for patents and other intellectual
property have been pledged as collateral to secure our obligations to pay
certain debts, and our default with respect to those obligations could result in
the transfer of our patents to our creditor. In the event of such a
transfer, we may be unable to continue to operate our business.
Patent
examiners may reject our patent applications and thereby prevent us from
receiving more patents. Competitors, licensees and others may
challenge our patents and, if successful, our patents may be denied, subjected
to reexamination, rendered unenforceable, or invalidated. The cost of litigation
to uphold the validity of patents, and to protect and prevent infringement can
be substantial. We may not be able to adequately protect the aspects of our
treatment programs that are not patented or have only limited patent protection.
Furthermore, competitors and others may independently develop similar or more
advanced treatment programs and technologies, may design around aspects of our
technology, or may discover or duplicate our trade secrets and proprietary
methods.
To the
extent we utilize processes and technology that constitute trade secrets under
applicable laws, we must implement appropriate levels of security to ensure
protection of such laws, which we may not do effectively. Policing compliance
with our confidentiality agreements and unauthorized use of our technology is
difficult. In addition, the laws of many foreign countries do not protect
proprietary rights as fully as the laws of the United States. The loss of any of
our trade secrets or proprietary rights which may be protected under the
foregoing
intellectual
property safeguards may result in the loss of our competitive advantage over
present and potential competitors. Our intellectual property may not prove to be
an effective barrier to competition, in which case our business could be
materially adversely affected.
Our
pending patent applications disclose and claim various approaches to the use of
the PROMETA Treatment Program. There is no assurance that we will
receive one or more patents from these pending applications, or that,
even if we receive one or more patents, the patent claims will be
sufficiently broad to create patent infringement liability for competitors using
treatment programs similar to the PROMETA Treatment Program.
Confidentiality
agreements with employees, licensees and others may not adequately prevent
disclosure of trade secrets and other proprietary information
In order
to protect our proprietary technology and processes, we rely in part on
confidentiality provisions in our agreements with employees, licensees, treating
physicians and others. These agreements may not effectively prevent disclosure
of confidential information and may not provide an adequate remedy in the event
of unauthorized disclosure of confidential information. In addition, others may
independently discover trade secrets and proprietary information. Costly and
time-consuming litigation could be necessary to enforce and determine the scope
of our proprietary rights, and failure to obtain or maintain trade secret
protection could adversely affect our competitive business position. We have had
three instances in which it was necessary to send a formal demand to cease and
desist using our programs to treat patients due to breach of confidentiality
provisions in our agreements, and in one instance have had to file suit to
enforce these provisions.
We
may be subject to claims that we infringe the intellectual property rights of
others, and unfavorable outcomes could harm our business
Our
future operations may be subject to claims, and potential litigation, arising
from our alleged infringement of patents, trade secrets or copyrights owned by
other third parties. Within the healthcare, drug and bio-technology industry,
many companies actively pursue infringement claims and litigation, which makes
the entry of competitive products more difficult. We may experience claims or
litigation initiated by existing, better-funded competitors and by other third
parties. Court-ordered injunctions may prevent us from continuing to market
existing products or from bringing new products to market and the outcome of
litigation and any resulting loss of revenues and expenses of litigation may
substantially affect our ability to meet our expenses and continue
operations.
Risks
related to our industry
Our
policies and procedures may not fully comply with complex and increasing
regulation by state and federal authorities, which could negatively impact our
business operations
Our
PROMETA Treatment Program have not been approved by the Food and Drug
Administration (FDA), and while the drugs incorporated in the PROMETA Treatment
Program have been approved for other indications, they are not FDA approved for
the treatment of alcohol or substance dependency. We have not sought, and do not
currently intend to seek, FDA approval for the PROMETA Treatment
Program. It is possible that in the future the FDA could require us
to seek FDA approval for the PROMETA Treatment Program.
The
healthcare industry is highly regulated and continues to undergo significant
changes as third-party payors, such as Medicare and Medicaid, traditional
indemnity insurers, managed care organizations and other private payors increase
efforts to control cost, utilization and delivery of healthcare services.
Healthcare companies are subject to extensive and complex federal, state and
local laws, regulations and judicial decisions. The U.S. Congress and state
legislatures are considering legislation that could limit funding to our
licensees and CompCare's clients. In addition, the FDA regulates
development, testing, labeling, manufacturing, marketing, promotion,
distribution, record-keeping and reporting requirements for prescription drugs,
medical devices and biologics. Other regulatory requirements apply to dietary
supplements, including vitamins. Compliance with laws and regulations enforced
by regulatory agencies that have broad discretion in applying them may be
required for our programs or other medical programs or services developed or
used by us. Many healthcare laws and regulations applicable to our business are
complex, applied broadly and subject to interpretation by courts and government
agencies. Regulatory, political and legal action and pricing pressures could
prevent us from marketing some or all of our products and services for a period
of time or permanently. Our failure, or the failure of our licensees, to comply
with applicable regulations may result in the imposition of civil or criminal
sanctions that we cannot afford, or require redesign or withdrawal of our
programs from the market.
We
may be subject to regulatory, enforcement and investigative proceedings, which
could adversely affect our financial condition or operations
We could
become the subject of regulatory, enforcement, or other investigations or
proceedings, and our relationships, business structure, and interpretations of
applicable laws and regulations may be challenged. The defense of any such
challenge could result in substantial cost and a diversion of management’s time
and attention. In addition, any such challenges could require significant
changes to how we conduct our business. Any such challenge could have a material
adverse effect on our business, regardless of whether it ultimately is
successful. If determination is made that we have failed to comply with any
applicable laws, our business, financial condition and results of operations
could be adversely affected.
The
promotion of our treatment programs may be found to violate federal law
concerning off-label uses of prescription drugs, which could prevent us from
marketing our programs
Generally,
the Food, Drug, and Cosmetic (FDC) Act, requires that a prescription drug be
approved by FDA for a specific indication before the product can be distributed
in interstate commerce. Although the FDC Act does not prohibit a
doctor’s use of a drug for another indication (this is referred to as off-label
use), it does prohibit the promotion of a drug product for an unapproved use.
FDA also permits the non-promotional discussion of information related to
off-label use in the context of scientific or medical communications. Our
treatment programs include the use of prescription drugs that have been approved
by FDA, but not for the treatment of chemical dependence and drug addiction,
which is how the drugs are used in our programs. Although we carefully structure
our communications in a way that is intended to comply with the FDC Act and FDA
regulations, it is possible that our actions could be found to violate the
prohibition on off-label promotion of drugs. In addition, the FDC Act imposes
limits on the types of claims that may be made for a dietary supplement, and the
promotion of a dietary supplement beyond such claims may also be seen as the
unlawful promotion of a drug product for an unapproved use. Because our
treatment programs also include the use of nutritional supplements, it is
possible that claims made for those products could also put us at risk of FDA
enforcement for making unlawful claims.
Violations
of the FDC Act or FDA regulations can result in a range of sanctions, including
administrative actions by FDA (such as issuance of a Warning Letter), seizure of
product, issuance of an injunction prohibiting future violations, and imposition
of criminal or civil penalties. A successful enforcement action could prevent
promotion of our treatment programs and we may be unable to continue operating
under our current business model. Even if we defeat an enforcement action, the
expenses associated with doing so, as well as the negative publicity concerning
the “off-label” use of drugs in our treatment programs, could adversely affect
our business and results of operation.
The FDA
has recently increased enforcement efforts in the area of promotion of
“off-label” use of drugs, and we cannot assure you that our business practices
or third party clinical trials will not come under scrutiny.
Treatment
using our programs may be found to require FDA or other review or approval,
which could delay or prevent the study or use of our treatment
programs
Under
authority of the FDC Act, FDA extensively regulates entities and individuals
engaged in the conduct of clinical trials, which broadly includes experiments in
which a drug is administered to humans. FDA regulations require,
among other things, submission of a clinical trial treatment program for FDA
review, obtaining from the agency an investigational new drug (IND) exemption
before initiating a clinical trial, obtaining appropriate informed consent from
study subjects, having the study approved and subject to continuing review by an
Institutional Review Board (IRB), and reporting to FDA safety information
regarding the conduct of the trial. Certain third parties have
engaged or are engaging in the use of our treatment program and the collection
of outcomes data in ways that may be considered to constitute a clinical trial,
and that may be subject to FDA regulations and require IRB approval and
oversight. In addition, it is possible that use of our treatment
program by individual physicians in treating their patients may be found to
constitute a clinical trial or investigation that requires IRB review or
submission of an IND or is otherwise subject to regulation by
FDA. FDA has authority to inspect clinical investigation sites and
IRBs, and to take action with regard to any violations. Violations of
FDA regulations regarding clinical trials can result in a range of actions,
including suspension of the trial, prohibiting the clinical investigator from
ever participating in clinical trials, and criminal
prosecution. Individual hospitals and physicians may also submit
their use of our
treatment
programs to their IRBs, which may prohibit or place restrictions on
it. FDA enforcement actions or IRB restrictions could adversely
affect our business and the ability of our customers to use our treatment
programs.
The FDA
has recently increased enforcement efforts regarding clinical trials, and we
cannot assure you that the activities of our customers or others using our
treatment programs will not come under scrutiny.
Failure
to comply with FTC or similar state laws could result in sanctions or limit the
claims we can make
Our
promotional activities and materials, including advertising to consumers and
professionals, and materials provided to licensees for their use in promoting
our treatment programs, are regulated by the Federal Trade Commission
(FTC) under the FTC Act, which prohibits unfair and deceptive acts and
practices, including claims which are false, misleading or inadequately
substantiated. The FTC typically requires competent and reliable scientific
tests or studies to substantiate express or implied claims that a product or
service is safe or effective. If the FTC were to interpret our promotional
materials as making express or implied claims that our treatment programs are
safe or effective for the treatment of alcohol, cocaine or methamphetamine
addiction, or any other claims, it may find that we do not have adequate
substantiation for such claims. Allegations of a failure to comply with the FTC
Act or similar laws enforced by state attorneys general and other state and
local officials could result in administrative or judicial orders limiting or
eliminating the claims we can make about our treatment programs, and other
sanctions including substantial financial penalties.
Our
business practices may be found to constitute illegal fee-splitting or corporate
practice of medicine, which may lead to penalties and adversely affect our
business
Many
states, including California in which our principal executive offices and one of
our managed treatment centers is located, have laws that prohibit business
corporations, such as us, from practicing medicine, exercising control over
medical judgments or decisions of physicians, or engaging in arrangements with
physicians such as employment, payment for referrals or fee-splitting. Courts,
regulatory authorities or other parties, including physicians, may assert that
we are engaged in the unlawful corporate practice of medicine by providing
administrative and other services in connection with our treatment programs or
by consolidating the revenues of the physician practices we manage, or that
licensing our technology for a license fee that could be characterized as a
portion of the patient fees, or subleasing space and providing turn-key business
management to affiliated medical groups in exchange for management and licensing
fees, constitute improper fee-splitting or payment for referrals, in which case
we could be subject to civil and criminal penalties, our contracts could be
found invalid and unenforceable, in whole or in part, or we could be required to
restructure our contractual arrangements. If so, we may be unable to restructure
our contractual arrangements on favorable terms, which would adversely affect
our business and operations.
Our
business practices may be found to violate anti-kickback, physician
self-referral or false claims laws, which may lead to penalties and adversely
affect our business
The
healthcare industry is subject to extensive federal and state regulation with
respect to financial relationships and kickbacks involving healthcare providers,
physician self-referral arrangements, filing of false claims and other fraud and
abuse issues. Federal anti-kickback laws and regulations prohibit offers,
payments, solicitations, or receipts of remuneration in return for (i) referring
patients for items or services covered by Medicare, Medicaid or other federal
healthcare programs, or (ii) purchasing, leasing, ordering or arranging for or
recommending any service, good, item or facility for which payment may be made
by a federal health care program. In addition, subject to numerous exceptions,
federal physician self-referral legislation, commonly known as the Stark law,
generally prohibits a physician from referring patients for certain
designated health services reimbursable by Medicare or Medicaid from
any entity with which the physician has a financial relationship, and many
states have analogous laws. Other federal and state laws govern the submission
of claims for reimbursement, or false claims laws. One of the most prominent of
these laws is the federal Civil False Claims Act, and violations of other laws,
such as the federal anti-kickback law or the FDA prohibitions against promotion
of off-label uses of drugs, may also be prosecuted as violations of the Civil
False Claims Act.
Federal
or state authorities may claim that our fee arrangements, agreements and
relationships with contractors, hospitals and physicians violate these laws and
regulations. Violations of these laws may be punishable by monetary fines, civil
and criminal penalties, exclusion from participation in government-sponsored
healthcare programs and
forfeiture
of amounts collected in violation of such laws. If our business practices are
found to violate any of these provisions, we may be unable to continue with our
relationships or implement our business plans, which would have an adverse
effect on our business and results of operations.
We
may be subject to healthcare anti-fraud initiatives, which may lead to penalties
and adversely affect our business
State and
federal governments are devoting increased attention and resources to anti-fraud
initiatives against healthcare providers, and may take an expansive definition
of fraud that includes receiving fees in connection with a healthcare business
that is found to violate any of the complex regulations described above. While
to our knowledge we have not been the subject of any anti-fraud investigations,
if such a claim were made defending our business practices could be time
consuming and expensive, and an adverse finding could result in substantial
penalties or require us to restructure our operations, which we may not be able
to do successfully.
Our
use and disclosure of patient information is subject to privacy and security
regulations, which may result in increased costs
In
conducting research or providing administrative services to healthcare providers
in connection with the use of our treatment programs, we may collect, use,
disclose, maintain and transmit patient information in ways that will be subject
to many of the numerous state, federal and international laws and regulations
governing the collection, use, disclosure, storage, transmission and/or
confidentiality of patient-identifiable health information, including the
administrative simplification requirements of the Health Insurance Portability
and Accountability Act of 1996 and its implementing regulations (HIPAA). The
HIPAA Privacy Rule restricts the use and disclosure of patient information, and
requires safeguarding that information. The HIPAA Security Rule establishes
elaborate requirements for safeguarding patient information transmitted or
stored electronically. HIPAA applies to covered entities, which may
include healthcare facilities and does include health plans that will contract
for the use of our programs and our services. The HIPAA rules require covered
entities to bind contractors like us to compliance with certain burdensome HIPAA
rule requirements known as business associate requirements. If we are providing
management services that include electronic billing on behalf of a physician
practice or facility that is a covered entity, we may be required to conduct
those electronic transactions in accordance with the HIPAA regulations governing
the form and format of those transactions (HIPAA Transactions Rule). Other
federal and state laws restricting the use and protecting the privacy and
security of patient information also apply to our licensees directly and in some
cases to us, either directly or indirectly. We may be required to make costly
system purchases and modifications to comply with the HIPAA rule requirements
that are imposed on us and our failure to comply may result in liability and
adversely affect our business.
Federal
and state consumer protection laws are being applied increasingly by the FTC and
state attorneys general to regulate the collection, use, storage, and disclosure
of personal or patient information, through web sites or otherwise, and to
regulate the presentation of web site content. Courts may also adopt the
standards for fair information practices promulgated by the FTC, which concern
consumer notice, choice, security and access. Numerous other federal and state
laws protect the confidentiality and security of personal and patient
information. Other countries also have, or are developing laws governing the
collection, use, disclosure and transmission of personal or patient information
and these laws could create liability for us or increase our cost of doing
business.
Our
business arrangements with health care providers may be deemed to be franchises,
which could negatively impact our business operations
Franchise
arrangements in the United States are subject to rules and regulations of the
FTC and various state laws relating to the offer and sale of
franchises. A number of the states in which we operate regulate the
sale of franchises and require registration of the franchise offering circular
with state authorities and the delivery of a franchise offering circular to
prospective franchisees. State franchise laws often limit, among
other things, the duration and scope of non-competitive provisions, the ability
of a franchisor to terminate or refuse to renew a franchise and the ability of a
franchisor to designate sources of supply. Franchise laws and
regulations are complex, apply broadly and are subject to interpretation by
courts and government agencies. Federal or state authorities or
healthcare providers with whom we contract may claim that the agreements under
which we license rights to our technology and trademarks and provide services
violate these laws and regulations. Violations of these laws are punishable by
monetary fines, civil and criminal penalties, and forfeiture of amounts
collected in violation of such
laws. If
our business practices are found to constitute franchises, we could be subject
to civil and criminal penalties, our contracts could be found invalid and
unenforceable, in whole or in part, or we could be required to restructure our
contractual arrangements. We may be unable to continue with our
relationships or restructure them on favorable terms, which would have an
adverse effect on our business and results of operations. We may also
be required to furnish prospective franchisees with a franchise offering
circular containing prescribed information, and restrict how we market to or
deal with healthcare providers, potentially limiting and substantially
increasing our cost of doing business.
Risks
related to our common stock
Approximately
25% of our stock is controlled by our chairman and chief executive officer, who
has the ability to substantially influence the election of directors and other
matters submitted to stockholders
Reserva
Capital, LLC and Bonmore, LLC, whose sole managing member is our chairman and
chief executive officer, beneficially own 13,600,000 shares of our common stock,
which represent 24.7% of our 55,074,000 shares outstanding as of March 27, 2009.
As a result, he has and is expected to continue to have the ability to
significantly influence the election of our Board of Directors and the outcome
of all other issues submitted to our stockholders. The interests of these
principal stockholders may not always coincide with our interests or the
interests of other stockholders, and they may act in a manner that advances his
best interests and not necessarily those of other stockholders. One consequence
to this substantial influence or control is that it may be difficult for
investors to remove management of the company. It could also deter unsolicited
takeovers, including transactions in which stockholders might otherwise receive
a premium for their shares over then current market prices.
Our
stock price may be subject to substantial volatility, and the value of your
investment may decline
Our
common stock is traded on The NASDAQ Global Market, and trading volume may be
limited or sporadic. The market price of our common stock has
experienced, and may continue to experience, substantial volatility. Over 2008,
our common stock has traded between $0.39 and $3.14 per share, on volume ranging
from approximately 6,100 to 3.9 million shares per day. As a result,
the current price for our common stock on NASDAQ is not necessarily a reliable
indicator of our fair market value. The price at which our common stock will
trade may fluctuate as a result of a number of factors, including the number of
shares available for sale in the market, quarterly variations in our operating
results and actual or anticipated announcements of pilots and scientific studies
of the effectiveness of our PROMETA Treatment Program, our Catasys Program, new
products or services by us or competitors, regulatory investigations or
determinations, acquisitions or strategic alliances by us or our competitors,
recruitment or departures of key personnel, the gain or loss of significant
customers, changes in the estimates of our operating performance, actual or
threatened litigation, market conditions in our industry and the economy as a
whole.
Volatility
in the price of our common stock on the NASDAQ Global Market may depress the
trading price of our common stock. The risk of volatility and
depressed prices of our common stock also applies to warrant holders who receive
shares of common stock upon conversion.
Numerous
factors, including many over which we have no control, may have a significant
impact on the market price of our common stock, including:
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●
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announcements
of new products or services by us or our competitors; current events
affecting the political, economic and social situation in the United
States and other countries where we
operate;
|
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●
|
trends
in our industry and the markets in which we
operate;
|
|
●
|
changes
in financial estimates and recommendations by securities
analysts;
|
|
●
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acquisitions
and financings by us or our
competitors;
|
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●
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the
gain or loss of a significant
customer;
|
|
●
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quarterly
variations in operating
results;
|
|
●
|
volatility
in exchanges rate between the US dollar and the currencies of the foreign
countries in which we operate;
|
|
●
|
the
operating and stock price performance of other companies that investors
may consider to be comparable; and
|
|
●
|
purchases
or sales of blocks of our
securities.
|
Furthermore,
stockholders may initiate securities class action lawsuits if the market price
of our stock drops significantly, which may cause us to incur substantial costs
and could divert the time and attention of our management.
Future
sales of common stock by existing stockholders, or the perception that such
sales may occur, could depress our stock price
The
market price of our common stock could decline as a result of sales by, or the
perceived possibility of sales by, our existing stockholders. We have
completed a number of private placements of our common stock and other
securities over the last several years, and we have effective resale
registration statements pursuant to which the purchasers can freely resell their
shares into the market. In addition, most of our outstanding shares are
eligible for public resale pursuant to Rule 144 under the Securities Act of
1933, as amended. Approximately 15 million shares of our common stock are
currently held by our affiliates and may be sold pursuant to an effective
registration statement or in accordance with the volume and other limitations of
Rule 144 or pursuant to other exempt transactions. Future sales of
common stock by significant stockholders, including those who acquired their
shares in private placements or who are affiliates, or the perception that such
sales may occur, could depress the price of our common stock.
Future
issuances of common stock and hedging activities may depress the trading price
of our common stock
Any
future issuance of equity securities, including the issuance of shares upon
exercise of outstanding warrants, could dilute the interests of our existing
stockholders, and could substantially decrease the trading price of our common
stock. We currently have outstanding approximately 11 million
warrants and options to acquire our common stock at prices between $0.59 and
$9.20 per share. We may issue equity securities in the future
for a number of reasons, including to finance our operations and business
strategy, in connection with acquisitions, to adjust our ratio of debt to
equity, to satisfy our obligations upon the exercise of outstanding warrants or
options or for other reasons.
Additionally,
we have outstanding warrants to acquire up to 1,300,000 shares of our common
stock at an exercise price of $2.15 per share which contain anti-dilution
adjustments that will be triggered if we sell shares of common stock for less
than $2.15.
Provisions
in our certificate of incorporation, bylaws, charter documents and Delaware law
could discourage a change in control, or an acquisition of us by a third party,
even if the acquisition would be favorable to you, thereby and adversely affect
existing stockholders
Our
certificate of incorporation and the Delaware General Corporation Law contain
provisions that may have the effect of making more difficult or delaying
attempts by others to obtain control of our company, even when these attempts
may be in the best interests of stockholders. For example, our certificate of
incorporation also authorizes our Board of Directors, without stockholder
approval, to issue one or more series of preferred stock, which could have
voting and conversion rights that adversely affect or dilute the voting power of
the holders of common stock. Delaware law also imposes conditions on certain
business combination transactions with “interested stockholders.”
These
provisions and others that could be adopted in the future could deter
unsolicited takeovers or delay or prevent changes in our control or management,
including transactions in which stockholders might otherwise receive a premium
for their shares over then current market prices. These provisions may also
limit the ability of stockholders to approve transactions that they may deem to
be in their best interests.
We
do not expect to pay dividends in the foreseeable future, and accordingly you
must rely on stock appreciation for any return on your investment
We have
paid no cash dividends on our common stock to date, and we currently intend to
retain our future earnings, if any, to fund the continued development and growth
of our business. As a result, we do not expect to pay any cash dividends in the
foreseeable future. Further, any payment of cash dividends will also
depend on our financial condition, results of operations, capital requirements
and other factors, including contractual restrictions to which we may be
subject, and will be at the discretion of our Board of Directors.
ITEM
1B. UNRESOLVED
STAFF COMMENTS
There are no unresolved written
comments that were received from the Securities and Exchange Commission’s staff
180 days or more before the end of Hythiam’s fiscal year relating to our
periodic or current reports filed under the Securities Exchange Act of
1934.
ITEM
2. PROPERTIES
Information
concerning our principal facilities, all of which are leased at December 31,
2008, is set forth below:
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Location
|
Use
|
Approximate
Area in
Square Feet
|
||||
|
11150
and 11100 Santa Monica Blvd.
Los
Angeles, California
|
Principal
executive and administrative offices
|
22,000
|
||||
|
1315
Lincoln Blvd.
Santa
Monica, California
|
Medical
office space for The PROMETA Center, Inc.
|
5,400
|
||||
Our
principal executive and administrative offices are located in Los Angeles,
California and consist of leased office space totaling approximately 22,000
square feet. Our base rent is currently approximately $75,000 per month, subject
to annual adjustments, with aggregate minimum lease commitments at December 31,
2008, totaling approximately $1.7 million. The initial term of the lease expires
in December 2010, with an option to extend for five additional
years.
In April
2005 we entered into a five-year lease for approximately 5,400 square feet of
medical office space in Santa Monica, California, which is occupied by The
PROMETA Center, Inc., which operates under a full service management agreement
with us. Our base rent is currently approximately $21,000 per month. In August
2006, we entered into a five-year lease for approximately 4,000 square feet of
medical office space, located in San Francisco, California, at an initial base
rent of approximately $11,000 per month, which was occupied by The PROMETA
Center, Inc., until it was closed in January 2008. We are currently
seeking to sublease this vacant space. The minimum base rent for the two medical
offices are subject to annual adjustments, with aggregate minimum lease
commitments at December 31, 2008, totaling approximately $858,000.
In
November 2006, we entered into a five-year lease for office space in Switzerland
at an initial base rent of 4,052 Swiss Francs per month (approximately US$3,800
using the December 31, 2008 conversion rate).
In
connection with a management services agreement that we executed with a
treatment center in Dallas, Texas, we assumed the obligation for two lease
agreements at a current combined amount of approximately $10,000 per month,
which expire in May 2011.
As we
expand in the future, we may lease additional regional office facilities, as
necessary, to service our customer base. We believe that the current office
space is adequate to meet our current needs and that additional facilities will
be available for lease to meet our future needs.
ITEM
3. 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.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of security holders during the quarter ended
December 31, 2008.
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY
SECURITIES
|
Our
common stock is traded on The NASDAQ Global Market under the symbol “HYTM.” As
of March 27, 2009, there were 89 record holders representing
approximately 5,700 beneficial owners of our common stock. Following is a
list by fiscal quarters of the closing sales prices of our stock:
|
Closing
Sales Prices
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||||||||
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2008
|
High
|
Low
|
||||||
|
4th
Quarter
|
$ | 1.50 | $ | 0.39 | ||||
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3rd
Quarter
|
2.46 | 1.29 | ||||||
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2nd
Quarter
|
2.95 | 1.38 | ||||||
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1st
Quarter
|
3.14 | 1.18 | ||||||
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2007
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High
|
Low
|
||||||
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4th
Quarter
|
$ | 8.64 | $ | 2.68 | ||||
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3rd
Quarter
|
8.77 | 6.43 | ||||||
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2nd
Quarter
|
8.71 | 6.53 | ||||||
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1st
Quarter
|
10.21 | 6.48 | ||||||
Dividends
We have
never declared or paid any dividends. We may, as our Board of Directors deems
appropriate, continue to retain all earnings for use in our business or may
consider paying dividends in the future.
Comparison
of 63-month cumulative total return
Among
Hythiam, Inc., the Russell 200 Index and the S&P Health Care
Index
* The above graph measures the change of $100 invested in Hythiam, Inc. common stock based on its closing price of $7.10 on September 30, 2003 and its quarter-end and December 31 year-end closing price thereafter. Hythiam, Inc.'s relative performance is then compared with the Russell 2000 and S&P Health Care total return indices.
Recent
Sales of Unregistered Securities
None
Additional
information is incorporated by reference to Part III of this
report.
ITEM
6. SELECTED
FINANCIAL DATA
The
selected financial data set forth below, derived from our audited consolidated
financial statements and the related notes thereto (collectively, the Financial
Statements), should be read in conjunction with the Financial Statements,
Item 7. Management’s Discussion and Analysis of Results of Financial
Condition and Results of Operations and Item 8. Financial Statements
and Supplementary Data, included elsewhere in this report.
|
(In
thousands, except per share amounts)
|
For
the years ended December 31,
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|||||||||||||||||||||
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||||
|
Statement
of Operations Data:
|
||||||||||||||||||||||
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Revenues:
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||||||||||||||||||||||
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Behavioral
health managed care services
|
$ | 35,156 | $ | 36,306 |
(a)
|
$ | - | $ | - | $ | - | |||||||||||
|
Healthcare
services
|
6,074 | 7,695 | 3,906 | 1,164 | 192 | |||||||||||||||||
|
Total
revenues
|
41,230 |
|
44,001 | 3,906 | 1,164 |
|
192 | |||||||||||||||
|
Loss
from operations
|
(53,603 | ) |
(f)
|
(47,531 | ) |
(d)
|
(39,926 | ) | (24,872 | ) |
(e)
|
(11,945 | ) | |||||||||
|
Loss
on extinguishment of debt
|
- | (741 | ) |
(b)
|
- | - | - | |||||||||||||||
|
Other
than temporary loss on marketable
|
||||||||||||||||||||||
|
securities
|
(1,428 | ) |
(g)
|
- | - | - | - | |||||||||||||||
|
Change
in fair value of warrant liabilities
|
5,744 |
(c)
|
3,471 |
(c)
|
- | - | - | |||||||||||||||
|
Net
loss
|
(50,418 | ) |
(f)
|
(45,462 | ) | (38,298 | ) | (24,038 | ) | (11,775 | ) | |||||||||||
|
Loss
Per Share:
|
||||||||||||||||||||||
|
Net
loss per share - basic and diluted
|
$ | (0.92 | ) | $ | (0.99 | ) | $ | (0.96 | ) | $ | (0.77 | ) | $ | (0.47 | ) | |||||||
|
Weighted
average shares outstanding
|
||||||||||||||||||||||
|
-
basic and diluted
|
54,675 | 45,695 | 39,715 | 31,173 | 24,877 | |||||||||||||||||
|
Cash
Flows Data:
|
||||||||||||||||||||||
|
Net
cash provided by (used in)
|
||||||||||||||||||||||
|
operating
activities
|
(29,446 | ) | $ | (39,220 | ) | $ | (28,499 | ) | $ | (18,819 | ) | $ | (9,947 | ) | ||||||||
|
Net
cash provided by (used in)
|
||||||||||||||||||||||
|
investing
activities
|
23,308 | (4,091 | ) | 4,730 | (22,206 | ) | (10,913 | ) | ||||||||||||||
|
Net
cash provided by financing
|
||||||||||||||||||||||
|
activities
|
5,882 | 48,759 | 26,053 | 40,442 | 21,416 | |||||||||||||||||
|
As
of December 31,
|
||||||||||||||||||||||
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||||
|
Balance
Sheet Data:
|
||||||||||||||||||||||
|
Cash,
cash equivalents and marketable
|
||||||||||||||||||||||
|
securities
|
$ | 11,039 |
(h)
|
$ | 46,989 | $ | 43,447 | $ | 47,000 | $ | 27,479 | |||||||||||
|
Total
current assets
|
13,990 | 50,342 | 44,549 | 47,720 | 28,093 | |||||||||||||||||
|
Total
assets
|
31,866 | 70,646 | 52,205 | 54,462 | 33,962 | |||||||||||||||||
|
Short-term
debt
|
9,835 | 4,742 | - | - | - | |||||||||||||||||
|
Long-term
debt
|
2,341 | 2,057 |
(a)
|
- | - | - | ||||||||||||||||
|
Warrant
liabilities
|
156 | 2,798 |
(c)
|
- | - | - | ||||||||||||||||
|
Total
liabilities
|
30,758 | 27,382 | 10,176 | 4,723 | 2,128 | |||||||||||||||||
|
Stockholders’
equity
|
1,108 | 43,264 | 42,029 | 49,739 | 31,834 | |||||||||||||||||
|
Book
value per share
|
$ | 0.02 | $ | 0.80 | $ | 0.96 | $ | 1.27 | $ | 1.07 | ||||||||||||
|
(a)
|
We
began consolidating CompCare’s operations on January 13,
2007.
|
|
(b)
|
The
$741,000 loss on extinguishment of debt resulted from a $5 million
redemption of the Highbridge senior secured notes on November 7,
2007. See further discussion in Note 6 – Debt
Outstanding.
|
|
(c)
|
The
fair value of warrants issued in conjunction with the registered direct
placement on November 7, 2007 was accounted for as a liability and was
revalued at $156,000 and $2.8 million at December 31, 2008 and 2007,
respectively, resulting in a $5.7 and $3.5 million non-operating gain,
respectively.
|
|
(d)
|
Includes
a $2.4 million impairment loss related to the non-cash stock settlement
reached with XINO Corporation in August 2007. See further
discussion in Note 5 – Intangible
Assets.
|
|
(e)
|
We recorded an impairment charge
of $272,000 in December 2005 to fully write off the cost of a patent for
opiate addiction treatment. See further discussion in Note 5 –
Intangible
Assets.
|
|
(f)
|
Includes
goodwill impairment charge of $9.8 million in December
2008. See further discussion in Note 1 – Summary of Significant
Accounting Policies, "Goodwill."
|
|
(g)
|
An
impairment charge of $1.4 million related to ARS was recognized in Q4
2008. The charge was deemed necessary after an analysis of
other-than-temporary impairment factors, including the severity of decline
in the ARS, the length of time that the estimated fair value of
the
|
ARS had
been below book value, our intent & ability to hold the ARS until they
recover in value and current financial market conditions. See further
discussion in Note 1 – Summary
of Significant Accounting Policies, Marketable
Securities.
|
(h)
|
Not
including $10.1 million of auction-rate securities classified in long-term
marketable
securites.
|
ITEM
7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Forward-Looking
Statements
The
forward-looking comments contained in the following discussion involve risks and
uncertainties. Our actual results may differ materially from those discussed
here due to factors such as, among others, limited operating history, difficulty
in developing, exploiting and protecting proprietary technologies, intense
competition and substantial regulation in the healthcare industry. Additional
factors that could cause or contribute to such differences can be found in the
following discussion, as well as under Item 1A, “Risks
Factors.”
OVERVIEW
General
We are a
healthcare services management company, providing through our
Catasys™ subsidiary behavioral health management services for
substance abuse to health plans. Catasys is focused on offering integrated
substance dependence solutions, including our patented PROMETA® Treatment
Program for alcoholism and stimulant dependence. The PROMETA Treatment Program,
which integrates behavioral, nutritional, and medical components, is also
available on a private-pay basis through licensed treatment providers and
company managed treatment centers that offer the PROMETA Treatment Program, as
well as other treatments for substance dependencies. We also research, develop,
license and commercialize innovative and proprietary physiological, nutritional,
and behavioral treatment programs.
Our
Strategy
Our
business strategy is to provide quality treatment programs in a cost effective
manner that will become the standard-of-care for those suffering from alcoholism
and other substance dependencies, autism and ADHD in a cost effective manner. We
intend to grow our business through implementing and
increasing adoption of our Catasys integrated substance dependence
solutions and our autism and ADHD solutions by managed care health plans,
employers, unions and other third-party payors. We also intend to
grow our business through increased utilization of our PROMETA Treatment Program
from within existing and new licensees and managed treatment
centers.
Key elements of our business
strategy include:
|
●
|
Providing
our Catasys integrated substance dependence solutions to managed care
health plans for reimbursement on a case rate or capitated
basis
|
|
●
|
Demonstrating
the potential for improved clinical outcomes and cost effectiveness
associated with using the PROMETA Treatment Program, through
implementation of our Catasys programs with key managed care and other
third-party payors
|
|
●
|
Launching
autism and ADHD specialty behavioral health products and programs that
will be supported by CompCare through our ASO services
agreement
|
|
●
|
Expanding
Catasys into other areas that can benefit from integrated behavioral and
medical treatment and case
management
|
|
●
|
Expanding
the base of our self-pay licensed treatment sites and managed treatment
centers, focusing primarily on existing service
areas
|
|
●
|
Seeking
additional scientific and clinical research data by leading research
institutions and preeminent researchers in the field of alcohol and
substance abuse to further validate the benefits of using the PROMETA
Treatment Program
|
Effective
January 12, 2007, we acquired a 50.3% controlling interest in Comprehensive Care
Corporation (CompCare) through the acquisition of Woodcliff Healthcare
Investment Partners, LLP (Woodcliff). Our consolidated financial statements
include the business and operations of CompCare subsequent to this
date.
CompCare
provides managed care services in the behavioral health and psychiatric
fields. CompCare manages the delivery of a continuum of psychiatric
and substance abuse services to commercial, Medicare and Medicaid members on
behalf of employers, health plans, government organizations, third-party claims
administrators, and commercial and other group purchasers of behavioral
healthcare services. The customer base for CompCare’s services
includes both private and governmental entities. During the year ended December
31, 2008, CompCare 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.
CompCare’s Medicare, Medicaid and CHIP contracts are subject to agreements with
their HMO clients whose contracts with the various governmental agencies may be
subject to renegotiation at the election of the specific agency.
On
January 20, 2009 we sold our interest in CompCare. Additionally, we entered into
an administrative services only (ASO) agreement with CompCare to provide certain
administrative services under CompCare’s NCQA accreditation, including but not
limited to case management and authorization services, in support of our newly
launched specialty products and programs for autism and ADHD. See
further discussion under Recent Developments
below.
Segment
Reporting
We have
conducted our operations through two business segments: healthcare services and
behavioral health managed care services. Our healthcare services segment
provides our Catasys integrated substance dependence, autism and ACHD solutions
to health plans, employers and unions through a network of licensed and company
managed healthcare providers, and provides licensing, administrative and
management services to licensees that administer PROMETA and other treatment
programs, including managed treatment centers that are licensed and/or managed
by us. Our behavioral health managed care services segment, comprised entirely
of the operations of our consolidated subsidiary, CompCare, provides managed
care services in the behavioral health, psychiatric and substance abuse fields.
A majority of our consolidated revenues and assets are earned or located within
the United States.
Operations
Healthcare
Services
Catasys
In 2008
we developed and operationalized our Catasys integrated substance dependence
solutions for third-party payors, and in January 2009 we launched additional
Catasys specialty products for autism and ADHD. We believe that our Catasys
offerings will address the largest segment of the healthcare market for
substance dependence and other behavioral disorders.
Licensing
Operations
Under our
licensing agreements, we provide physicians and other licensed treatment
providers access to our PROMETA Treatment Program, education and training in the
implementation and use of the licensed technology and marketing support. The
patient’s physician determines the appropriateness of the use of the PROMETA
Treatment Program. We receive a fee for the licensed technology and related
services generally on a per patient basis. As
of December 31, 2008, we had active licensing agreements with physicians,
hospitals and treatment providers for 84 sites throughout the United States,
with 49 sites contributing to revenue in 2008. We will continue to
enter into agreements on a selective basis with additional healthcare providers
to increase the availability of the PROMETA Treatment Program, but only in
markets we are presently operating or where such sites will provide support for
our Catasys products. As such revenues are generally related to the
number of patients treated, key
indicators
of our financial performance for the PROMETA Treatment Program will be the
number of facilities and healthcare providers that license our technology, and
the number of patients that are treated by those providers using our PROMETA
Treatment Program.
Managed
Treatment Centers
We
currently manage two treatment centers under our licensing agreements, located
in Santa Monica, California (dba The PROMETA Center, Inc.) and Dallas, Texas
(Murray Hill Recovery, LLC). In January 2007, a second PROMETA Center was opened
in San Francisco, which was subsequently closed in January 2008. We manage the
business components of the treatment centers and license the PROMETA
Treatment Program and use of the name in exchange for management and licensing
fees under the terms of full business service management agreements.
These centers offer treatment with the PROMETA Treatment Program for
dependencies on alcohol, cocaine and methamphetamines and also offer medical
interventions for other substance dependencies.
The
revenues and expenses of these centers are included in our consolidated
financial statements under accounting standards applicable to variable
interest entities. Revenues from licensed and managed treatment centers,
including the PROMETA Centers, accounted for approximately 33% of our healthcare
services revenues in 2008.
Research
and Development, Pilot Studies
To date,
we have incurred approximately $12.6 million related to research and
development, including $3.4 million in 2008, $3.3 million in 2007 and $3.1
million in 2006, respectively, in funding for commercial pilots and unrestricted
grants for a number of clinical research studies by researchers in the field of
substance dependence and leading research institutions to evaluate the efficacy
of the PROMETA Treatment Program in treating alcohol and stimulant
dependence. We plan to incur approximately $400,000 in 2009 for
unrestricted research grants and commercial pilots.
Pilot
programs are used in conjunction with drug court systems, state programs and
managed care organizations to allow such programs to evaluate the outcomes and
cost effectiveness of the PROMETA Treatment Program. The focus of these pilot
programs is to assist such organizations in assessing the impact on their
population, and as a result, the method, manner, timing, participants and
metrics may change and develop over time, based on initial results from the
particular program, other pilots, and research studies. We generally do not
provide updates on status after a pilot is initially announced.
International
In 2007,
we expanded our operations into Europe with our Swiss foreign subsidiary
commencing operations in the first quarter of 2007. However, in 2008 we
decided to substantially curtail our foreign operations to reduce costs and
focus on our Catasys product offerings.
On
January 20, 2009 we sold our entire interest in our majority-owned, controlled
subsidiary CompCare for aggregate gross proceeds of $1.5 million. We
expect to recognize a gain of approximately $11.2 million from the sale of our
CompCare interest, which will be included in our Consolidated Statement of
Operations for the three month period ending March 31, 2009. Additionally, we
entered into an administrative services only (ASO) agreement with CompCare to
provide certain administrative services under CompCare’s NCQA accreditation,
including but not limited to case management and authorization services, in
support of our newly launched specialty products and programs for autism and
ADHD.
Beginning
in the fourth quarter of 2008, we have initiated actions to reduce our cash
operating expenditures by an additional $10.2 million from the third quarter
2008 expenditure level, resulting in total budgeted cash operating expenditures
of approximately $17.7 million for 2009. The actions we took included
significant reductions in field and regional sales personnel and related
corporate support personnel, curtailment of our international operations, a
reduction in outside consultant expense and overall reductions in overhead
costs.
In May
2008, we entered into an agreement with a CIGNA HealthCare affiliate to be
reimbursed for providing our PROMETA based substance dependence treatment
program in Texas. The program became effective July 1, was initially
offered through our managed treatment center in Dallas and is now being expanded
into Houston and Los Angeles. The program will not require any significant
infrastructure investment by us to support the agreement. Medical and
psychosocial treatment is being provided by our licensed providers to CIGNA
HealthCare members, and although we anticipate expansion throughout Texas, the
clinical and financial impact of the program will be evaluated with the
objective of continued expansion beyond Texas.
Behavioral
Health Managed Care Services
Our
consolidated subsidiary, CompCare, typically enters into contracts on an annual
basis to provide managed behavioral healthcare and substance abuse treatment to
clients’ members. Arrangements with clients fall into two broad categories:
capitation arrangements, where clients pay CompCare a fixed fee per member per
month, and fee-for-service and administrative service arrangements where
CompCare may manage behavioral healthcare programs or perform various managed
care services. Approximately $34.1 million and $35.2 million, or 97%
of CompCare’s revenues for both the year ended December 31, 2008 and the period
January 13 through December 31, 2007, respectively, were derived from capitation
arrangements. Under capitation arrangements, CompCare receives premiums from
clients based on the number of covered members as reported by the clients. The
amount of premiums received 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.
Effective
January 1, 2007, CompCare commenced a contract with a health plan to provide
behavioral healthcare services to approximately 250,000 Medicaid recipients in
Indiana. This contract amounted to $17.8 million and $15 million,
respectively, in revenue for the year ended December 31, 2008 and the period
January 13 though December 31, 2007. This contract accounted for approximately
51%, of CompCare’s annual revenue in 2008. As discussed in “Recent Developments”
below, CompCare ceased providing behavioral health services to this client
effective on December 31, 2008.
Seasonality
of Business
Historically,
CompCare’s managed care plans have experienced increased member utilization
during the months of March, April and May, and consistently lower utilization by
members during the months of June, July,
and
August. Such variations in member utilization impact the costs of
care during these months, generally having a negative impact on gross margins
and operating profits during the former period, and a positive impact on gross
margins and operating profits during the latter period.
Concentration
of Risk
Over
eighty percent of CompCare’s operating revenue is currently concentrated, and
has been concentrated in past fiscal periods, in contracts with four to seven
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 CompCare’s financial
results.
Recent
Developments
On
January 1, 2009, CompCare 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.
Through
its newly formed, majority owned subsidiary, CompCare de Puerto Rico, Inc.,
CompCare began providing, on December 1, 2008, behavioral health services to
approximately 9,000 members of a health plan located in Puerto Rico. Effective
January 1, 2009, CompCare 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.
As of
December 31, 2008, CompCare ceased providing behavioral health services to
278,000 Medicaid members of its major Indiana HMO client, which had decided to
manage its membership through its own provider delivery system. Revenues from
this client accounted for $17.8 million, or 51% of CompCare's operating revenue,
and $15.0 million, or 40%, of CompCare’s operating revenues for the year ended
December 31, 2008 and the period from January 13 to December 31, 2007,
respectively. In addition, CompCare’s contract with a Maryland HMO covering
approximately 11,000 Medicare members ended December 31, 2008. This contract
accounted for $1.9 million, or 5%, and $1.3 million, or 4% of CompCare's
revenues for the year ended December 31, 2008 and the period from January 13 to
December 31, 2007, respectively.
In
October 2008, CompCare was awarded full accreditation by the
NCQA. NCQA accreditation validates that CompCare meets 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 an MBHO is founded on principles of quality and is continuously
improving 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.
How
We Measure Our Results
Our
healthcare services revenues to date have been primarily generated from fees
that we charge to hospitals, healthcare facilities and other healthcare
providers that license our PROMETA Treatment Program, and from patient service
revenues related to our licensing and management services agreements with
managed treatment centers. Our technology license and management services
agreements provide for an initial fee for training and other start-up related
costs, plus a combined fee for the licensed technology and other related
services, generally set on a per-treatment basis, and thus a substantial portion
of our revenues is closely related to the number of patients treated. Patients
treated by managed treatment centers generate higher average revenues per
PROMETA patient than our other licensed sites due to consolidation of their
gross patient revenues in our financial statements. Key indicators of
our financial performance will be the number of health plans and other
organizations that contract with us for our Catasys products, the number of
managed care lives covered by such plans, and the number of facilities and
healthcare providers that contract with us to license our technology and the
number of patients that are treated by those providers using the PROMETA
Treatment Program. Additionally, our financial results will depend on our
ability to expand the adoption of Catasys and the PROMETA Treatment Program
among government and other third
party
payer groups, and our ability to effectively price these products, and manage
general, administrative and other operating costs.
For
behavioral health managed care services, our largest expense to date has been
CompCare’s cost of behavioral health managed care services that it provides,
which is based primarily on its arrangements with healthcare providers. Since
CompCare’s costs are subject to increases in healthcare operating expenses based
on an increase in the number and frequency of the members seeking behavioral
health care services, CompCare’s profitability depends on its ability to predict
and effectively manage healthcare operating expenses in relation to the fixed
premiums it receives under capitation arrangements. Providing
services on a capitation basis exposes CompCare to the risk that its contracts
may ultimately be unprofitable if CompCare is unable to anticipate or control
healthcare costs. Estimation of healthcare operating expense is
one of our most significant critical accounting estimates. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations —
Critical Accounting Estimates.”
CompCare
currently depends upon a relatively small number of customers for a significant
percentage of its behavioral health managed care operating revenues. A
significant reduction in sales to any of CompCare’s large customers or a
customer exerting significant pricing and margin pressures on CompCare would
have a material adverse effect on CompCare's consolidated results of operations
and financial condition. In the past, some of CompCare’s customers have
terminated their arrangements or have significantly reduced the amount of
services requested (see Note 12 —Major
Customers/Contracts).
Results
of Operations
Table
of Summary Financial Information
The table
below and the discussion that follows summarize our results of operations and
certain selected operating statistics for the last three fiscal years (amounts
in thousands):
|
(In
thousands)
|
Year
Ended December 31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Revenues
|
||||||||||||
|
Behavioral
health managed care services
|
$ | 35,156 | $ | 36,306 | $ | - | ||||||
|
Healthcare
services
|
6,074 | 7,695 | 3,906 | |||||||||
|
Total
revenues
|
41,230 | 44,001 | 3,906 | |||||||||
|
Operating
Expenses
|
||||||||||||
|
Behavioral
health managed care expenses
|
36,496 | 35,679 | - | |||||||||
|
Cost
of healthcare services
|
1,718 | 2,052 | 818 | |||||||||
|
General
and administrative expenses
|
40,741 | 45,554 | 38,680 | |||||||||
|
Impairment
loss
|
- | 2,387 | - | |||||||||
|
Research
and development
|
3,370 | 3,358 | 3,053 | |||||||||
|
Goodwill
Impairment
|
9,775 | - | - | |||||||||
|
Depreciation
and amortization
|
2,733 | 2,502 | 1,281 | |||||||||
|
Total
operating expenses
|
94,833 | 91,532 | 43,832 | |||||||||
|
Loss
from operations
|
(53,603 | ) | (47,531 | ) | (39,926 | ) | ||||||
|
Interest
income
|
830 | 1,584 | 1,630 | |||||||||
|
Interest
expense
|
(1,939 | ) | (2,190 | ) | - | |||||||
|
Other
than temporary loss on marketable securities
|
(1,428 | ) | - | - | ||||||||
|
Loss
on extinguishment of debt
|
- | (741 | ) | - | ||||||||
|
Change
in fair value of warrant liabilities
|
5,744 | 3,471 | - | |||||||||
|
Other
non-operating expense, net
|
5 | 32 | - | |||||||||
|
Loss
before provision for income taxes
|
$ | (50,391 | ) | $ | (45,375 | ) | $ | (38,296 | ) | |||
|
Includes
results of CompCare, as reported in our behavioral health managed care
segment, which was sold in January
2009.
|
Summary
of Consolidated Operating Results
In
2008, our loss before provision for income taxes included a $9.8 million
goodwill impairment charge, a $1.4 million other-than-temporary loss on
marketable securities and $3.1 million in costs to streamline our operations.
The 2007 loss before provision for income taxes includes a $2.4 million
impairment charge related to intangible assets. Additionally, the 2008 results
reflect $8.6 million in share-based expense compared to $2.6 million in 2007.
Excluding the impact of these charges, the loss before provision for income
taxes decreased by $12.9 million in 2008 when compared to 2007, primarily due to
a $13.2 million reduction in total operating expenses and a $2.3 million
increase in income from the change in fair value of warrant liabilities,
partially offset by a $2.8 million decline in total revenues.
The
decline in total revenues resulted mainly from the impact of streamlining of our
healthcare services operations during 2008 to increase our focus on disease
management and managed care opportunities, which included the elimination of
field and regional sales personnel and closing of the PROMETA Center in San
Francisco, as well as the loss of contracts and decline in membership in
behavioral health managed care services.
The
reduction in total operating expenses also resulted mainly from the streamlining
in healthcare services operations, which accounted for a $13.9 million decrease
in operating expenses in that segment compared to 2007 (excluding the impact of
impairment charges, costs to streamline our operations and share-based expense),
partially offset by an increase in claims expense in behavioral health managed
care services.
The
2007 loss before provision for income taxes includes the $2.4 million impairment
charge and $2.6 million of share-based expense and the 2006 results include $3.7
million of share-based expense. Excluding the impact of these charges, the loss
before provision for income taxes in 2007 increased by $5.9 million compared to
2006, due to the inclusion of a $4.1 million loss from CompCare’s operations, a
$6.1 million increase in operating expenses in healthcare services, $2.2 million
increase in interest expense on debt outstanding and a $741,000 loss on
extinguishment of debt, partially offset by a $3.8 million increase in revenues
from healthcare services and favorable $3.5 million fair value adjustment of the
warrant liability. We acquired a majority controlling interest in CompCare,
resulting from our acquisition of Woodcliff on January 12, 2007, and began
including its results in our consolidated financial statements subsequent to
that date. These results are reported in our behavioral health managed care
services segment.
Our
healthcare services revenues virtually doubled in 2007, when compared to 2006.
The increase was due to the increase in the number of patients treated at our
U.S. licensed sites and at our managed treatment centers, administrative fees
from new licensees and other revenues from the commencement of international
operations and licenses with government agencies and other third-party
payors.
Excluding
the impact of CompCare, impairments and share-based expense, operating expenses
increased by approximately $6.1 million in 2007 when compared to the same period
in 2006. The increase is due mainly to the increase in the number of our sales
field personnel, the expansion in number of licensees, the strengthening and
expansion in our management and support teams, an increase in funding of
clinical research studies and investment in development of additional markets
for our services, including managed care, statewide agencies, criminal justice
systems and other third-party payors as well as international
opportunities.
We
incurred approximately $1.9 million of interest expense during the year ended
December 31, 2007 associated with the CompCare acquisition-related financing
with Highbridge International LLC (Highbridge) that originally consisted of the
issuance of a $10 million senior secured note and warrants to purchase our
common stock.
Reconciliation
of Segment Results
The
following table summarizes and reconciles the loss from operations of our
reportable segments to the loss before provision for income taxes from our
consolidated statements of operations for the years ended December 31, 2008,
2007 and 2006:
|
(In
thousands)
|
Year
Ended December 31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Healthcare
services
|
$ | (44,252 | ) | $ | (41,270 | ) | $ | (38,296 | ) | |||
|
Behavioral
health managed care services
|
(6,139 | ) | (4,105 | ) | - | |||||||
|
Loss
before provision for income taxes
|
$ | (50,391 | ) | $ | (45,375 | ) | $ | (38,296 | ) | |||
Healthcare
Services
The
following table summarizes the operating results for healthcare services for the
years ended December 31, 2008, 2007 and 2006:
|
(In
thousands, except patient treatment data)
|
December
31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Revenues
|
||||||||||||
|
U.S.
licensees
|
$ | 2,817 | $ | 3,807 | $ | 2,650 | ||||||
|
Managed
treatment centers (a)
|
2,006 | 2,416 | 1,137 | |||||||||
|
Other
revenues
|
1,251 | 1,472 | 119 | |||||||||
|
Total
revenues
|
6,074 | 7,695 | 3,906 | |||||||||
|
Operating
Expenses
|
||||||||||||
|
Cost
of healthcare services
|
1,718 | 2,052 | 818 | |||||||||
|
General
and administrative expenses
|
||||||||||||
|
Salaries
and benefits
|
21,392 | 21,272 | 16,212 | |||||||||
|
Other
expenses
|
15,667 | 20,561 | 22,468 | |||||||||
|
Impairment
loss
|
- | 2,387 | - | |||||||||
|
Goodwill
impairment
|
9,775 | - | - | |||||||||
|
Research
and development
|
3,370 | 3,358 | 3,053 | |||||||||
| Depreciation and amortization | 1,861 | 1,578 | 1,281 | |||||||||
|
Total
operating expenses
|
53,783 | 51,208 | 43,832 | |||||||||
|
Loss
from operations
|
(47,709 | ) | (43,513 | ) | (39,926 | ) | ||||||
|
Interest
income
|
804 | 1,439 | 1,630 | |||||||||
|
Interest
expense
|
(1,663 | ) | (1,926 | ) | - | |||||||
|
Other
than temporary loss on marketable securities
|
(1,428 | ) | - | - | ||||||||
|
Loss
on extinguishment of debt
|
- | (741 | ) | - | ||||||||
|
Change
in fair value of warrant liabilities
|
5,744 | 3,471 | - | |||||||||
|
Loss
before provision for income taxes
|
$ | (44,252 | ) | $ | (41,270 | ) | $ | (38,296 | ) | |||
|
PROMETA
Patients Treated
|
||||||||||||
|
U.S.
licensees
|
504 | 559 | 427 | |||||||||
|
Managed
treatment centers (a)
|
148 | 239 | 140 | |||||||||
|
Other
|
69 | 124 | 15 | |||||||||
| 721 | 922 | 582 | ||||||||||
|
Average
revenue per PROMETA patient treated (b)
|
||||||||||||
|
U.S.
licensees
|
$ | 5,412 | $ | 5,444 | $ | 5,915 | ||||||
|
Managed
treatment centers (a)
|
9,041 | 8,840 | 8,121 | |||||||||
|
Other
|
8,449 | 5,810 | 2,463 | |||||||||
|
Overall
average
|
6,455 | 6,374 | 6,357 | |||||||||
|
(a)
|
Includes
managed and/or licensed PROMETA
Centers.
|
|
(b)
|
The
average revenue per patient treated excludes administrative fees and other
non-PROMETA patient revenues.
|
Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007
Revenues
Revenues
for the year ended December 31, 2008 decreased $1.6 million compared to 2007,
mainly due to a $656,000 decrease in administrative fees earned from new
licensees, a decline in the number of sites contributing to revenue, a decease
in the number of patients treated at U.S.-licensed sites and managed treatment
centers and a $222,000 decrease in revenues from third party payors and
international locations, partially offset by increases in non-PROMETA treatments
at managed treatment centers. The number of licensed sites contributing to
revenue
amounted
to 49 in 2008 compared to 70 in 2007. The number of patients treated at
U.S.-licensed sites decreased to 505 patients in 2008 from 559 in 2007,
resulting in a $310,000 decline in revenues. The number of patients treated at
managed treatment centers decreased to 148 in 2008 from 239 in 2007, resulting
in a $775,000 decline in revenue. The average revenue per treatment remained
relatively unchanged at U.S. licensed sites, but increased slightly, by 2%, at
managed treatment centers in 2008 compared to 2007. The increase in other
treatment revenues at managed treatment centers was driven mainly by revenue
from the new center in Dallas, Texas, which commenced operations in August 2007.
The decrease in other revenues resulted principally from a decline in revenues
from government payors. Our revenue may be further impacted in first quarter of
2009 by market conditions due to the uncertain economy, and also as we maintain
our commitment to reduce cash expenditures in components of healthcare services
that are revenue generating, but unprofitable.
Operating
Expenses
Total
operating expenses amounted to $53.8 million in 2008 and include a $9.8 million
impairment charge related to the goodwill assigned to healthcare services
(following the acquisition of CompCare in 2007). We concluded that the goodwill
had become fully impaired as part of our fourth quarter impairment testing,
mainly resulting from the decline in the value of the reporting unit that arose
from the downward re-pricing of risk that occurred broadly in the equity markets
and affected the reporting unit in the quarter. Additionally,
2008 expense includes $8.5 million of share-based expense (in addition to the
$596,000 of share-based expense included in costs associated with streamlining
our operations).
Also,
2008 expenses included $3.1 million (including $596,000 in share-based
expense) in costs associated with actions taken to streamline our
operations in January, April and the fourth quarter of 2008 to increase our
focus on managed care opportunities. In January 2008, the actions we took to
streamline operations included significant reductions in field and regional
sales personnel and related corporate support personnel, closing the PROMETA
Center in San Francisco, and reducing overall overhead costs and the number of
outside consultants, all of which resulted in an overall reduction of operating
expenses by 25% to 30% for the remainder of 2008. In April 2008, we took further
action to streamline our operations by reducing total operating expenses an
additional 20% to 25% for the remainder of 2008. Beginning in the fourth quarter
of 2008, we initiated actions to reduce our operating expenditures by an
additional $10.2 million from the third quarter 2008 expenditure level,
resulting in total budgeted operating expenses of approximately $17.7 million
for 2009.
Total
operating expenses in 2007 amounted to $51.2 million and included a $2.4 million
impairment charge related to the non-cash stock settlement reached with XINO
Corporation (see discussion below) and $2.5 million in share-based
expense.
Excluding
the impact of the impairment charges, costs associated with streamlining our
operations and share-based expense, operating expenses decreased by $13.8
million in 2008, compared to the same period in 2007, primarily due to a $13.8
million decrease in general and administrative expenses and a $334,000 decrease
in costs of healthcare services, partially offset by a $283,000 increase in
depreciation & amortization.
Cost of
healthcare services consists of royalties we pay for the use of the PROMETA
Treatment Program, and costs incurred by our consolidated managed treatment
centers (including PROMETA Centers) for direct labor costs for physicians and
nursing staff, continuing care expense, medical supplies and treatment program
medicine costs. The decrease in these costs primarily reflects the decrease in
revenues from these treatment centers.
General
and administrative expenses consist primarily of salaries and benefits expense
and other operating expense, including support and occupancy costs, outside
services and marketing. Excluding the impairment and costs associated with
streamlining our operations, general and administrative expenses decreased by
$13.8 million during the year ended December 31, 2008 compared to the same
period in 2007, due to decreases in all categories of expense. Salaries and
benefits expense decreased by $6.0 million in 2008 compared to 2007, due to the
decrease in personnel from 160 employees at December 31, 2007 to 81 employees at
December 31, 2008, as we eliminated manager and staff positions in the field
supporting our licensed sites and decreased our corporate staff supporting
operations, research, sales and marketing efforts, new business initiatives and
general and administrative functions. Support and occupancy costs, such as
insurance, rent and travel costs, decreased by $2.6 million in 2008 compared to
2007 due to the overall decrease in staffing and corporate infrastructure. Costs
related to outside services, such as
audit,
legal, investor relations, marketing, business development, advertising and
other consulting expenses decreased by $4.7 million in 2008 compared to 2007.
Overall consulting expense declined by $1.7 million, advertising expense
decreased by $1.5 million and legal costs were reduced by $927,000, compared to
2007.
Research
and development expense remained relatively unchanged in 2008, compared to
2007.
Interest
Income
Interest
income for the year ended December 31, 2008 decreased compared to the same
period in 2007 due to a decrease in the average invested balance of cash
equivalents and marketable securities, and a decrease in average interest
rates.
Interest
Expense
Interest
expense primarily relates to debt outstanding, which includes the $5 million
amended senior secured note issued to Highbridge, the $5.8 million UBS line of
credit and the CompCare convertible notes. The note issued to Highbridge bears
interest at a rate equal to prime plus 2.5% (6.50% at December 31, 2008) and the
UBS line of credit bears interest at a rate equal to the 91-day U.S. Treasury
bill rate plus 120 basis points. For the year ended December 31, 2008, interest
expense decreased by $263,000 when compared to the prior year, primarily
from a lower average amount of debt outstanding and a decline in average
interest rates.
Other
than Temporary Loss on Marketable Securities
An
impairment charge of $1.4 million related to our auction rate securities
portfolio (ARS) was recognized in the fourth quarter of 2008. ARS
with an original par value of $11.5 million were written down to an
estimated fair value of $10.1 million as of December 31
2008. The charge was deemed necessary after an analysis of
other-than-temporary impairment factors, including the severity of decline
in the ARS, the length of time that the estimated fair value of the ARS had
been below book value, our intent and ability to hold the ARS until they recover
in value and current financial market conditions.
Change
in Fair Value of Warrant Liability
Warrants
issued in connection with a registered direct stock placement completed on
November 7, 2007 and warrants issued in connection with the Highbridge note
issued on January 18, 2007 and amended on July 31, 2008, are being accounted for
as liabilities in accordance with EITF 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock
(EITF 00-19), based on an analysis of the terms and conditions of the
warrant agreement.
The fair
value of the warrants issued in connection with the November 7, 2007 registered
direct stock placement (five-year warrants to purchase approximately
2.4 million shares of our common stock at an exercise price of $5.75)
amounted to $49,000 and $2.8 million on December 31, 2008 and 2007,
respectively, resulting in a $2.7 million non-operating gain in the Consolidated
Statement of Operations for 2008. For the warrants issued in connection with the
Highbridge note (five-year warrant to purchase approximately 1.3 million shares
of our common stock at an exercise price of $2.15, based on amended terms), the
estimated fair value amounted to $1.8 million on the date of issuance and
$107,000 at December 31, 2008, resulting in a $1.7 million non-operating
gain in the Consolidated Statement of Operations for 2008. Additionally, we
recognized $1.3 million for the change in valuation related to prior periods,
after the classification of the original warrants was reassessed at the date of
amendment and reclassified from additional paid-in capital to liabilities. Both
warrants are being valued at each reporting period using the Black-Scholes
pricing model to determine the fair market value per share. We will
continue to mark the warrants to market value each quarter-end until they are
completely settled.
Year
Ended December 31, 2007 Compared to Year Ended December 31,
2006
Revenues
Revenues
for the year ended December 31, 2007 virtually doubled compared to 2006,
due to an increase in the number of patients treated across all of our markets,
expansion of the number of contributing licensees,
administrative
fees from new licensees and other revenues from the commencement of
international operations and licenses with third-party payors. The number of
PROMETA patients treated increased by 58% in 2007 compared to 2006. The number
of licensed sites that contributed to revenues increased to 70 for the year
ended December 31, 2007 compared to 41 sites contributing to revenues in 2006,
including two new PROMETA Centers that were opened in San Francisco and New
Jersey in January 2007, and the addition of a managed treatment center in
Dallas, Texas, in August 2007. The average revenue per patient treated at
U.S. licensed sites in 2007 decreased compared to 2006 due to higher average
discounts granted by our licensees resulting principally from the launch of a
patient assistance program with our licensees, new site training and business
development initiatives. The average revenue for PROMETA patients treated at the
managed treatment centers increased in 2007 from 2006 due to a lower
percentage of discounted and training patients, and is higher than our other
licensed sites due to the consolidation of their gross patient revenues in our
financial statements. Other revenues in 2007 consisted of revenues from our
international operations and third-party payors. International revenues in
2007 include the commencement of operations in Europe in the first quarter of
2007 and revenues from Panama commencing in September 2007.
Operating
Expenses
Total
operating expenses increased by $7.4 million during the year ended December 31,
2007 compared to the same period in 2006, as we incurred a $2.4 million
impairment loss related to the non-cash stock settlement reached with XINO
Corporation, increased the number of our sales field personnel, expanded the
number of licensees, strengthened and expanded our management and support teams,
increased funding for clinical research studies and invested in development of
additional markets for our services, including managed care, statewide agencies,
criminal justice systems and other third-party payors as well as international
opportunities.
Cost of
healthcare services consists of royalties we pay for the use of the PROMETA
Treatment Program, and costs incurred by our consolidated managed treatment
centers (including PROMETA Centers) for direct labor costs for physicians and
nursing staff, continuing care expense, medical supplies and treatment program
medicine costs. The increase in these costs primarily reflects the increase in
revenues from these treatment centers, including the new sites added in 2007
discussed above.
General
and administrative expenses consist primarily of salaries and benefits expense
and other operating expense, including support and occupancy costs, outside
services and marketing. General and administrative expenses increased by $3.2
million during the year ended December 31, 2007 compared to the same period in
2006, due mainly to an increase in salaries and benefits expenses and support
and occupancy costs, partially offset by reductions in certain outside services
costs and advertising expenses. Salaries and benefits expenses increased by $5.1
million in 2007 compared to 2006, due to the increase in personnel from 120
employees at December 31, 2007 to approximately 160 employees at December 31,
2007, as we added managers and staff in the field to support our licensed sites,
increased our corporate staff to support our rapid growth in operations,
research, sales and marketing efforts, new business initiatives and general and
administrative functions. Support and occupancy costs, such as insurance, rent
and travel costs, increased by $2.5 million in 2007 compared to 2006 due to the
growth of our business and the resulting overall increase in staffing and
corporate infrastructure to support this growth. Costs related to
outside services, such as audit, legal, investor relations, marketing, business
development and other consulting expenses and non-cash stock-based compensation
charges for services received from non-employees, decreased by $1.9 million in
2007 compared to 2006. Advertising expense declined to $872,000 from $3.4
million in 2006, primarily due to increased costs for a drug addiction awareness
campaign for PROMETA in the first half of 2006.
The
impairment loss of $2.4 million resulted from the non-cash settlement
agreement reached with XINO Corporation in August 2007 to release 310,000 of the
360,000 shares of our common stock previously issued to XINO in 2003 in
connection with our acquisition of a patent for a treatment method for opiate
addition, which has never been utilized in our business plan.
Research
and development expense increased by $306,000 in 2007 compared to 2006 due to an
increase in funding for unrestricted grants for research studies to evaluate the
clinical effectiveness of our PROMETA Treatment Program and the commencement of
additional commercial pilot studies.
Interest
Income
Interest
income for the year ended December 31, 2007 decreased compared to the same
period in 2006 due to a decrease in the average invested balance of cash
equivalents and marketable securities, and a decrease in average interest
rates.
Interest
Expense
Interest
expense primarily relates to the $10 million senior secured note issued on
January 17, 2007 to finance the CompCare acquisition, accrued at a rate equal to
prime plus 2.5% (9.75% at December 31, 2007). For the year ended December 31,
2008, interest expense includes $949,000 in amortization of the $1.4 million
discount resulting from the value allocated to the warrants issued with the debt
and related borrowing costs. As discussed more fully in Note 6 –
Debt Outstanding, we
entered into a redemption agreement to redeem $5 million in principal related to
the senior secured notes as part of the securities offering completed on
November 7, 2007.
Loss
on Extinguishment of Debt
The loss
on extinguishment of debt of $741,000 was due to a redemption agreement with
Highbridge to redeem $5 million in principal related to the senior secured
notes as part of our securities offering completed on November 7, 2007. The loss
represents the difference between the reacquisition price, which included
$350,000 for an early redemption penalty, and the net carrying amount of the
principal amount being redeemed and related deferred costs of
issuance.
Change
in Fair Value of Warrant Liability
We issued
five-year warrants to purchase an aggregate of approximately 2.4 million
additional shares of our common stock at an exercise price of $5.75 per share in
connection with a registered direct stock placement completed on
November 7, 2007. The proceeds attributable to the warrants, based on the
fair value of the warrants at the date of issue, amounted to approximately
$6.3 million, and was accounted for as a liability in accordance with EITF
00-19. The warrant liability was revalued at $2.8 million at December 31, 2007,
resulting in a $3.5 million non-operating gain to the statement of operations.
We will continue to mark the warrants to market value each quarter-end until
they are completely settled.
Behavioral
Health Managed Care Services
The
following table summarizes the operating results for behavioral health managed
care services for the year ended December 31, 2008 and the period January 13
through December 31, 2007, which consisted entirely of the operations of
CompCare subsequent to our acquisition of a majority controlling interest in
CompCare on January 12, 2007 and related purchase accounting adjustments.
CompCare’s operating results for periods prior to the acquisition are not
included in our consolidated financial statements. In
January 2009, we sold our interest in CompCare.
|
For
the period
|
||||||||
|
For
the year
|
January
13
|
|||||||
|
ended
|
through
|
|||||||
|
(In
thousands)
|
December
31,
|
December
31,
|
||||||
|
2008
|
2007
|
|||||||
|
Revenues
|
||||||||
|
Capitated
contracts
|
$ | 34,117 | $ | 35,226 | ||||
|
Non-capitated
contracts
|
1,039 | 1,080 | ||||||
|
Total
revenues
|
35,156 | 36,306 | ||||||
|
Operating
Expenses
|
||||||||
|
Claims
expense
|
30,492 | 29,041 | ||||||
|
Other
behavioral health managed care services expense
|
6,004 | 6,638 | ||||||
|
Total
healthcare operating expense
|
36,496 | 35,679 | ||||||
|
General
and administrative expenses
|
3,682 | 3,721 | ||||||
|
Depreciation
and amortization
|
872 | 923 | ||||||
|
Loss
from operations
|
(5,894 | ) | (4,017 | ) | ||||
|
Other
non-operating income, net
|
5 | 32 | ||||||
|
Interest
income
|
26 | 143 | ||||||
|
Interest
expense
|
(276 | ) | (263 | ) | ||||
|
Loss
before provision for income taxes
|
$ | (6,139 | ) | $ | (4,105 | ) | ||
|
Total
membership
|
959,000 | 1,025,000 | ||||||
|
Medical
Loss Ratio (1)
|
89 | % | 82 | % | ||||
(1)
Medical loss ratio reflects claims expenses as a percentage of revenue of
capitated contracts.
Year
Ended December 31, 2008 Compared to Period January 13, 2007 through December 31,
2007
Revenues
Operating
revenues from capitated contracts decreased by $1.1 million, or approximately
3%, for the year ended December 31, 2008 compared to the period January 13
through December 31, 2007. The decline stems mainly from the loss of two
clients in Indiana and one in Texas accounting for approximately $5.7 million of
revenue during the period January 13 through December 31, 2007, compared to
$37,000 during the year ended December 31, 2008. The decrease was partially
offset by revenue attributable to twelve more days in the 2008 period,
accounting for approximately $1.2 million, and $3.7 million of additional
business from four existing customers in Indiana, Maryland and Michigan. The
decrease in non-capitated revenue is primarily attributable to the loss of
business from customers in Indiana and Texas.
Operating
Expenses
For the
year ended December 31, 2008, claims expense on capitated contracts increased by
approximately $1.5 million when compared to the period January 13 through
December 31, 2007, due to a higher medical loss ratio
experienced
with the major Indiana HMO client and the additional twelve days included in our
consolidated financial statements for the 2008 period relative to 2007. Claims
expense as a percentage of capitated revenues increased from 83.5% for the
period January 13 through December 31, 2007 to 89.4% for the year ended December
31, 2008 due to a high medical loss ratio experienced with CompCare's major
Indiana client.
The
decline in other healthcare expenses (which are attributable to servicing both
capitated and non-capitated contracts) in 2008 compared to the period January 13
through December 31, 2007, was due mainly to staff decreases in response to the
loss of revenues in Indiana and Pennsylvania.
General
and administrative expenses decreased slightly in 2008 compared to the period
January 13 through December 31, 2007, due primarily to the impact of
cost-reduction efforts in the third and fourth quarter of 2008, the $416,000 in
severance costs incurred from the retirement of CompCare’s former CEO in 2007,
$239,000 in costs and expenses incurred in 2007 relating to the acquisition and
proposed merger between our company and CompCare and for legal services in
defense against two class action lawsuits related to the proposed merger that
have subsequently been dismissed. The decreases were partially offset by the
impact of twelve more days in 2008 compared to the period in the prior year,
increased consulting fees for compliance and information system management
services, $80,000 in additional compensation expense from stock options due to
option grants subsequent to September 30, 2007, and increased financial advisory
fees. General and administrative expense as a percentage of operating revenue
was approximately 10% for both 2008 and the period January 13, 2007 to December
31, 2007.
Depreciation
and amortization in 2008 and the period January 13 through December 31, 2007
includes $719,000 and $775,000, respectively, of amortization related to the
fair value attributable to managed care contracts and other identifiable
intangible assets acquired as part of the CompCare acquisition.
Interest
Income
Interest
income for 2008 decreased compared to the period January 13 through December 31,
2007 due to a decline in the average balance of cash, cash equivalents and
marketable securities, and in average investment yields.
Interest
Expense
Interest
expense primarily relates to the $2.2 million in 7.5% convertible subordinated
debentures at CompCare and includes approximately $84,000 and $78,000 of
amortization related to the purchase price allocation adjustment related to the
CompCare acquisition for 2008 and the period January 13 through December 31,
2007, respectively.
Liquidity
and Capital Resources
Liquidity
As of
December 31, 2008, we had a balance of approximately $11.0 million in cash, cash
equivalents and current marketable securities, of which approximately $1.1
million was held by CompCare. In addition, we had approximately
$10.1 million (net of $1.4 million impairment charge for other than
temporary decline in value) of ARS, which are classified in long-term assets as
of December 31, 2008.
ARS
are variable-rate instruments with longer stated maturities whose interest rates
are reset at predetermined short-term intervals through a Dutch auction
system. However, commencing in February 2008, auctions for these securities
have failed, meaning the parties desiring to sell securities could not be
matched with an adequate number of buyers, resulting in our having to continue
to hold these securities. We believe that we ultimately should be able to
liquidate all of our ARS investments without significant loss because the
securities are Aaa/AAA rated and collateralized by portfolios of student loans
guaranteed by the U.S. government. However, current conditions in the ARS
market make it likely that auctions will continue to be unsuccessful in the
short-term, limiting the liquidity of these investments until the auction
succeeds, the issuer calls or refinances the securities, or they mature. As a
result of the current turmoil in the credit markets, our ability to liquidate
our investment and fully recover the carrying value of our investment in the
near term may be limited or not exist. Based on the foregoing, we believe at the
current time that our ARS investments most likely cannot be sold at par within
the next 12 months. Therefore, we have classified the ARS investments in
long-term assets at December 31, 2008.
In
October 2008, UBS made a “Rights” offering to its clients, pursuant to which we
are entitled to sell to UBS all auction-rate securities held by us in our UBS
account. The Rights permit us to require UBS to purchase our ARS for a price
equal to original par value plus any accrued but unpaid interest beginning on
June 30, 2010 and ending on July 2, 2012 if the securities are not
earlier redeemed or sold. As discussed below in “Capital Structure &
Financing Activities” below, UBS has provided us, as part of the offering, a
line of credit equal to 75% of the market value of the ARS until they are
purchased by UBS. The line of credit has certain restrictions described in
the prospectus. We accepted this offer on November 6,
2008.
Due to
our current financial condition, we are no longer able to conclude that we have
the ability to hold the ARS until we are able to recover full value for them.
Accordingly, we recorded a $1.4 million impairment charge for other than
temporary decline in value of the ARS as of December 31, 2008. If current market
conditions deteriorate further, the credit rating of the ARS issuers
deteriorates, or the anticipated recovery in the market values does not occur,
we may be required to make further adjustments to the carrying value of the ARS
through impairment charges in the Consolidated Statement of Operations, and any
such impairment adjustments may be material.
As of
December 31, 2008, we had a working capital deficit of approximately $11.5
million, of which $5.6 million is related to CompCare, which was sold on January
20, 2009. Additionally, our working capital deficit is impacted by $5.7 million
of outstanding borrowings under the UBS line of credit that is payable on demand
and classified in current liabilities, but are secured by $10.1 million of ARS
investments that are classified in long-term assets as discussed above. We
have incurred significant net losses and negative operating cash flows since our
inception. We expect to continue to incur net losses and negative operating cash
flows for at least the next twelve months. As of December 31, 2008, these
conditions raised substantial doubt from our auditors as to our ability to
continue as a going concern. Our ability to fund our ongoing operations and
continue as a going concern is dependent on raising additional capital, signing
and generating revenue from new contracts for our Catasys managed care
programs and the success of management’s plans to increase revenue and continue
to decrease expenses. In the fourth quarter of 2008, management
took actions that resulted in reducing annual operating expenses by $10.2
million compared to the third quarter of 2008. In addition,
management currently has plans for additional cost reductions from the
elimination of certain positions in our licensee and PROMETA Center operations
and related corporate staff and a reduction in certain support and occupancy
costs, consulting and other outside services if required. Also, we have
renegotiated certain leasing and vendor agreements to obtain more favorable
pricing and to restructure payment terms. We have also negotiated and plan to
negotiate more favorable payment terms with vendors, which include negotiating
settlements for outstanding liabilities. We may exit additional markets in our
licensee and PROMETA Center operations to reduce costs or if management
determines that those markets will not provide short term profitability.
Additionally, we are pursuing new Catasys contracts, additional capital and will
consider liquidating our ARS, if necessary. There can be no assurance that we
will be successful in our efforts to generate, increase, or maintain revenue. We
have been in discussions with third parties regarding financing that management
anticipates would, if concluded, meet our capital needs. We may not be
successful in raising necessary funds on acceptable terms or at all, and we may
not be able to offset this by sufficient reductions in expenses and increases in
revenue. If this occurs, we may be unable to meet our cash obligations as they
become due and we may be required to further delay or reduce operating expenses
and curtail our operations, which would have a material adverse effect on
us.
CompCare
As of
December 31, 2008, CompCare had net cash on hand of approximately $1.1 million,
a working capital deficit of $5.7 million and a stockholders’ equity deficit of
$9.2 million. On January 20, 2009 we sold our entire interest in CompCare for
gross proceeds of $1.5 million and as a result we are under no obligation to
provide CompCare with any form if financing or cash investment.
Cash
Flows
Net cash
used in operating activities included $24.0 million and $41.3 million for
healthcare services operations during 2008 and 2007, respectively. The primary
source of funds in our healthcare services operations includes revenue from
licensing the PROMETA Treatment Program and managed treatment centers and
revenues from government and third-party payors. Use of funds in operating
activities include general and administrative expense (excluding share-based
expense), cost of healthcare services revenue and research and development
costs, which totaled approximately $32.6 million in 2008, compared to $44.7
million for 2007. The decrease in net cash used between 2008 and 2007 reflects
the decline in such expenses, resulting mainly from our efforts to streamline
operations, as described below.
In
January 2008, we streamlined our healthcare services operations to increase our
focus on managed care opportunities, which resulted in an overall reduction of
25% to 30% of operating expenses from prior levels. The actions we took
included significant reductions in field and regional sales personnel and
related corporate support personnel, closing the PROMETA Center in San Francisco
and reducing overall overhead costs and the number of outside consultants. In
April 2008 we continued to streamline our operations by reducing future monthly
costs an additional 20% to 25% compared to the three months ended March 31,
2008. Following
the streamlining actions taken in January 2008 and April 2008, general and
administrative expense (excluding share-based expense), cost of healthcare
services revenue and research and development costs were $6.1 million in
the fourth quarter ended December 31, 2008, compared to $10.7 million, $8.5
million and $7.3 million in the first, second and third quarters of 2008,
respectively, and an average of $11.2 million per quarter in 2007. Beginning in
the fourth quarter of 2008, we have initiated actions to reduce our operating
expenses by an additional $10.2 million from the third quarter 2008 expenditure
level, resulting in total budgeted operating expenses of approximately $17.7
million for 2009.
We
recorded approximately $3.1 million in costs associated with these actions
during 2008, which primarily represent severance and related benefits and costs
incurred to close the San Francisco PROMETA Center and international operations.
All such costs are included in general and administrative expenses in the
Consolidated Statement of Operations.
During
2008, we expended approximately $993,000 in capital expenditures for the
development of our information systems and other equipment needs. We expect our
capital expenditures to be approximately $40,000 during 2009. Our future
capital requirements will depend upon many factors, including progress with our
marketing efforts, the time and costs involved in preparing, filing,
prosecuting, maintaining and enforcing patent claims and other proprietary
rights, the necessity of, and time and costs involved in obtaining, regulatory
approvals, competing technological and market developments, and our ability to
establish collaborative arrangements, effective commercialization, marketing
activities and other arrangements.
Other
Additionally,
we have received $2.0 million and $1.7 million of proceeds from exercises of
stock options and warrants during the years ended December 31, 2007 and 2006.
There were no exercises of stock options and warrants during
2008.
Investment
in CompCare
In
January 2007, we acquired all of the outstanding membership interests of
Woodcliff for $9 million in cash and approximately 215,000 shares of our common
stock. Woodcliff owns 1,739,000 shares of common stock and 14,400 shares of
Series A Convertible Preferred Stock of CompCare, the conversion of which would
result in us owning over 50% the outstanding shares of common stock of CompCare
as of that date. The preferred stock has voting rights and, combined with the
common shares held by us, gives us voting control over CompCare. The
preferred stock gives us rights, including:
|
●
|
The
right to designate the majority of CompCare’s Board of
Directors
|
|
●
|
Dividend
and liquidation preferences, and
|
|
●
|
Anti-dilution
protection.
|
In
addition, without our consent, CompCare is prevented from engaging in any of the
following transactions:
|
●
|
Any
sale or merger involving a material portion of assets or
business
|
|
●
|
Any
single or series of related transactions in excess of $500,000,
and
|
|
●
|
Incurring
any debt in excess of $200,000.
|
We
received $10 million in proceeds from the issuance of a secured note to finance
the cash portion of the CompCare acquisition. See discussion in “Highbridge
Senior Secured Note” below.
Our controlling
interest in CompCare did not require any material amount of additional cash
investment or expenditures by us in 2008, other than expenditures made by
CompCare from its existing cash reserves and cash flow from its
operations.
Pursuant
to a stock purchase agreement between WoodCliff (our wholly-owned subsidiary)
and Core Corporate Consulting Group, Inc (CCCG), dated January 14, 2009, and
effective as of January 20, 2009, we have disposed of our entire interest in our
controlled subsidiary Comprehensive Care Corporation (CompCare), consisting of
14,400 shares of Class A Series Preferred Stock, and 1,739,130 shares of common
stock of CompCare held by Woodcliff, for aggregate gross proceeds of $1.5
million. We expect to recognize a gain of approximately $11.2 million from the
sale of our CompCare interest, which will be included in our Consolidated
Statement of Operations for the three month period ending March 31,
2009.
CompCare
Cash Flow
During
the year ended December 31, 2008, CompCare's net cash and cash equivalents
decreased by $5.2 million. Net cash used in behavioral health managed
care operations totaled $5.5 million, attributable primarily to payment of
claims on the 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 CompCare’s large Indiana client, which was
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 CompCare’s 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 $163,000 in net proceeds from the
issuance of common stock and $200,000 from the issuance of a convertible
promissory note in September 2008, 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, CompCare had a working capital deficit of $5.7 million and a
stockholders’ deficit of $9.2 million. During June and July of 2008,
CompCare reduced its usage of consultants and temporary employees and eliminated
certain staffing positions. In addition CompCare implemented a 10%
salary reduction for employees at the vice president level and above and reduced
outside directors fees by 10%. CompCare has also requested rate increases from
several of its existing clients. In February 2009, CompCare obtained
additional equity financing in the amount of $1.6 million through the sale of
6.4 million shares of its unregistered common stock to two
investors.
The
unpaid claims liability for managed care services is estimated using an
industry-accepted actuarial paid completion factor methodology and other
statistical analyses. These estimates are subject to the effects of trends
in utilization and other factors. Although considerable variability
is inherent in such estimates, CompCare believes that the unpaid claims
liability is adequate. However, actual results could differ from the $6.8
million claims payable amount reported as of December 31, 2008.
Capital
Structure & Financing Activities
Public
and Private Placement Stock Offerings
We have
financed our operations, since inception, primarily through the sale of shares
of our common stock in public and private placement stock offerings. The
following table sets forth a summary of our equity offering proceeds, net of
expenses, since our inception (in millions):
|
Date
|
Transaction Type
|
Amount
|
|||
|
September
2003
|
Private
Placement
|
$ | 21.3 | ||
|
December
2004
|
Private
Placement
|
21.3 | |||
|
November
2005
|
Public
Offering
|
40.2 | |||
|
December
2006
|
Private
Placement
|
24.4 | |||
|
November
2007
|
Registered
Direct Placement
|
42.8 | |||
| $ | 150.0 | ||||
On
November 7, 2007, we completed a registered direct placement, in which we
issued an aggregate of 9,635,000 shares of common stock at a price of $4.79 per
share, for gross proceeds of approximately $46.2 million,
with
select institutional investors. We also issued five-year warrants to purchase an
aggregate of approximately 2.4 million additional shares of our common stock at
an exercise price of $5.75 per share. Included in the gross proceeds was $5.35
million from the conversion of $5 million of the senior secured notes issued to
Highbridge (see discussion below), which includes $350,000 based on a redemption
price of 107% of the principal amount being redeemed pursuant to a redemption
agreement entered into with Highbridge in November 2007. The fair value of the
warrants at the date of issue was estimated at $6.3 million, accounted for
as a liability in accordance with EITF 00-19. We incurred approximately $3.2
million in fees to placement agents and other transaction costs in connection
with the transaction.
In
December 2006, we issued 3,573,000 shares of common stock at a price of $7.30
per share in a closed private placement offering for a total of $26.1 million in
proceeds from funds affiliated with existing investors and accredited
institutional investors. We paid $1.8 million in placement fees to the
underwriters in connection with the transaction.
In
November 2005, we completed an underwritten equity offering of 9,200,000 shares
at a price of $4.75 per share for a total of $43.7 million in
proceeds. We paid $3.1 million in placement fees to the underwriters
in connection with the transaction.
Highbridge
Senior Secured Note
In
January 2007, to finance the CompCare acquisition, we entered into a securities
purchase agreement pursuant to which we sold to Highbridge (a) $10 million
original principal amount of senior secured notes and (b) warrants to purchase
up to approximately 250,000 shares of our common stock (adjusted to 285,000
shares as of December 31, 2007). The note bears interest at a rate of prime plus
2.5%, interest payable quarterly commencing on April 15, 2007, and matures on
January 15, 2010, The note was redeemable at our option anytime prior to
maturity at a redemption price ranging from 103% to 110% of the principal amount
during the first 18 months and was originally redeemable at the option of
Highbridge beginning on July 18, 2008.
Total
original funds received of $10.0 million were allocated to the warrant and the
senior secured note in the amounts of $1.4 million and $8.6 million,
respectively, in accordance with their relative fair values as determined at the
date of issuance. The value allocated to the warrant was treated as a discount
to the note and was amortized to interest expense over the 18 month period
between the date of issuance (January 17, 2007) and the date that Highbridge
first had the right to redeem the note (July 18, 2008), using the effective
interest method. In addition, we paid a $150,000 origination fee and incurred
approximately $150,000 in other costs associated with the financing, which were
allocated to the warrant and senior secured note in accordance with the relative
fair values assigned to these instruments, and was deferred and also amortized
over the same 18-month period.
The
original warrant issued had a term of five years, and was initially exercisable
at $12.01 per share, or 120% of the $10.01 closing price of our common stock on
January 16, 2007. Pursuant to an anti-dilution adjustment clause in the
note, the exercise price of the warrant was adjusted to $10.52 per share and the
number of shares was adjusted to 285,185. The warrant is subject to further
adjustments if we sell or are deemed to have sold shares at a price below the
adjusted exercise price per share, and will be proportionately adjusted for
stock splits or dividends. Similarly, if we were to issue convertible debt, the
anti-dilution adjustment would also be triggered should the conversion price be
less than it current price per share.
We
entered into a redemption agreement with Highbridge to redeem $5 million in
principal related to the senior secured note as part of our securities
offering completed on November 7, 2007. Included in the gross proceeds received
on that date was $5.35 million for the conversion of $5 million of the senior
note, which also included payment of $350,000 for an early redemption penalty,
based on a redemption price of 107% of the principal amount being redeemed
pursuant to the redemption agreement. The $350,000 is included as part of the
reacquisition cost of the notes and the difference between the reacquisition
price and the net carrying amount of the principal amount redeemed was
recognized as a loss of $741,000 on extinguishment of debt in our statement of
operations during the year ended December 31, 2007.
On July
31, 2008, we amended the note to extend, from July 18, 2008 to July 18, 2009,
the optional redemption date exercisable by Highbridge for the $5 million
remaining under the Note, and remove certain restrictions on our ability to
obtain a margin loan on our ARS. In connection with this extension, we granted
Highbridge additional
redemption
rights in the event of certain strategic transactions or other events generating
additional liquidity for us, including, without limitation, the conversion of
some or all of our ARS into cash. We also granted Highbridge a right of first
refusal relating to the disposition of our ARS and amended the existing warrant
held by Highbridge for 285,185 shares of our common stock at $10.52 per share.
The amended warrant expires five years from the amendment date and is
exercisable for 1,300,000 shares of our common stock at a price per share of
$2.15, priced off of the $2.14 closing price of our common stock on July 22,
2008. The terms of the amended warrant required that it be accounted for as a
liability in accordance in EITF 00-19 and the fair value amounted to $1.8
million at the date of amendment. The interest terms of the note remained
unchanged at a rate of prime plus 2.5%, which amounted to a current interest
rate at December 31, 2008 of 5.75% and the note is classified in short-term
liabilities on our consolidated balance sheet.
Pursuant
to EITF 96-19, Debtor’s
Accounting for a Modification or Exchange of Debt Instruments, the
amended note was considered to have substantially different terms and was
accounted for in the same manner as a debt extinguishment. The difference
between the fair value of the amended debt and the carrying value of the
original debt amounted to $1.7 million and was recognized as a debt
extinguishment gain. The incremental fair value of the amended warrant compared
to the original warrant, treated as consideration granted by us for the
amendment, amounted to $1.7 million on the date of amendment and was accounted
for as a debt extinguishment loss since the amendment is being accounted for as
a debt extinguishment. The gain and loss on the debt extinguishment offset each
other and netted to a zero amount. The difference between the fair value and
principal amount of the amended debt, amounting to $1.7 million, is being
treated as a discount to the note and is being amortized to interest expense
over a 12-month period, until the July 18, 2009 optional redemption date. The
warrant liability was revalued at $107,000 at December 31, 2008, resulting in
$1.7 million non-operating gain included in our Consolidated Statement of
Operations for the year ended December 31, 2008. We will continue to re-measure
the warrants at fair value each reporting period until they are completely
settled or expire.
The
senior secured note restricts any new debt offerings so that we are only able to
issue unsecured, subordinated debt so long as the principal payments are beyond
the maturity of the senior secured note (January 15, 2010) and the
interest rate is not greater than the senior secured note rate (Prime+2.5%). The
new debt cannot have call rights during the senior secured note term and
Highbridge must consent to the issuance of new debt.
In
connection with the financing, we entered into a security agreement granting
Highbridge a first-priority perfected security interest in all of our assets
owned at the date of the original note or acquired thereafter. We also entered
into a pledge agreement with Highbridge, as collateral agent, pursuant to which
we delivered equity interests evidencing 65% of our ownership of our foreign
subsidiaries. In the event of a default, the collateral agent is given broad
powers to sell or otherwise deal with the pledged collateral. There are no
material financial covenant provisions associated with the senior secured
note.
UBS
Line of Credit
In May
2008, our investment portfolio manager, UBS, provided us with a demand
margin loan facility collateralized by our ARS, which allowed us to borrow up to
50% of the UBS-determined market value of our ARS.
As
discussed above in “Liquidity,” UBS made a “Rights” offering to its clients in
October 2008, pursuant to which we are entitled to sell to UBS all ARS held in
our UBS account. As part of the offering, UBS has provided us a line of credit
(replacing the demand margin loan), subject to certain restrictions as described
in the prospectus, equal to 75% of the market value of the ARS, until they are
purchased by UBS. We accepted the UBS offer on November 6,
2008.
As of
December 31, 2008, the outstanding balance on our line of credit was $5.7
million. The loan is subject to a rate of interest based upon the current 91-day
U.S. Treasury bill rate plus 120 basis points, payable monthly, and is carried
in short-term liabilities on our Consolidated Balance
Sheet.
CompCare
Debt
outstanding also includes 7.5% convertible subordinated debentures of CompCare
with a remaining principal balance of $2,244,000. As part of the
acquisition-related purchase price allocation, an adjustment of $266,000 was
made at the date of acquisition to reduce the carrying value of this debt to its
estimated fair value. This adjustment was treated as a discount and is being
amortized over the remaining contractual maturity term of the note (April 2010)
using the effective interest method.
On
September 3, 2008, CompCare entered into a purchase agreement with an investor,
in which it issued 200,000 shares of CompCare common stock and a $200,000
convertible promissory note for aggregate consideration of $250,000. CompCare
intends to use the net proceeds from the sale of stock and the promissory note
for working capital and general corporate purposes. The promissory note matures
August 31, 2011 and bears interest at the rate of 8.5% per annum, payable
monthly in arrears. The promissory note is convertible into CompCare common
stock at the rate of $0.25 per share.
As
discussed above, we sold our interest in CompCare in January
2009.
Contractual
Obligations and Commercial Commitments
The
following table sets forth a summary of our material contractual obligations and
commercial commitments as of December 31, 2008 (in thousands):
|
Contractual
Obligations
|
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
|||||||||||||||
|
Debt
obligations, including interest (4)
|
$ | 13,494 | $ | 11,165 | $ | 2,329 | $ | - | $ | - | ||||||||||
|
Claims
payable (1)
|
6,791 | 6,791 | - | - | - | |||||||||||||||
|
Reinsurance
claims payable (2)
|
2,526 | - | 2,526 | - | - | |||||||||||||||
|
Capital
lease obligations (5)
|
351 | 191 | 160 | - | - | |||||||||||||||
|
Operating
lease obligations (3)
|
3,977 | 1,756 | 2,206 | 15 | - | |||||||||||||||
|
Contractual
commitments for clinical studies
|
2,910 | 1,257 | 1,653 | - | - | |||||||||||||||
| $ | 30,049 | $ | 21,160 | $ | 8,874 | $ | 15 | $ | - | |||||||||||
|
(1)
|
These
CompCare claim liabilities represent the best estimate of benefits to be
paid under capitated contracts and consist of reserves for claims and
IBNR. Because of the nature of such contracts, there is typically no
minimum contractual commitment associated with covered claims. Both the
amounts and timing of such payments are estimates, and the actual claims
paid could differ from the estimated amounts
presented.
|
|
(2)
|
This
item represents a CompCare liability relating to denied claims for a
terminated reinsurance contract. Any adjustment to the
reinsurance claims liability would be accounted for in the statement of
operations in the period in which the adjustment is
determined.
|
|
(3)
|
Operating
lease commitments for our and CompCare’s corporate office facilities, two
PROMETA Centers, including deferred rent liability, a managed treatment
center in Dallas, Texas and facilities related to our international
operations. These amounts include $1.1 million related to CompCare, which
was sold in January 2009.
|
|
(4)
|
Includes
$2.5 million related to CompCare, which was sold in January
2009.
|
|
(5)
|
Includes
$141,000 related to CompCare, which was sold in January
2009.
|
Off-Balance
Sheet Arrangements
As of
December 31, 2008, we had no off-balance sheet arrangements.
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.
Effects
of Inflation
Our most
liquid assets are cash, cash equivalents and marketable securities. Because of
their liquidity, these assets are not directly affected by inflation. Because we
intend to retain and continue to use our equipment, furniture and fixtures and
leasehold improvements, we believe that the incremental inflation related to
replacement costs of such items will not materially affect our operations.
However, the rate of inflation affects our expenses, such as
those for
employee compensation and contract services, which could increase our level of
expenses and the rate at which we use our resources.
Critical
Accounting Estimates
The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. GAAP require
management to make estimates, judgments and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, and the disclosure of
contingent assets and liabilities. We base our estimates on experience and on
various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that may not be readily apparent
from other sources. 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. Our actual results may differ from these
estimates.
We
consider our critical accounting estimates to be those that (1) involve
significant judgments and uncertainties, (2) require estimates that are
more difficult for management to determine, and (3) may produce materially
different results when using different assumptions. We have discussed these
critical accounting estimates, the basis for their underlying assumptions and
estimates and the nature of our related disclosures herein with the audit
committee of our Board of Directors. We believe our accounting policies specific
to behavioral health managed care services revenue recognition, managed care
premium deficiencies, accrued claims payable and claims expense for managed care
services, share-based compensation expense, the impairment assessments for
goodwill and other intangible assets and valuation of marketable securities
involve our most significant judgments and estimates that are material to our
consolidated financial statements. They are discussed further
below:
Managed
Care Services Revenue Recognition
CompCare
provides 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 qualified participants is supplied by
CompCare’s clients and CompCare reviews membership eligibility records and other
reported information to verify its accuracy in determining the amount of revenue
to be recognized. Consequently, the vast majority of our managed behavioral
healthcare 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.
CompCare
may experience adjustments to its revenues to reflect changes in the number and
eligibility status of members subsequent to when revenue is recognized.
Subsequent adjustments to CompCare’s revenue have not been material in the
past.
Premium
Deficiencies
CompCare
accrues losses under capitated contracts when it is probable that a loss has
been incurred and the amount of the loss can be reasonably estimated. CompCare
performs 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 CompCare’s 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, CompCare generally has the ability to cancel
the contract with 60 to 90 days written notice. Prior to
cancellation, CompCare will usually submit a request for a rate increase
accompanied by supporting utilization data. Although CompCare’s
clients have historically been generally receptive to such requests, no
assurance can be given that such requests will be fulfilled in the future in
CompCare’s favor. If a rate increase is not granted, CompCare has the
ability to terminate the contract and limit its risk to a short-term
period.
On a
quarterly basis, CompCare performs a review of its 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, CompCare believes no contract loss
reserve for future periods is necessary for these contracts.
Accrued
Claims Payable and Claims Expense
Behavioral
health managed care operating expenses are composed of claims expense and other
healthcare expenses. Claims expense includes amounts paid to
hospitals, physician groups and other managed care organizations under capitated
contracts. Other healthcare expenses include items such as information systems,
provider contracting, case management and quality assurance, attributable to
both capitated and non-capitated contracts.
The cost
of behavioral health services is recognized in the period in which an eligible
member actually receives services and includes an estimate of IBNR. CompCare
contracts 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. CompCare determines that a
member has received services when it receives a claim within the contracted
timeframe with all required billing elements correctly completed by the service
provider. CompCare then determines 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 CompCare’s employees. If all of these
requirements are met, the claim is entered into CompCare’s 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 CompCare.
Accrued
claims payable consists primarily of CompCare’s reserves established for
reported claims and IBNR, which are unpaid through the respective balance sheet
dates. CompCare’s 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 an initial range of estimates, CompCare’s management uses an actuarial
model that incorporates past claims payment experience, enrollment data and key
assumptions such as trends in healthcare costs and seasonality. Authorization
data, utilization statistics, calculated completion percentages and qualitative
factors are then combined with the initial range to form the basis of
management’s best estimate of the accrued claims payable balance.
At
December 31, 2008, CompCare’s management determined its best estimate of the
accrued claims liability to be $6.8 million. Approximately $3.4 million of the
accrued claims payable balance at December 31, 2008 is attributable to the major
HMO contract in Indiana that started January 1, 2007 and terminated on December
31, 2008.
Accrued
claims payable at December 31, 2008 and 2007 comprises approximately $1.6
million and $1.1 million of submitted and approved claims, which had not yet
been paid, and $5.2 million and $4.4 million for IBNR claims,
respectively.
Many
aspects of the managed care 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
claims payable amount presented. The following are factors that would
have an impact on CompCare’s future operations and financial
condition:
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Changes
in utilization patterns
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Changes
in healthcare costs
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Changes
in claims submission timeframes by
providers
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Success
in renegotiating contracts with healthcare
providers
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Occurrence
of catastrophes
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Changes
in benefit plan design
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The
impact of present or future state and federal
regulations.
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A 5%
increase or decrease in assumed healthcare cost trends from those used in the
calculations of IBNR at December 31, 2008, could increase or decrease CompCare’s
claims expense by approximately $127,000.
Share-based
expense
Commencing
January 1, 2006, we implemented the accounting provisions of Statement of
Financial Accounting Standards (SFAS) 123R on a modified-prospective basis to
recognize share-based compensation for employee stock option awards in our
statements of operations for future periods. We accounted for the issuance of
stock, stock options and warrants for services from non-employees in accordance
with SFAS 123, Accounting for
Stock-Based Compensation and FASB Emerging Issues Task Force Issue
No. 96-18, Accounting For Equity Instruments That Are Issued To Other Than
Employees For Acquiring Or In Conjunction With Selling Goods Or Services.
We estimate the fair value of options and warrants issued using the
Black-Scholes pricing model. This model’s calculations include the exercise
price, the market price of shares on grant date, weighted average assumptions
for risk-free interest rates, expected life of the option or warrant, expected
volatility of our stock and expected dividend yield.
The
amounts recorded in the financial statements for share-based expense could vary
significantly if we were to use different assumptions. For example, the
assumptions we have made for the expected volatility of our stock price have
been based on the historical volatility of our stock and the stock of other
public healthcare companies, measured over a period generally commensurate with
the expected term, since we have a limited history as a public company and
complete reliance on our actual stock price volatility would not be meaningful.
If we were to use the actual volatility of our stock price, there may be a
significant variance in the amounts of share-based expense from the amounts
reported. Based on the 2008 assumptions used for the Black-Scholes pricing
model, a 50% increase in stock price volatility would have increased the fair
values of options by approximately 25%. The weighted average expected option
term for 2008, 2007 and 2006 reflects the application of the simplified method
set out in SEC Staff Accounting Bulletin No. 107, which defines the life as the
average of the contractual term of the options and the weighted average vesting
period for all option tranches.
From time
to time, we have retained terminated employees as part-time consultants upon
their resignation from the company. Because the employees continued to provide
services to us, their options continued to vest in accordance with the original
terms. Due to the change in classification of the option awards, the options
were considered modified at the date of termination in accordance with SFAS
123R. The modifications were treated as exchanges of the original awards in
return for the issuance of new awards. At the date of termination, the unvested
options were no longer accounted for as employee awards under SFAS 123R and were
accounted for as new non-employee awards under EITF 96-18. The accounting for
the portion of the total grants that have already vested and have been
previously expensed as equity awards is not changed.
Goodwill
In
accordance with SFAS 142, Goodwill and Other Intangible
Assets, goodwill is not amortized, but instead is subject to impairment
tests. Our policy is to evaluate goodwill assigned to both our healthcare
services and behavioral health managed care reporting units for impairment
annually, at each year-end and between annual evaluations, if events occur or
circumstances change that would more likely than not reduce the fair value of
goodwill below its carrying amount.
There are
two steps in applying the goodwill impairment test per SFAS 142. The first step
is to determine whether there is a potential impairment. The fair values of our
two reporting units are compared to the reporting unit’s carrying book value
amounts, including the goodwill. If the fair values of our reporting units
exceed their carrying amounts, then the goodwill associated with the reporting
unit is considered not to be impaired and the second step of the impairment test
is unnecessary. If the carrying amounts of our reporting units exceed their fair
value, the second step of the goodwill impairment test shall be performed to
measure the amount of impairment loss, if any. The second step of the goodwill
impairment test, used to measure the amount of impairment loss, compares the
implied fair value of reporting unit goodwill with the carrying amount of that
goodwill. If the carrying amount of the goodwill exceeds the implied fair value
of that goodwill, an impairment loss shall be recognized in an amount equal to
that excess. In estimating the fair value of the reporting units, we consider
both the income and market approaches to fair value determination. The income
approach is based on a discounted cash flow methodology, in which we make our
best assumptions regarding future cash flows and a discount rate to be applied
to the cash flows
to yield
a present, fair value of the reporting unit. The market approach is based
primarily on reference to transactions involving the company’s common stock and
the quoted market prices of our common stock.
Due to
the decline in trading price of Hythiam’s and CompCare’s common stock during
2008, and the resulting lower valuation of our reporting units relative to their
book value, we have tested goodwill for impairment at each quarter-end without
exception. However, in January 2009, as part of our fourth quarter impairment
testing, we concluded that the goodwill in our healthcare services reporting
unit had been impaired mainly resulting from the decline in the value of the
reporting unit that arose from the downward re-pricing of risk that occurred
broadly in the equity markets and affected the reporting unit in the
quarter. Based on a valuation of our healthcare services reporting unit,
utilizing the income approach, the estimated, implied fair value of the goodwill
was determined to be fully impaired and the $9.8 million carrying value was
recorded as an impairment charge in our Consolidated Statement of Operations for
the year ended December 31, 2008.
In
reviewing the $493,000 of goodwill relating to the behavioral health managed
care services reporting unit, we approximated the value of the reporting unit by
considering the $1.5 million proceeds and $11.2 million estimated gain on the
sale of our interest in CompCare on January 20, 2009 and other factors, in
concluding that the estimated fair value of the reporting unit exceeded its book
value and the goodwill was recoverable.
Impairment
of Intangible Assets
We have
capitalized significant costs for acquiring patents and other intellectual
property directly related to our products and services. In addition, intangible
assets include identified intangible assets acquired as part of the CompCare
acquisition, including the value of managed care contracts, the value of the
healthcare provider network and the professional designation from the NCQA. In
accordance with SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, we review our intangible
assets for impairment whenever events or circumstances indicate that the
carrying amount of these assets may not be recoverable. In reviewing for
impairment, we compare the carrying value of such assets to the estimated
undiscounted future cash flows expected from the use of the assets and/or their
eventual disposition. If the estimated undiscounted future cash flows are less
than their carrying amount, we record an impairment loss to recognize a loss for
the difference between the assets’ fair value and their carrying value. Since we
have not recognized significant revenue to date, our estimates of future revenue
may not be realized and the net realizable value of our capitalized costs of
intellectual property or other intangible assets may become
impaired.
In August
2007, we recorded an impairment charge of $2.4 million, when we recognized the
fair value of 310,000 shares of our common stock that had been previously issued
as additional consideration related to the purchase of an opiate patent which
has never been utilized in our business plan. The shares had been subject to a
stock pledge agreement pending the resolution of certain contingencies until we
agreed to release the shares as a result of a settlement agreement reached in
August 2007 with the seller of the patent. The fair value of these shares was
based on the closing stock price on the date of the settlement
We have
evaluated the carrying values of intangible assets for possible impairment at
reporting period-end during 2008 and at December 31, 2008 without exception,
since the projected undiscounted cash flows were sufficient to recover the
carrying value. In reviewing the intangible assets relating to CompCare, which
amounted to $642,000 at December 31, 2008, we considered the $1.5 million
proceeds and $11.2 million estimated gain on the sale of our interest in
CompCare on January 20, 2009 among other factors, and determined that such
assets were recoverable.
No other
impairments were identified in our reviews at December 31, 2008 and 2007.
However, we will continue to review these assets for potential impairment each
reporting period.
Valuation
of Marketable Securities
Investments
include ARS, U.S. Treasury bills, commercial paper and certificates of
deposit with maturity dates greater than three months when purchased, which are
classified as available-for-sale investments and reflected in current or
long-term assets, as appropriate, as marketable securities at fair market value
in accordance with SFAS 115, Accounting for Certain Investments
in Debt and Equity Securities. Unrealized gains and losses are
reported in our Consolidated Balance Sheet within accumulated other
comprehensive loss and within other
comprehensive
loss. Realized gains and losses and declines in value judged to be
“other-than-temporary” are recognized as a non-reversible impairment charge in
the Statement of Operations on the specific identification method in the period
in which they occur.
Since
there have been continued auction failures with our ARS portfolio, quoted prices
for our ARS did not exist as of December 31, 2008 and un-observable inputs were
used. We determined that use of a valuation model was the best available
technique for measuring the fair value of our ARS portfolio and we based our
estimates of the fair value using valuation models and methodologies that
utilize an income-based approach to estimate the price that would be received if
we sold our securities in an orderly transaction between market participants.
The estimated price was derived as the present value of expected cash flows over
an estimated period of illiquidity, using a risk adjusted discount rate that was
based on the credit risk and liquidity risk of the securities. Based on the
valuation models and methodologies, and consideration of other factors, we wrote
down our ARS portfolio to its estimated fair value of $10.1 million, reflecting
a $1.4 million reduction in value. While our valuation model includes inputs
based on observable measures (credit quality and interest rates) and
un-observable inputs, we determined that the un-observable inputs were the most
significant to the overall fair value measurement, particularly the estimates of
risk adjusted discount rates and estimated periods of
illiquidity.
We
regularly review the fair value of our investments. If the fair value of any of
our investments falls below our cost basis in the investment, we analyze the
decrease to determine whether it represents an other-than-temporary decline in
value. In making our determination for each investment, we consider the
following factors:
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●
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How
long and by how much the fair value of the investments have been below
cost
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The
financial condition of the issuers
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Any
downgrades of the investment by rating
agencies
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Default
on interest or other terms
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Our
intent and ability to hold the investments long enough for them to recover
their value
|
We
determined that the loss in fair value of our ARS investments was
other-than-temporary, in connection with our assessment and review of the
factors listed above at December 31, 2008. Accordingly, we recognized an
impairment loss in non-operating expenses of approximately $1.4 million in our
Statement of Operations for the year ended December 31, 2008.
Recent
Accounting Pronouncements
Recently
Adopted
In
September 2006, the FASB issued SFAS 157, Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value in
GAAP, 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. In February
2008, FASB Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No.
157, which delays the effective date of SFAS 157 to fiscal years and
interim periods within those fiscal years beginning after November 15, 2008
for non-financial assets and non-financial liabilities, except for items that
are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually). We elected to defer the adoption of the
Standard for these non-financial assets and liabilities, and are currently
evaluating the impact, if any, that the deferred provisions of the Standard will
have on our consolidated financial statements. Because we did not elect to apply
the fair value accounting option, the adoption of SFAS 157 for our financial
assets and liabilities did not have an impact on our financial position or
operating results.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 allows companies to measure
many financial assets and liabilities at fair value. It also establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types
of assets and liabilities. SFAS 159 is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. The adoption of SFAS No. 159 did not affect our
financial position, results of operations or cash flows.
In
October 2008, FASB Staff Position (FSP) on FAS 157-3 was issued, which clarifies
the application of SFAS 157 in an inactive market and provides an example to
demonstrate how the fair value of a financial asset is determined when the
market for that financial asset is inactive. FSP FAS 157-3 was effective upon
issuance, including prior periods for which financial statements had not been
issued. The adoption of this standard as of September 30, 2008 did not have
a material impact on our financial position, results of operations or cash
flows.
In
December 2008, the FASB issued FSP FAS 140-4 and FASB Interpretation No. (FIN)
46R-8, Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities. This FSP amends FASB Statement No. 140 Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities to
require public entities to provide additional disclosures about transfers of
financial assets. It also amends FIN 46, Consolidation of Variable Interest
Entities as revised to require public enterprises to provide additional
disclosures about their involvement with VIEs. FSP FAS 140-4 and FIN 46(R)-8 are
effective for the Company's fiscal year ending December 31, 2008. We
are required to consolidate the revenues and expenses of the managed medical
corporations. The financial results of managed treatment centers are
included in our consolidated financial statements under accounting standards
applicable to VIEs. Disclosures regarding our
involvement
with VIEs are appropriately included in Note 1 – Summary of Significant Accounting
Policies, Variable Interest Entities, in Part IV, Item 15 (a) (1) (2)
Financial Statements.
Recently
Issued
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51. 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. SFAS 160 will have no material impact on our financial
position, results of operations or cash flows.
In March
2008, the FASB issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS
133. SFAS 161 requires enhanced disclosures about an entity’s
derivative and hedging activities, including how an entity uses derivative
instruments, how derivative instruments and related hedged items are accounted
for under SFAS 133, Accounting
for Derivative Instruments and Hedging Activities, and how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. The provisions of SFAS 161 are effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008. We do not expect the adoption of SFAS 161 to have a
material impact on our consolidated financial statements.
In
December 2007, the FASB issued SFAS 141R, Business Combinations. SFAS
141R replaces SFAS 141, Business Combinations, and
retains the requirement that the purchase method of accounting for acquisitions
be used for all business combinations. SFAS 141R 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 141R also requires
an acquirer to record an adjustment to income tax expense for changes in
valuation allowances or uncertain tax positions related to acquired businesses.
SFAS 141R 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 have adopted this statement as of January 1, 2009. The impact that
the adoption of SFAS 141R will have on our consolidated financial statements
will depend on the nature, terms and size of our business combinations that
occur after the effective date.
In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets. FSP 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible
Assets. This change is intended to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the period
of expected cash flows used to measure the fair value of the asset under SFAS
No. 141R and other GAAP. FSP 142-3 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. The requirement for determining useful lives must be applied
prospectively to intangible assets acquired after the effective date and the
disclosure requirements must be applied prospectively to all intangible assets
recognized as of, and subsequent to, the effective date. We do not expect the
adoption of this statement to have a material impact on our consolidated results
of operations, financial position or cash flows.
ITEM
7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We invest
our cash in short term high grade commercial paper, certificates of deposit,
money market accounts and marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased to
be cash equivalents. We classify investments with maturity dates greater than
three months when purchased as marketable securities, which have readily
determined fair values at the time of purchase and are classified as
available-for-sale securities. Our investment policy requires that all
investments be investment grade quality and no more than ten percent of our
portfolio may be invested in any one security or with one
institution.
As of
December 31, 2008 our total investment in ARS was $11.5 million. Since February
13, 2008, auctions for these securities have failed, meaning the parties
desiring to sell securities could not be matched with an adequate number of
buyers, resulting in our having to continue to hold these
securities. Although the securities are Aaa/AAA rated and collateralized by
portfolios of student loans guaranteed by the U.S. government, based on current
market conditions it is likely that auctions will continue to be unsuccessful in
the short-term, limiting the liquidity of these investments until the auction
succeeds, the issuer calls the securities, or they mature. The remaining
maturity periods range from nineteen to thirty-eight years. As a result, our
ability to liquidate our investment and fully recover the carrying value of our
investment in the near term may be limited or not exist. In December,
we utilized a third-party valuation firm to assist us with determining the fair
market value of our ARS which was estimated to be $10.1 million, resulting in a
$1.4 million estimated decline in value.
In making
our determination whether losses are considered to be “other-than-temporary”
declines in value, we consider the following factors at each quarter-end
reporting period:
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How
long and by how much the fair value of the ARS securities have been below
cost
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The
financial condition of the issuers
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Any
downgrades of the securities by rating
agencies
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Default
on interest or other terms
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Our
intent & ability to hold the ARS long enough for them to recover their
value
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We
determined that the loss in the fair value of our ARS investments was
“other-than-temporary,” in connection with our year end assessment. Accordingly,
we recognized an other-than-temporary loss in non-operating expenses of
approximately $1.4 million in December 2008, which is reflected as a
non-operating expense in our Consolidated Statement of Operations.
In May
2008, our investment portfolio manager, UBS AG (UBS), provided us with a demand
margin loan facility, allowing us to borrow up to 50% of the market value of the
ARS, as determined by UBS. The margin loan facility is collateralized by the
ARS. In October 2008, UBS made a “Rights” offering to its clients,
pursuant to which we are entitled to sell to UBS all auction-rate securities
held by us in our UBS account. The Rights permit us to require UBS to purchase
our ARS for a price equal to original par value plus any accrued but unpaid
interest beginning on June 30, 2010 and ending on July 2, 2012 if the
securities are not earlier redeemed or sold. As part of the offering, UBS would
provide us a line of credit equal to 75% of the market value of the ARS until
they are purchased by UBS. The line of credit has certain restrictions
described in the prospectus. We accepted this offer on November 6,
2008.
These
securities will be analyzed each reporting period for additional
other-than-temporary impairment factors. Due to the current
uncertainty in the credit markets and the terms of the Rights offering with UBS,
we have classified the fair value of our ARS as long-term assets as of December
31, 2008.
The
weighted average interest rate of marketable securities held at December 31,
2008 was 1.14%. Investments in both fixed rate and floating rate interest
earning instruments carry a degree of interest rate risk arising from changes in
the level or volatility of interest rates; however interest rate movements do
not materially affect the market value of our ARS because of the frequency of
the rate resets and the short-term nature of these investments. A reduction in
the overall level of interest rates may produce less interest income from our
investment portfolio. If overall interest rates had declined by an average of
100 basis points during 2008, the amount of interest income earned from our
investment portfolio in 2008 would have decreased by an estimated amount of
$220,000. The market risk associated with our investments in debt securities is
substantially mitigated by the frequent turnover of our portfolio.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Our
consolidated financial statements and related financial information required to
be filed hereunder are indexed under Item 15 of this report and are incorporated
herein by reference.
ITEM
9. CHANGES
AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A. CONTROLS
AND PROCEDURES
Disclosure
Controls
We have
evaluated, with the participation of our chief executive officer and our chief
financial officer, the effectiveness of our system of disclosure controls and
procedures as of the end of the period covered by this report. Based on this
evaluation our chief executive officer and our chief financial officer have
determined that they are effective in connection with the preparation of this
report.
Management's
Report on Internal Control over Financial Reporting
Our management is responsible for
establishing and maintaining adequate internal control over financial reporting
(as defined in Rule 13a-15(f) under the Exchange Act) and for assessing the
effectiveness of our internal control over financial reporting. Our internal
control system is designed to provide reasonable assurance to our management and
Board of Directors regarding the preparation and fair presentation of published
financial statements in accordance with United States generally accepted
accounting principles (GAAP).
There
were no changes in our internal controls over financial reporting during the
year ended December 31, 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
Our
internal control over financial reporting is supported by written policies and
procedures that:
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pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of our
assets;
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●
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provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP and that our
receipts and expenditures are being made only in accordance with
authorizations of our management and our Board of Directors;
and
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●
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provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have
a material effect on our financial
statements.
|
Our
management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2008 using the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission in Internal
Control-Integrated Framework. Management's assessment included an evaluation of
the design of our internal control over financial reporting and testing of the
operational effectiveness of our internal control over financial reporting.
Based on this assessment, our management concluded that, as of December 31,
2008, our internal control over financial reporting was effective.
Because
of its inherent limitations, a system of internal control over financial
reporting can provide only reasonable assurance and may not prevent or detect
misstatements. In addition, projections of any evaluation of effectiveness to
future periods are subject to the risks that controls may become inadequate
because of changes in conditions and that the degree of compliance with the
policies or procedures may deteriorate.
BDO
Seidman, LLP, the independent registered public accounting firm that audited the
financial statements included in this Annual Report on Form 10-K, was
engaged to attest to and report on the effectiveness of our internal control
over financial reporting as of December 31, 2008. A copy of this report is
included at page F-3 of this Annual Report on Form 10-K.
ITEM
9B. OTHER
INFORMATION
Not
applicable.
The
information required by Items 10 through 14 of Part III is incorporated by
reference from Item 1 of this report and from registrants’ proxy statement
that will be mailed to stockholders in connection with the registrant’s 2009
annual meeting of stockholders.
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ITEM
10.
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
|
Our Board
of Directors has adopted a Code of Ethics applicable to our Chief Executive
Officer, Chief Financial Officer and persons performing similar
functions. Our Code of Ethics is listed hereto as Exhibit
14.1.
The
remaining information required under Item 10 is incorporated by reference from
Item 1 of this report and from registrant’s definitive proxy statement for the
2009 annual meeting.
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ITEM
11.
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EXECUTIVE
COMPENSATION
|
Incorporated
by reference from registrant’s definitive proxy statement for the 2009 annual
meeting.
|
ITEM
12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
Incorporated
by reference from registrant’s definitive proxy statement for the 2009 annual
meeting.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
|
Incorporated
by reference from registrant’s definitive proxy statement for the 2009 annual
meeting.
|
ITEM
14.
|
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|
Incorporated
by reference from registrant’s definitive proxy statement for the 2009 annual
meeting.
ITEM
15. EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
(a)(1),(2) Financial
Statements
The
Financial Statements and Financial Statement Schedules listed on page F-1 of
this document are filed as part of this filing.
(a)(3) Exhibits
The following exhibits are filed as
part of this report:
|
Exhibit
No.
|
Description
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2.1
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Stock
Purchase Agreement between WoodCliff Healthcare Investment
Partners,
LLC
and Core Corporate Consulting Group, Inc., dated January 14,
2009,
incorporated
by reference to Exhibit 10.1 of the Hythiam Inc.’s current report
on
Form
8-K/A filed January 26, 2009.
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3.1
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Certificate
of Incorporation of Hythiam, Inc., a Delaware corporation, filed with the
Secretary of State of Delaware on September 29, 2003, incorporated by
reference to exhibit of the same number of Hythiam Inc.’s Form 8-K filed
September 30, 2003.
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3.2
|
By-Laws
of Hythiam, Inc., a Delaware corporation, incorporated by reference to
exhibit of the same number of Hythiam, Inc.’s Form 8-K filed
September 30, 2003.
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4.1
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Specimen
Common Stock Certificate, incorporated by reference to exhibit of the same
number to Hythiam Inc.’s annual report on Form 10-K for the year ended
December 31, 2005.
|
|
|
10.1*
|
2003
Stock Incentive Plan, incorporated by reference to exhibit of the same
number of Hythiam Inc.’s Form 8-K filed September 30,
2003.
|
|
|
10.2*
|
Employment
Agreement between Hythiam, Inc. and Terren S. Peizer, dated September 29,
2003, incorporated by reference to exhibit of the same number to Hythiam
Inc.’s annual report on Form 10-K for the year ended December 31,
2005.
|
|
|
10.3*
|
Employment
Agreement between Hythiam, Inc. and Richard A. Anderson, dated
April 19, 2005, incorporated by reference to exhibit of the same number to
Hythiam Inc.’s annual report on Form 10-K for the year ended December 31,
2005.
|
|
|
10.6*
|
Management
and Support Services Agreement between Hythiam, Inc. and David E. Smith,
M.D. Medical Group, Inc, dated November 15, 2005, incorporated by
reference to exhibit of the same number to Hythiam Inc.’s annual report on
Form 10-K for the year ended December 31, 2005.
|
|
|
10.7*
|
Consulting
Services Agreement between Hythiam, Inc. and David E. Smith &
Associates, dated September 15, 2005, incorporated by reference to exhibit
of the same number to Hythiam Inc.’s annual report on Form 10-K for the
year ended December 31, 2005.
|
|
|
10.8*
|
First
Amendment to Consulting Services Agreement between Hythiam, Inc. and David
E. Smith, M.D. Medical Group, Inc., effective January 1, 2007,
incorporated by reference to exhibit of the same number to Hythiam Inc.’s
annual report on Form 10-K for the year ended December 31,
2006.
|
|
|
10.9*
|
First
Amendment to Management and Support Services Agreement Services Agreement
between Hythiam, Inc. and David E. Smith, M.D. Medical Group, Inc.,
effective December 5, 2005, incorporated by reference to exhibit of the
same number to Hythiam Inc.’s annual report on Form 10-K for the year
ended December 31, 2006.
|
|
|
10.10*
|
Second
Amendment to Management and Support Services Agreement Services Agreement
between Hythiam, Inc. and David E. Smith, M.D. Medical Group, Inc.,
effective November 15, 2006, incorporated by reference to exhibit of the
same number to Hythiam Inc.’s annual report on Form 10-K for the year
ended December 31, 2006.
|
|
|
10.11*
|
Employment
Agreement between Hythiam, Inc. and Christopher Hassan., dated July 26,
2006, incorporated by reference to exhibit of the same number to Hythiam
Inc.’s annual report on Form 10-K for the year ended December 31,
2007.
|
|
10.12*
|
2007
Stock Incentive Plan, incorporated by reference to the Hythiam Inc.’s
Revised
Definitive
Proxy on Form DEFR14A filed May 11, 2007.
|
|
|
10.13
|
Technology
License and Administrative Services Agreement
|
|
|
10.14*
|
Amendment
No. 2 to Consulting Services Agreement between Hythiam, Inc. and David E.
Smith & Associates, a California professional
corporation
|
|
|
10.15
|
Redemption
Agreement between Hythiam, Inc. and Highbridge International, LLC., dated
November 7, 2007, incorporated by reference to exhibit of the same number
to Hythiam, Inc.’s annual report on Form 10-K for the year ended December
31, 2007.
|
|
|
10.16
|
Securities
and Purchase Agreement between Hythiam, Inc. and Highbridge International,
LLC, dated January 17, 2007, incorporated by reference to Exhibit 10.4 of
Hythiam Inc.’s current report on Form 8-K filed January 18,
2007.
|
|
|
10.17*
|
Registration
Rights Agreement between Hythiam, Inc. and Highbridge International, LLC,
dated January 17, 2007, incorporated by reference to Exhibit 10.5 of
Hythiam Inc.’s current report on Form 8-K filed January 18,
2007.
|
|
|
10.18
|
Pledge
Agreement between Hythiam, Inc. and Highbridge
International,
LLC, dated January 17, 2007, incorporated by reference to
Exhibit
10.8
of Hythiam Inc.’s current report on Form 8-K filed January 18,
2007.
|
|
|
10.19
|
Security
Agreement between Hythiam, Inc. and Highbridge
International,
LLC, dated January 17, 2007, incorporated by reference to
Exhibit
10.9
of Hythiam Inc.’s current report on Form 8-K filed January 18,
2007.
|
|
|
10.20
|
Securities
and Purchase Agreement between Hythiam, Inc. and Highbridge International,
LLC, dated November 11, 2007, incorporated by reference to Exhibit 10.1 of
Hythiam Inc.’s current report on Form 8-K filed November 7,
2007.
|
|
|
10.21*
|
See
Exhibit 2.1.
|
|
|
10.22*
|
Amendment
to Employment Agreement of Richard A. Anderson, dated July 16, 2008,
incorporated by reference to Exhibit 10.1 of Hythiam Inc.’s
current report on Form 8-K filed July 18, 2008.
|
|
|
10.23
|
Amendment
and Exchange Agreement with Highbridge International LLC,
dated
July
31, 2008, incorporated by reference to Exhibit 10.1 of the Hythiam
Inc.’s
current
report on Form 8-K filed August 1, 2008.
|
|
|
10.24
|
Amended
and Restated Senior Secured Note with Highbridge International
LLC,
dated
July 31, 2008, incorporated by reference to Exhibit 10.2 of the
Hythiam
Inc.’s
current report on Form 8-K filed August 1, 2008.
|
|
|
10.25
|
Amended
and Restated Warrant to Purchase Common Stock with Highbridge
International
LLC, dated July 31, 2008, incorporated by reference to Exhibit
10.3
of
the Hythiam Inc.’s current report on Form 8-K filed August 1,
2008.
|
|
|
10.26*
|
Employment
Agreement between Hythiam, Inc. and Maurice Hebert, dated
November
12, 2008, incorporated by reference to Exhibit 10.1 of the
Hythiam
Inc.’s
current report on Form 8-K filed November 14, 2008.
|
|
|
10.27*
|
Consulting
Agreement between Hythiam, Inc. and Chuck Timpe, dated
November
12,
2008, incorporated by reference to Exhibit 10.2 of the Hythiam Inc.’s
current
report
on Form 8-K filed November 14, 2008.
|
|
|
14.1
|
Code
of Conduct and Ethics, incorporated by reference to exhibit of the same
number to the Hythiam Inc.’s annual report on Form 10-K for the year ended
December 31, 2003.
|
|
|
14.2
|
Code
of Ethics for CEO and Senior Financial Officers, incorporated by reference
to exhibit of the same number to Hythiam Inc.’s annual report on Form 10-K
for the year ended December 31, 2003.
|
|
|
21.1
|
Subsidiaries
of the Company
|
|
|
23.1
|
Consent
of Independent Registered Public Accounting Firm – BDO Seidman,
LLP
|
|
|
31.1
|
Certification
by the Chief Executive Officer, pursuant to Rule 13-a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
31.2
|
Certification
by the Chief Financial Officer, pursuant to Rule 13-a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
32.1
|
Certification
by the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
32.2
|
Certification
by the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
* Management
contract or compensatory plan or arrangement.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
|
HYTHIAM,
INC.
|
||
|
Date: March
31, 2009
|
By:
|
/s/
TERREN S. PEIZER
|
|
Terren
S. Peizer
|
||
|
Chief
Executive Officer
|
||
POWER
OF ATTORNEY
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
Signature
|
Title(s)
|
Date
|
||
|
/s/
TERREN S. PEIZER
|
Chairman
of the Board of Directors
|
March
31, 2009
|
||
|
Terren
S. Peizer
|
and
Chief Executive Officer
|
|||
|
(Principal
Executive Officer)
|
||||
|
/s/
MAURICE S. HEBERT
|
Chief
Financial Officer
|
March
31, 2009
|
||
|
Maurice
S. Hebert
|
(Principal
Financial and
|
|||
|
Accounting
Officer)
|
||||
|
/s/
RICHARD A. ANDERSON
|
President,
Chief Operating Officer
|
March
31, 2009
|
||
|
Richard
A. Anderson
|
and
Director
|
|||
|
/s/
CHRISTOPHER S. HASSAN
|
Chief
Strategy Officer and Director
|
March
31, 2009
|
||
|
Christopher
S. Hassan
|
||||
|
/s/
STEVE KRIEGSMAN
|
Director
|
March
31, 2009
|
||
|
Steve
Kriegsman
|
||||
|
/s/
MARC G. CUMMINS
|
Director
|
March
31, 2009
|
||
|
Marc
G. Cummins
|
||||
|
/s/
ANDREA GRUBB BARTHWELL, M.D.
|
Director
|
March
31, 2009
|
||
|
Andrea
Grubb Barthwell, M.D.
|
HYTHIAM,
INC. AND SUBSIDIARIES
Index
to Financial Statements and Financial Statement Schedules
Financial
Statements
|
Report
of Independent Registered Public Accounting Firm
|
F-2
|
||
|
Report
of Independent Registered Public Accounting Firm
|
F-3
|
||
|
Consolidated
Balance Sheets as of December 31, 2008 and 2007
|
F-4
|
||
|
Consolidated
Statements of Operations for the Years Ended December 31, 2008, 2007 and
2006
|
F-5
|
||
|
Consolidated
Statements of Stockholders’ Equity for Years Ended December 31, 2008, 2007
and 2006
|
F-6
|
||
|
Consolidated
Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and
2006
|
F-7
|
||
|
Notes
to Consolidated Financial Statements
|
F-8
|
Financial
Statement Schedules
All
financial statement schedules are omitted because they are not applicable,
not required, or the information is shown in the Financial Statements or Notes
thereto.
Report
of Independent Registered Public Accounting Firm
To
the Board of Directors and Shareholders
Hythiam,
Inc.
Los
Angeles, California
We
have audited the accompanying consolidated balance sheets of Hythiam, Inc. as of
December 31, 2008 and 2007 and the related consolidated statements of
operations, stockholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2008. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with auditing standards generally accepted in
the United States of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall 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 financial position of the Company at
December 31, 2008 and 2007, and the results of its operations and its cash flows
for the three years in the period ended December 31, 2008, in conformity with
accounting principles generally accepted in the United States of
America.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the consolidated
financial statements, the Company has suffered recurring losses from operations
and negative cash flows from operating activities that raise substantial
doubt about its ability to continue as a going concern. Management’s plans in
regard to these matters are also described in Note 1. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company’s internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated March 31,
2009 expressed an unqualified opinion thereon.
/s/
BDO Seidman, LLP
Los
Angeles, California
March
31, 2009
To
the Board of Directors and Shareholders
Hythiam,
Inc.
Los
Angeles, California
We
have audited Hythiam, Inc. and subsidiaries’ (the Company) internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Hythiam’s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in Item 9A, Management’s Report on
Internal Control Over Financial Reporting. Our responsibility is to express an
opinion on the company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exits, and
testing and evaluating the design and operating effectiveness of internal
control based on assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with both generally accepted accounting principles and regulatory reporting
instructions. A company's internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with both generally accepted accounting principles and
regulatory reporting instructions, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our opinion, Hythiam, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on the
COSO criteria.
We
have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Hythiam, Inc as of December 31, 2008 and 2007, and the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2008 and our report dated March 31,
2009 expressed an unqualified opinion thereon and contains an explanatory
paragraph regarding the Company’s ability to continue as a going
concern.
/s/
BDO Seidman, LLP
Los
Angeles, California
March
31, 2009
HYTHIAM, INC. AND
SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
|
(Dollars
in thousands, except share data)
|
December
31,
|
|||||||
|
ASSETS
|
2008
|
2007
|
||||||
|
Current
assets
|
||||||||
|
Cash
and cash equivalents
|
$ | 10,893 | $ | 11,149 | ||||
|
Marketable
securities, at fair value
|
146 | 35,840 | ||||||
|
Restricted
cash
|
24 | 39 | ||||||
|
Receivables,
net
|
2,234 | 1,787 | ||||||
|
Notes
receivable
|
17 | 133 | ||||||
|
Prepaids
and other current assets
|
676 | 1,394 | ||||||
|
Total
current assets
|
13,990 | 50,342 | ||||||
|
Long-term
assets
|
||||||||
|
Marketable
securities, at fair value
|
10,072 | - | ||||||
|
Property and equipment, net of accumulated depreciation
|
||||||||
|
and
amortization of $6,376 and $5,630, respectively
|
2,860 | 4,291 | ||||||
|
Goodwill
|
493 | 10,557 | ||||||
|
Intangible
assets, less accumulated amortization of
|
||||||||
|
$2,745
and $1,609, respectively
|
3,899 | 4,836 | ||||||
|
Deposits
and other assets
|
552 | 620 | ||||||
|
Total
Assets
|
$ | 31,866 | $ | 70,646 | ||||
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
|
Current
liabilities
|
||||||||
|
Accounts
payable
|
$ | 3,784 | $ | 4,038 | ||||
|
Accrued
compensation and benefits
|
1,844 | 2,860 | ||||||
|
Accrued
liabilities
|
3,191 | 2,030 | ||||||
|
Accrued
claims payable
|
6,791 | 5,464 | ||||||
|
Short-term
debt
|
9,835 | 4,742 | ||||||
|
Income
taxes payable
|
19 | 94 | ||||||
|
Total
current liabilities
|
25,464 | 19,228 | ||||||
|
Long-term
liabilities
|
||||||||
|
Long-term
debt
|
2,341 | 2,057 | ||||||
|
Accrued
reinsurance claims payable
|
2,526 | 2,526 | ||||||
|
Warrant
liabilities
|
156 | 2,798 | ||||||
|
Capital
lease obligations
|
144 | 331 | ||||||
|
Deferred
rent and other long-term liabilities
|
127 | 442 | ||||||
|
Total
Liabilities
|
30,758 | 27,382 | ||||||
|
Commitments and contingencies
(See Note 13)
|
||||||||
|
Stockholders'
equity
|
||||||||
|
Preferred
stock, $.0001 par value; 50,000,000 shares authorized;
|
||||||||
|
no
shares issued and outstanding
|
- | - | ||||||
|
Common
stock, $.0001 par value; 200,000,000 shares authorized;
|
||||||||
|
issued
and outstanding shares -- 54,965,000 and 54,335,000
|
||||||||
|
at
December 31, 2008 and 2007, respectively
|
6 | 5 | ||||||
|
Additional
paid-in-capital
|
174,721 | 166,460 | ||||||
|
Accumulated
deficit
|
(173,619 | ) | (123,201 | ) | ||||
|
Total
Stockholders' Equity
|
1,108 | 43,264 | ||||||
|
Total
Liabilities and Stockholders' Equity
|
$ | 31,866 | $ | 70,646 | ||||
The
accompanying Notes to Consolidated Financial Statements are an integral part of
these statements.
HYTHIAM, INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
(Dollars
in thousands, except per share data)
|
Year
Ended December 31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Revenues
|
||||||||||||
|
Behavioral
health managed care services
|
$ | 35,156 | $ | 36,306 | $ | - | ||||||
|
Healthcare
services
|
6,074 | 7,695 | 3,906 | |||||||||
|
Total
revenues
|
41,230 | 44,001 | 3,906 | |||||||||
|
Operating
expenses
|
||||||||||||
|
Behavioral
health managed care expenses
|
36,496 | 35,679 | - | |||||||||
|
Cost
of healthcare services
|
1,718 | 2,052 | 818 | |||||||||
|
General
and administrative expenses
|
40,741 | 45,554 | 38,680 | |||||||||
|
Goodwill
impairment
|
9,775 | - | - | |||||||||
|
Other
impairment
|
- | 2,387 | - | |||||||||
|
Research
and development
|
3,370 | 3,358 | 3,053 | |||||||||
|
Depreciation
and amortization
|
2,733 | 2,502 | 1,281 | |||||||||
|
Total
operating expenses
|
94,833 | 91,532 | 43,832 | |||||||||
|
Loss
from operations
|
(53,603 | ) | (47,531 | ) | (39,926 | ) | ||||||
|
Non-operating
income (expenses)
|
||||||||||||
|
Interest
income
|
830 | 1,584 | 1,630 | |||||||||
|
Interest
expense
|
(1,939 | ) | (2,190 | ) | - | |||||||
|
Other
than temporary impairment of marketable securities
|
(1,428 | ) | - | - | ||||||||
|
Loss
on extinguishment of debt
|
- | (741 | ) | - | ||||||||
|
Change
in fair value of warrant liabilities
|
5,744 | 3,471 | - | |||||||||
|
Other
non-operating income, net
|
5 | 32 | - | |||||||||
|
Loss
before provision for income taxes
|
(50,391 | ) | (45,375 | ) | (38,296 | ) | ||||||
|
Provision
for income taxes
|
27 | 87 | 2 | |||||||||
|
Net
loss
|
$ | (50,418 | ) | $ | (45,462 | ) | $ | (38,298 | ) | |||
|
Net
loss per share - basic and diluted
|
$ | (0.92 | ) | $ | (0.99 | ) | $ | (0.96 | ) | |||
|
Weighted
average number of shares
|
||||||||||||
|
outstanding
- basic and diluted
|
54,675 | 45,695 | 39,715 | |||||||||
The
accompanying Notes to Consolidated Financial Statements are an integral part of
these statements.
HYTHIAM, INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
|
Additional
|
||||||||||||||||||||
|
(Dollars
in thousands)
|
Common
Stock
|
Paid-In
|
Accumulated
|
|||||||||||||||||
|
Shares
|
Amount
|
Capital
|
Deficit
|
Total
|
||||||||||||||||
|
Balance
at December 31, 2005
|
39,144,000 | $ | 4 | $ | 89,176 | $ | (39,441 | ) | $ | 49,739 | ||||||||||
|
Common
stock issued for intellectual property
|
||||||||||||||||||||
|
and
outside services
|
157,000 | - | 1,064 | - | 1,064 | |||||||||||||||
|
Options
and warrants issued for employee
|
||||||||||||||||||||
|
and
outside services
|
- | - | 3,462 | - | 3,462 | |||||||||||||||
|
Exercise
of options and warrants
|
683,000 | - | 1,690 | - | 1,690 | |||||||||||||||
|
Common
stock issued in private placement
|
||||||||||||||||||||
|
offering,
net of expenses
|
3,573,000 | - | 24,372 | - | 24,372 | |||||||||||||||
|
Net
loss
|
- | - | - | (38,298 | ) | (38,298 | ) | |||||||||||||
|
Balance
at December 31, 2006
|
43,557,000 | 4 | 119,764 | (77,739 | ) | 42,029 | ||||||||||||||
|
Common
stock issued for intellectual property
|
||||||||||||||||||||
|
and
outside services
|
315,000 | - | 2,447 | - | 2,447 | |||||||||||||||
|
Options
and warrants issued for employee
|
||||||||||||||||||||
|
and
outside services
|
- | - | 2,397 | - | 2,397 | |||||||||||||||
|
Exercise
of options and warrants
|
586,000 | - | 1,940 | - | 1,940 | |||||||||||||||
|
Common
stock issued for employee stock
|
||||||||||||||||||||
|
purchase
plan
|
27,000 | - | 124 | - | 124 | |||||||||||||||
|
Common
stock issued for CompCare
|
||||||||||||||||||||
|
acquisition
|
215,000 | - | 2,084 | - | 2,084 | |||||||||||||||
|
Warrants
issued with debt
|
- | - | 1,342 | - | 1,342 | |||||||||||||||
|
Common
stock issued in registered direct
|
||||||||||||||||||||
|
placement,
net of expenses
|
9,635,000 | 1 | 36,362 | - | 36,363 | |||||||||||||||
|
Net
loss
|
- | - | - | (45,462 | ) | (45,462 | ) | |||||||||||||
|
Balance
at December 31, 2007
|
54,335,000 | 5 | 166,460 | (123,201 | ) | 43,264 | ||||||||||||||
|
Common
stock issued for outside services
|
601,000 | 1 | 1,665 | - | 1,666 | |||||||||||||||
|
Options
and warrants issued for employee
|
||||||||||||||||||||
|
and
outside services
|
- | - | 7,407 | - | 7,407 | |||||||||||||||
|
Common
stock issued for employee stock
|
||||||||||||||||||||
|
purchase
plan
|
29,000 | - | 29 | - | 29 | |||||||||||||||
|
Warrants issued with debt
(Note 1)
|
- | - | (1,380 | ) | - | (1,380 | ) | |||||||||||||
|
Common
stock issuance expense
|
||||||||||||||||||||
|
adjustment
|
- | - | 540 | - | 540 | |||||||||||||||
|
Net
loss
|
- | - | - | (50,418 | ) | (50,418 | ) | |||||||||||||
|
Balance
at December 31, 2008
|
54,965,000 | $ | 6 | $ | 174,721 | $ | (173,619 | ) | $ | 1,108 | ||||||||||
The
accompanying Notes to Consolidated Financial Statements are an integral part of
these statements.
HYTHIAM,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
(Dollars
in thousands)
|
Year
ended December 31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Operating
activities
|
||||||||||||
|
Net
loss
|
$ | (50,418 | ) | $ | (45,462 | ) | $ | (38,298 | ) | |||
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||||||
|
Depreciation
and amortization
|
2,733 | 2,502 | 1,281 | |||||||||
|
Amortization
of debt discount and issuance costs included in interest
expense
|
1,206 | 1,026 | - | |||||||||
|
Other
than temporary impairment of marketable securities
|
1,428 | - | - | |||||||||
|
Provision
for doubtful accounts
|
1,032 | 528 | 281 | |||||||||
|
Deferred
rent
|
(370 | ) | (6 | ) | 134 | |||||||
|
Share-based
compensation expense
|
9,214 | 2,605 | 3,691 | |||||||||
|
Goodwill
impairment loss
|
9,775 | - | - | |||||||||
|
Other
impairment loss
|
- | 2,387 | - | |||||||||
|
Loss
on extinguishment of debt
|
- | 741 | - | |||||||||
|
Fair
value adjustment on warrant liability
|
(5,744 | ) | (3,471 | ) | - | |||||||
|
Loss
on disposition of fixed assets
|
824 | - | - | |||||||||
|
Changes
in current assets and liabilities, net of business
acquired:
|
||||||||||||
|
Receivables
|
(1,480 | ) | (810 | ) | (737 | ) | ||||||
|
Prepaids
and other current assets
|
627 | (529 | ) | 141 | ||||||||
|
Accrued
claims payable
|
1,252 | 2,865 | - | |||||||||
|
Accounts
payable and other accrued liabilities
|
475 | (1,596 | ) | 5,008 | ||||||||
|
Net
cash used in operating activities
|
(29,446 | ) | (39,220 | ) | (28,499 | ) | ||||||
|
Investing
activities
|
||||||||||||
|
Purchases
of marketable securities
|
(76,944 | ) | (80,168 | ) | (47,813 | ) | ||||||
|
Proceeds
from sales and maturities of marketable securities
|
101,138 | 82,104 | 53,650 | |||||||||
|
Cash
paid related to acquisition of a business, net of cash
acquired
|
- | (4,760 | ) | - | ||||||||
|
Proceeds
from sales of property and equipment
|
24 | - | - | |||||||||
|
Payment
received on notes receivable
|
27 | - | - | |||||||||
|
Restricted
cash
|
15 | 43 | (38 | ) | ||||||||
|
Purchases
of property and equipment
|
(993 | ) | (1,142 | ) | (889 | ) | ||||||
|
Deposits
and other assets
|
241 | 152 | (37 | ) | ||||||||
|
Cost
of intangibles
|
(200 | ) | (320 | ) | (143 | ) | ||||||
|
Net
cash (used in) provided by investing activities
|
23,308 | (4,091 | ) | 4,730 | ||||||||
|
Financing
activities
|
||||||||||||
|
Proceeds
from sale of common stock and warrants
|
163 | 37,512 | 24,372 | |||||||||
|
Cost
related to issuance of common stock
|
- | (230 | ) | - | ||||||||
|
Payments
on long term debt
|
(55 | ) | - | - | ||||||||
|
Cost
related to issuance of debt and warrants
|
- | (303 | ) | - | ||||||||
|
Proceeds
from issuance of debt and warrants
|
5,933 | 10,000 | - | |||||||||
|
Capital
lease obligations
|
(159 | ) | (178 | ) | (9 | ) | ||||||
|
Exercises
of stock options and warrants
|
- | 1,958 | 1,690 | |||||||||
|
Net
cash provided by financing activities
|
5,882 | 48,759 | 26,053 | |||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(256 | ) | 5,448 | 2,284 | ||||||||
|
Cash and cash
equivalents at beginning of
period
|
11,149 | 5,701 | 3,417 | |||||||||
|
Cash and cash
equivalents at end of
period
|
$ | 10,893 | $ | 11,149 | $ | 5,701 | ||||||
|
Supplemental
disclosure of cash paid
|
||||||||||||
|
Interest
|
$ | 633 | $ | 1,059 | $ | - | ||||||
|
Income
taxes
|
115 | 36 | 2 | |||||||||
|
Supplemental
disclosure of non-cash activity
|
||||||||||||
|
Common
stock, options and warrants issued for outside services
|
$ | 2,157 | $ | 232 | $ | 97 | ||||||
|
Property
and equipment acquired through capital leases and other
financing
|
6 | 284 | 320 | |||||||||
|
Stock
issued for redemption of debt
|
- | 5,350 | - | |||||||||
|
Common
stock issued for acquisition of a business
|
- | 2,084 | - | |||||||||
|
Common
stock issued for intellectual property
|
- | - | 738 | |||||||||
The
accompanying Notes to Consolidated Financial Statements are an integral part of
these statements.
HYTHIAM,
INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
Note
1. Summary of Significant Accounting Policies
Description
of Business
Hythiam,
Inc. (referred to herein as the company, we, us or our) is a healthcare services
management company, providing behavioral health management services to health
plans. Catasys is focused on offering integrated substance dependence
solutions, including our patented PROMETA®
Treatment Program, for alcoholism and stimulant dependence. The PROMETA
Treatment Program, which integrates behavioral, nutritional, and medical
components, is also available on a private-pay basis through licensed treatment
providers and company managed treatment centers that offer the PROMETA Treatment
Program, as well as other treatments for substance dependencies. We also
research, develop, license and commercialize innovative and proprietary
physiological, nutritional, and behavioral treatment
programs.
Effective
January 12, 2007, we acquired a 50.3% controlling interest in Comprehensive Care
Corporation (CompCare) through the acquisition of Woodcliff Healthcare
Investment Partners, LLP (Woodcliff). CompCare
provides managed care services in the behavioral health and psychiatric
fields. CompCare manages the delivery of a continuum of psychiatric and
substance abuse services to commercial, Medicare and Medicaid members on behalf
of employers, health plans, government organizations, third-party claims
administrators, and commercial and other group purchasers of behavioral
healthcare services. The customer base for CompCare’s services includes
both private and governmental entities. Our consolidated financial
statements include the business and operations of CompCare for the period
January 13, 2007 to December 31, 2007 and the year ended December 31,
2008.
On
January 20, 2009 we sold our interest in CompCare. Concurrent with this
transaction, we entered into an administrative services only (ASO) agreement
with CompCare to provide certain administrative services under CompCare’s
National Committee on Quality Assurance (NCQA) accreditation, including, but not
limited to, case management and authorization services, in support of our newly
launched specialty products and programs for autism and attention deficit
hyperactivity disorder (ADHD). See Note 15 – Subsequent Events for further
discussion.
From
January 2007 until the sale of CompCare in January 2009, we operated within two
reportable segments: healthcare services and behavioral health managed care
services. Our healthcare services segment focused on providing licensing,
administrative and management services to licensees that administer PROMETA and
other treatment programs, including managed treatment centers. Our behavioral
health managed care services segment focused on providing managed care services
in the behavioral health, psychiatric and substance abuse fields, and principally includes
the operations of our majority-owned, controlled subsidiary, CompCare.
Substantially all of our consolidated revenues and assets are earned or located
within the United States.
Basis
of Consolidation and Presentation and Going Concern
Our consolidated
financial statements include the accounts of the company, our wholly-owned
subsidiaries, CompCare, and company-managed professional medical corporations.
Based on the provisions of management services agreements between us and the
medical corporations, we have determined that the medical corporations are
variable interest entities (VIEs), and that we are the primary beneficiary as
defined in Financial Accounting Standards Board (FASB) Interpretation No. 46R,
Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51 (FIN 46R).
Accordingly, we are required to consolidate the revenues and expenses of the
managed medical corporations. See further discussion in Note 2 – Management
Services Agreements.
All
inter-company transactions have been eliminated in consolidation. Certain
amounts in the consolidated financial statements and notes thereto for the years
ended December 31, 2007 and 2006 have been reclassified to conform to the
presentation for the year ended December 31, 2008.
The
accompanying financial statements have been prepared on the basis that we will
continue as a going concern. We have incurred significant operating losses and
negative cash flows from operations since our inception. As of December 31,
2008, these conditions raised substantial doubt as to our ability to continue as
a going concern. At December 31, 2008, cash,
cash equivalents and current marketable securities amounted to $11.0
million, of which $1.1 million related to CompCare, which was sold in January
2009. At that date, we had a working capital deficit of approximately $11.5
million, of which $5.7 million is related to CompCare. Additionally, our working
capital deficit is impacted by $5.7 million of outstanding borrowings under the
UBS line of credit that is payable on demand and classified in current
liabilities, but are secured by $10.1 million of auction-rate securities (ARS)
that are classified in long-term assets. During the year ended December 31,
2008, our cash and cash equivalents used in operating activities amounted to
$29.4 million, of which $5.5 million related to CompCare.
Our
ability to fund our ongoing operations and continue as a going concern is
dependent on raising additional capital, signing and generating revenue from new
contracts for our Catasys managed care programs and the success of management’s
plans to increase revenue and continue to decrease expenses. In
the fourth quarter of 2008, management took actions that we expect will
result in reducing annual operating expenses by $10.2 million compared to
the third quarter of 2008. In addition, management currently has
plans for additional cost reductions from the elimination of certain positions
in our licensee and PROMETA Center operations and related corporate staff and a
reduction in certain support and occupancy costs, consulting and other outside
services if required. Also, we have renegotiated certain leasing and vendor
agreements to obtain more favorable pricing and to restructure payment terms. We
have also negotiated and plan to negotiate more favorable payment terms with
vendors, which include negotiating settlements for outstanding liabilities. We
may exit additional markets in our licensee and PROMETA Center operations to
reduce costs or if management determines that those markets will not provide
short term profitability. Additionally, we are pursuing new Catasys contracts,
additional capital and will consider liquidating our ARS, if necessary. There
can be no assurance that we will be successful in our efforts to generate,
increase, or maintain revenue. We have been in discussions with third parties
regarding financing that management anticipates would, if concluded, meet its
capital needs. We may not be successful in raising necessary funds on
acceptable terms or at all, and we may not be able to offset this by sufficient
reductions in expenses and increases in revenue. If this occurs, we may be
unable to meet our cash obligations as they become due and we may be required to
further delay or reduce operating expenses and curtail our operations, which
would have a material adverse effect on us. This has raised substantial
doubts from our auditors as to our ability to continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability of the carrying amount of the recorded assets or the amount of
liabilities that might result from the outcome of this uncertainty.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) in the United States requires management to make
estimates and assumptions that affect the reported amounts in the financial
statements and disclosed in the accompanying notes. Significant areas requiring
the use of management estimates include expense accruals, accounts receivable
allowances, patient continuing care reserves, accrued claims payable, premium
deficiencies, the useful life of depreciable assets, the evaluation of asset
impairment and shared-based compensation. Actual results could differ from those
estimates.
Revenue
Recognition
Healthcare
Services
Our
healthcare services revenues to date have been primarily derived from licensing
our PROMETA Treatment Program and providing administrative services to
hospitals, treatment facilities and other healthcare providers, and from
revenues generated by our managed treatment centers. We record revenues
earned based on the terms of our licensing and management contracts, which
requires the use of judgment, including the assessment of the collectability of
receivables. Licensing agreements typically provide for a fixed fee on a
per-patient basis, payable to us following the providers’ commencement of the
use of our program to treat patients. For revenue recognition
purposes, we treat the program licensing and related administrative services as
one unit of accounting. We record the fees owed to us under the terms
of the agreements at the time we have performed substantially all required
services for each use of our program, which for the significant majority of our
license agreements to date is in the period in which the provider begins using
the program for medically directed and supervised treatment of a patient and, in
other cases, is at the time that medical treatment has been
completed.
The
revenues of our managed treatment centers, which we include in our
consolidated financial statements, are derived from charging fees directly to
patients for medical treatments, including the PROMETA Treatment
Program. Revenues from patients treated at the managed treatment
centers are recorded based on the number of days of treatment completed during
the period as a percentage of the total number treatment days for the PROMETA
Treatment Program. Revenues relating to the continuing care portion
of the PROMETA Treatment Program are deferred and recorded over the period
during which the continuing care services are provided.
Behavioral
Health Managed Care Services
Managed
care activities are performed by CompCare under the terms of agreements with
health maintenance organizations (HMOs), preferred provider organizations
(PPOs), and other health plans or payers to provide contracted behavioral
healthcare services to subscribing participants. Revenue under a substantial
portion of these agreements is earned monthly based on the number of qualified
participants regardless of services actually provided (generally referred to as
capitation arrangements). The information regarding qualified participants is
supplied by CompCare’s clients and CompCare reviews membership eligibility
records and other reported information to verify its accuracy in determining the
amount of revenue to be recognized. Revenues from capitation agreements
accounted for $34.1 million and $35.2 million of behavioral health managed care
revenues for the year ended December 31, 2008 and the period January 13
through December 31, 2007, respectively (97% in both periods). The remaining
balance of CompCare’s revenues is earned on a fee-for-service basis and is
recognized as services are rendered.
Cost
of Healthcare Services
Cost of
healthcare services represent direct costs that are incurred in connection with
licensing our treatment programs and providing administrative services in
accordance with the various technology license and services agreements, and are
associated directly with the revenue that we recognize. Consistent with our
revenue recognition policy, the costs associated with providing these services
are recognized, for a significant majority of our agreements, in the period in
which patient treatment commences, and in other cases, at the time treatment has
been completed. Such costs include royalties paid for the use of the PROMETA
Treatment Program for patients treated by all licensees, and direct labor costs,
continuing care expense, medical supplies and program medications for patients
treated at the managed treatment centers.
Behavioral
Health Managed Care Services Expense
Behavioral
health managed care operating expense is recognized in the period in which an
eligible member actually receives services and includes an estimate of the cost
of behavioral health services that have been incurred but not yet reported
(IBNR). See “Accrued Claims Payable” for a discussion of IBNR claims.
CompCare contracts with various healthcare providers including hospitals,
physician groups and other licensed behavioral healthcare professionals either
on a discounted fee-for-service or a per-case basis. CompCare
determines that a member has received services when CompCare receives a claim
within the contracted timeframe with all required billing elements correctly
completed by the service provider. CompCare then determines whether the member
is eligible to receive such services, whether the services provided are
medically necessary and are covered by the benefit plan’s certificate of
coverage. If all of these requirements are met, the services are
authorized by one of CompCare’s employees, and the claim is entered into
CompCare’s claims system for payment.
Premium
Deficiencies
CompCare
accrues losses under its capitated contracts when it is probable that a loss has
been incurred and the amount of the loss can be reasonably estimated. CompCare
performs 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 CompCare’s 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, CompCare generally has the ability to cancel
the contract with 60 to 90 days written notice. Prior to
cancellation, CompCare will usually submit a request for a rate increase
accompanied by supporting utilization data. Although CompCare’s
clients have historically been generally receptive to such requests, there is no
assurance that such requests will be satisfied in the future. If a
rate increase is not granted, CompCare has the ability, in most cases, to
terminate the contract and limit its risk to a short-term period.
On a
quarterly basis, CompCare performs a review of its 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, CompCare believes no contract loss
reserve for future periods is necessary.
Share-Based
Compensation
Healthcare
Services
Under our
2003 and 2007 Stock Incentive Plans (the Plans), we have granted incentive stock
options (ISOs) under Section 422A of the Internal Revenue Code and
non-qualified options (NSOs) to executive officers, employees, members of our
Board of Directors and certain outside consultants. We grant all such
share-based compensation awards at no less than the fair market value of our
stock on the date of grant. Employee and board of director awards generally vest
on a straight-line basis over three to five years. Total share-based
compensation expense on a consolidated basis amounted to $9.2 million, $2.6
million and $3.7 million for the years ended December 31, 2008, 2007 and 2006,
respectively. The
expense in 2008 includes $596,000 related to actions taken to streamline our
operations, as discussed in "Costs Associated with Streamlining our
Operations."
Stock
Options – Employees and Directors
On
January 1, 2006, we began accounting for all share-based payment awards made to
employees and directors by adopting SFAS 123 (Revised 2004), Share-Based Payment (SFAS 123R), using the
modified prospective method. SFAS 123R requires the measurement and
recognition of compensation expense based on the estimated fair value of
share-based payment awards to employees and directors on the date of grant using
an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service
periods in the consolidated statements of operations.
The
estimated weighted average fair values of options granted during 2008, 2007 and
2006 were $1.47, $4.50 and $3.95 per share, respectively, and were
calculated using the Black-Scholes pricing model based on the following
assumptions:
|
2008
|
2007
|
2006
|
|
|
Expected
volatility
|
72%
|
64%
|
66%
|
|
Risk-free
interest rate
|
3.03%
|
4.46%
|
4.72%
|
|
Weighted
average expected lives in years
|
5.8
|
6.5
|
6.1
|
|
Expected
dividend yield
|
0%
|
0%
|
0%
|
The
expected volatility assumption for 2008, 2007 and 2006 was based on the
historical volatility of our stock and the stock of other public healthcare
companies, measured over a period generally commensurate with the expected term.
The weighted average expected lives in years for 2008, 2007 and 2006
reflect the application of the simplified method set out in SEC Staff Accounting
Bulletin (SAB) 107 (and as amended by SAB 110), which defines the life as the
average of the contractual term of the options and the weighted average vesting
period for all option tranches. We use historical data to estimate
the rate of forfeitures assumption for awards granted to employees, which was
24% in 2008, 29% in 2007 and 27% in 2006.
We have
elected to adopt the detailed method prescribed in SFAS 123R for calculating the
beginning balance of the additional paid-in capital pool (APIC pool) related to
the tax effects of employee share-based compensation, and to determine the
subsequent impact on the APIC pool and consolidated statements of cash flows of
the tax effects of employee share-based compensation awards that were
outstanding upon adoption of SFAS 123R.
Stock
Options and Warrants – Non-employees
We
account for the issuance of stock options and warrants for services from
non-employees in accordance with SFAS 123 by estimating the fair value of stock
options and warrants issued using the Black-Scholes pricing model. This model’s
calculations incorporate the exercise price, the market price of shares on grant
date, the weighted average risk-free interest rate, expected life of the option
or warrant, expected volatility of our stock and expected
dividends.
For
options and warrants issued as compensation to non-employees for services that
are fully vested and non-forfeitable at the time of issuance, the estimated
value is recorded in equity and expensed when the services are performed and
benefit is received as provided by FASB Emerging Issues Task Force Issue (EITF)
No. 96-18, Accounting For Equity Instruments
That Are Issued To Other Than Employees For Acquiring Or In Conjunction With
Selling Goods Or Services. For unvested shares, the change in fair
value during the period is recognized in expense using the graded vesting
method.
From time
to time, Hythiam has retained terminated employees as part-time consultants upon
their resignation from the company. Because the employees continue to provide
services to Hythiam, their options continue to vest in accordance with the
original terms. Due to the change in classification of the option awards, the
options are considered modified at the date of termination in accordance with
SFAS 123R. The modifications are treated as exchanges of the original awards in
return for the issuance of new awards. At the date of termination, the unvested
options are no longer accounted for as employee awards under SFAS 123R but are
instead accounted for as new non-employee awards under EITF 96-18. The
accounting for the portion of the total grants that have already vested and have
been previously expensed as equity awards is not changed. We recorded
approximately $19,000 and $28,000 of expense in 2008 and 2007, respectively,
associated with the modified liability awards pursuant to the guidance in EITF
96-18.
Behavioral
Health Managed Care Services
CompCare’s
1995 and 2002 Incentive Plans (the CompCare Plans) provide for the issuance of
ISOs, NSOs, stock appreciation rights, limited stock appreciation rights, and
restricted stock grants to eligible employees and consultants, and stock options
to its employees and non-employee directors. Options for ISOs may be granted for
terms of up to ten years and are generally exercisable in cumulative increments
of 50% each six months. CompCare also has a non-qualified stock option plan for
its outside directors, in which the option grants vest in accordance with
vesting schedules established by CompCare’s Compensation and Stock Option
Committee.
Share-based
compensation expense recognized for employees and directors for the year ended
December 31, 2008 and period January 13 through December 31, 2007 was $130,000
and $83,000, respectively.
The
following table lists the assumptions utilized in applying the Black-Scholes
valuation model for options granted by CompCare. CompCare uses
historical data to estimate the expected term of the option. Expected
volatility is based on the historical volatility of CompCare’s traded stock
measured over a period generally commensurate with the expected
term. CompCare did not declare dividends in the past nor does it
expect to do so in the near future, and as such it assumes no expected
dividend. The risk-free rate is based on the U.S. Treasury yield
curve with the same expected term as that of the option at the time of
grant.
|
January
13
|
|||
|
through
|
|||
|
December
31,
|
|||
|
2008
|
2007
|
||
|
Expected
volatility
|
125.0%
- 130.0%
|
110%
|
|
|
Risk-free
interest rate
|
2.6%
- 3.2%
|
4.8%
|
|
|
Weighted
average expected lives in years
|
5-6
|
3
|
|
|
Expected
dividend yield
|
0%
|
0%
|
Costs
Associated with Streamlining our Operations
In
January 2008, we streamlined our operations to increase our focus on managed
care opportunities, significantly reducing our field and regional sales
personnel and related corporate support personnel, the number of outside
consultants utilized, closing our PROMETA Center in San Francisco and lowering
overall corporate overhead costs. In April 2008, and in the fourth quarter
of 2008, we took further actions to streamline our operations and increased the
focus on managed care opportunities.
During
2008, we recorded a total of approximately $3.1 million in costs associated with
actions taken to streamline our operations (including $596,000 in share-based
expense), which included costs primarily related to severance and related
benefits and costs incurred to close the San Francisco PROMETA Center and
international operations. These costs are classified as General and
Administrative expenses on our Statement of Operations. We have
accounted for these costs in accordance with SFAS 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS 146 states that a
liability for a cost associated with an exit or disposal activity shall be
recognized and measured initially at its fair value in the period when the
liability is incurred.
Foreign
Currency
The local
currency is the functional currency for all of our international operations. In
accordance with SFAS No. 52, Foreign Currency Translation, assets and
liabilities of our foreign operations are translated from foreign currencies
into U.S. dollars at year-end rates, while income and expenses are translated at
the weighted-average exchange rates for the year. The related translation
adjustments are included in the Consolidated Statements of Operations under the
caption General and administrative expenses and are
immaterial. Foreign currency translation gains (losses) were
($52,000), ($22,000) and $20,000 for the years ended December 31, 2008, 2007 and
2006, respectively. No foreign currency translation adjustments were
recorded to other comprehensive income.
Income
Taxes
We
account for income taxes using the liability method in accordance with SFAS 109,
Accounting for Income
Taxes. To date, no current income tax liability has been recorded
due to our accumulated net losses. Deferred tax assets and liabilities are
recognized for temporary differences between the financial statement carrying
amounts of assets and liabilities and the amounts that are reported in the tax
returns. Deferred tax assets and liabilities are recorded on a net basis;
however, our net deferred tax assets have been fully reserved by a valuation
allowance due to the uncertainty of our ability to realize future taxable income
and to recover our net deferred tax assets.
In
June 2006, the FASB issued FASB Interpretation No. 48 (FIN) 48, Accounting for Uncertainty in Income
Taxes, which clarifies the accounting for uncertainty in income taxes.
FIN 48 requires that companies recognize in the consolidated financial
statements the impact of a tax position if that position is more likely than not
of being sustained on audit based on the technical merits of the position. FIN
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods and disclosure. The provisions of FIN
48 are effective for fiscal years beginning after December 15, 2006. We
adopted FIN 48 on January 1, 2007, with no impact to our consolidated financial
statements.
Comprehensive
Income
Comprehensive
income generally represents all changes in stockholders’ equity during the
period except those resulting from investments by, or distributions to,
stockholders. For the first, second and third quarters of 2008, we
recorded accumulated unrealized losses related to our auction-rate securities of
$566,000, $776,000 and $1.1 million, respectively in other comprehensive
income. During the fourth quarter, $1.1 million was reclassified from
other comprehensive income to other than temporary impairment of marketable
securities. We recorded an additional $336,000 other than temporary
impairment during the fourth quarter of 2008, bringing our total impairment
charge for the year to $1.4 million.
For
the years ended December 31, 2008, 2007 and 2006, we have no other comprehensive
income or loss items that are not reflected in earnings and accordingly, our net
loss equals comprehensive loss for these periods.
The
components of total other comprehensive (loss) income for the years ended
December 31, 2008 and 2007 are as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Unrealized
gain (loss) on marketable securities:
|
||||||||
|
Unrealized
gain (loss) on marketable securities
|
$ | (1,092 | ) | $ | - | |||
|
Add-back
reclassification adjustment for impairment
|
||||||||
|
of
marketable securities included in net income
|
1,092 | - | ||||||
|
Net
unrealized gain (loss) on marketable securities
|
- | - | ||||||
|
Total
other comprehensive (loss) income
|
$ | - | $ | - | ||||
Basic
and Diluted Loss per Share
Basic
loss per share is computed by dividing the net loss to common stockholders
for the period by the weighted average number of common shares outstanding
during the period. Diluted loss per share is computed by dividing the net
loss for the period by the weighted average number of common and dilutive
common equivalent shares outstanding during the period.
Common
equivalent shares, consisting of approximately 14,533,000, 9,846,000, and
7,222,000 of incremental common shares as of December 31, 2008, 2007 and 2006,
respectively, issuable upon the exercise of stock options and warrants have been
excluded from the diluted loss per share calculation because their effect is
anti-dilutive.
Cash
and Cash Equivalents
We invest
available cash in short-term commercial paper and certificates of
deposit. Liquid investments with an original maturity of three months
or less when purchased are considered to be cash equivalents.
Restricted
cash represents deposits secured as collateral for a bank credit card
program.
Marketable
Securities
Investments
include auction rate securities (ARS), U.S. Treasury bills, commercial
paper and certificates of deposit with original maturity dates greater than
three months when purchased, which are classified as available-for-sale
investments and reflected in current or long-term assets, as appropriate, as
marketable securities at fair market value in accordance with SFAS No.
115, Accounting for Certain Investments
in Debt and Equity Securities. Unrealized gains and losses that are
temporary in nature are excluded from earnings and reported in comprehensive
loss. Realized gains and losses and declines in value judged to be
other-than-temporary are recognized as a non-reversible impairment charge in the
Consolidated Statement of Operations using the specific identification method in
the period in which they occur.
Our
short- and long-term marketable securities consisted of investments with the
following maturities as of December 31, 2008 and 2007:
|
(Dollars
in thousands)
|
Fair
Market
|
Less
than
|
More
than
|
|||||||||
|
Value
|
1
Year
|
10
Years
|
||||||||||
|
Balance
at December 31, 2008
|
||||||||||||
|
Certificates
of deposit (short-term)
|
$ | 146 | $ | 146 | $ | - | ||||||
|
Variable
auction-rate securities (long-term)
|
10,072 | - | 10,072 | |||||||||
|
Balance
at December 31, 2007
|
||||||||||||
|
Variable
auction-rate securities
|
$ | 19,000 | $ | - | $ | 19,000 | ||||||
|
Commercial
paper
|
16,518 | - | 16,518 | |||||||||
|
Certificates
of deposit
|
322 | 322 | - | |||||||||
|
Total
short-term marketable securities
|
$ | 35,840 | $ | 322 | $ | 35,518 | ||||||
The
carrying value of all securities presented above approximated fair market value
at December 31, 2008 and 2007, respectively.
Variable
Auction-Rate Securities
As of
December 31, 2008 our total investment in ARS was $11.5 million. Since February
13, 2008, auctions for these securities have failed, meaning the parties
desiring to sell securities could not be matched with an adequate number of
buyers, resulting in our having to continue to hold these
securities. Although the securities are Aaa/AAA rated and collateralized by
portfolios of student loans guaranteed by the U.S. government, based on current
market conditions it is likely that auctions will continue to be unsuccessful in
the short-term, limiting the liquidity of these investments until the auction
succeeds, the issuer calls the securities, or they mature. The remaining
maturity periods range from nineteen to thirty-eight years. As a result, our
ability to liquidate our investment and fully recover the carrying value of our
investment in the near term may be limited or not exist. In December,
we utilized a third-party valuation firm to assist us with determining the fair
market value of our ARS which was estimated to be $10.1 million, resulting in a
$1.4 million estimated decline in value.
In making
our determination whether losses are considered to be “other-than-temporary”
declines in value, we consider the following factors at each quarter-end
reporting period:
|
●
|
How
long and by how much the fair value of the ARS securities have been below
cost
|
|
●
|
The
financial condition of the issuers
|
|
●
|
Any
downgrades of the securities by rating
agencies
|
|
●
|
Default
on interest or other terms
|
|
●
|
Our
intent and ability to hold the ARS long enough for them to recover their
value
|
Due to
uncertainties as to whether we will hold the ARS until they recover in value, we
determined that the loss in the fair value of our ARS investments was
“other-than-temporary” in connection with our year end
assessment.
Accordingly,
we recognized an other-than-temporary loss of approximately $1.4 million in
December 2008, which is reflected as a non-operating expense in our Conslidated
Statement of Operations.
In May
2008, our investment portfolio manager, UBS AG (UBS), provided us with a demand
margin loan facility, allowing us to borrow up to 50% of the market value of the
ARS, as determined by UBS. The margin loan facility is collateralized by the
ARS. In October 2008, UBS made a “rights” offering to its clients,
pursuant to which we are entitled to sell to UBS all auction-rate securities
held by us in our UBS account. The rights permit us to require UBS to purchase
our ARS for a price equal to original par value plus any accrued but unpaid
interest beginning on June 30, 2010 and ending on July 2, 2012 if the
securities are not earlier redeemed or sold. As part of the offering, UBS would
provide us a line of credit equal to 75% of the market value of the ARS until
they are purchased by UBS. The line of credit has certain restrictions
described in the prospectus. We accepted this offer on November 6,
2008. As of December 31, 2008, the outstanding balance on our line of
credit was 5.7 million. This contract was treated as a separate unit of
account. We didn’t prescribe any value to the contract since we were
not able to conclude that we had the ability to hold the ARS until June 30,
2010.
These
securities will be analyzed each reporting period for additional
other-than-temporary impairment factors. Due to the current
uncertainty in the credit markets and the terms of the Rights offering with UBS,
we have classified the fair value of our ARS as long-term assets as of December
31, 2008.
Fair
Value Measurements
Fair
Value Information about Financial Instruments Measured at Fair
Value
Effective
January 1, 2008, we adopted SFAS 157, Fair Value Measurements. SFAS
157 does not require any new fair value measurements; rather, it defines fair
value, establishes a framework for measuring fair value in accordance with
existing GAAP and expands disclosures about fair value measurements. In February
2008, FASB Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement
No. 157 was issued, which delays the effective date of SFAS 157
to fiscal years and interim periods within those fiscal years beginning after
November 15, 2008 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). We elected to defer the
adoption of the Standard for these non-financial assets and liabilities and are
currently evaluating the impact, if any, that the deferred provisions of the
Standard will have on our consolidated financial statements. In October 2008,
FSP FAS 157-3, Fair Value
Measurements, was issued, which clarifies the application of SFAS 157 in
an inactive market and provides an example to demonstrate how the fair value of
a financial asset is determined when the market for that financial asset is
inactive. FSP FAS 157-3 was effective upon issuance, including prior periods for
which financial statements had not been issued. The adoption of SFAS 157 for our
financial assets and liabilities and FSP FAS 157-3 did not have an impact on our
financial position or operating results. Beginning January 1, 2008, assets
and liabilities recorded at fair value in the Consolidated Balance Sheets are
categorized based upon the level of judgment associated with the inputs used to
measure their fair value. The categories, as defined by SFAS 157, are as
follows:
|
Level Input:
|
Input
Definition:
|
|
|
Level
I
|
Inputs
are unadjusted, quoted prices for identical assets or liabilities in
active markets at the measurement date.
|
|
|
Level
II
|
Inputs,
other than quoted prices included in Level I, that are observable for the
asset or liability through corroboration with market data at the
measurement date.
|
|
|
Level
III
|
Unobservable
inputs that reflect management’s best estimate of what market participants
would use in pricing the asset or liability at the measurement
date.
|
The
following table summarizes fair value measurements by level at December 31, 2008
for assets and liabilities measured at fair value on a recurring
basis:
|
(Dollars
in thousands)
|
Level
I
|
Level
II
|
Level
III
|
Total
|
||||||||||||
|
Marketable
securities
|
$ | 146 | $ |
-
|
$ |
-
|
$ | 146 | ||||||||
|
Variable
auction rate securities
|
- | - | 10,072 | 10,072 | ||||||||||||
|
Certificates
of deposit *
|
133 | - | - | 133 | ||||||||||||
|
Total
assets
|
$ | 279 | $ | - | $ | 10,072 | $ | 10,351 | ||||||||
|
Warrant
liabilities
|
$ | - | $ | 156 | $ | - | $ | 156 | ||||||||
|
Total
liabilities
|
$ | - | $ | 156 | $ | - | $ | 156 | ||||||||
|
*
included in "deposits and other assets" on our Consolidated Balance
Sheets
|
||||||||||||||||
Liabilities
measured at market value on a recurring basis include warrant liabilities
resulting from a recent debt and equity financing. In accordance with EITF
00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock, the warrant liabilities are being marked to market
each quarter-end until they are completely settled. The warrants are valued
using the Black-Scholes pricing model, using assumptions consistent with our
application of SFAS 123R.
All of
the assets measured at fair value on a recurring basis using significant Level
III inputs as of December 31, 2008 were ARS. See discussion above in “Marketable
Securities” for additional information on our ARS, including a description of
the securities and underlying collateral, a discussion of the uncertainties
relating to their liquidity and our accounting treatment under SFAS 115. The
following table summarizes our fair value measurements using significant Level
III inputs, and changes therein, for the year ended December 31,
2008:
|
(Dollars
in thousands)
|
Level
III
|
|||
|
Balance
as of December 31, 2007
|
$ | - | ||
|
Transfers
in/out of Level III
|
- | |||
|
Purchases
and sales, net
|
- | |||
|
Net
unrealized losses
|
(1,428 | ) | ||
|
Net
realized gains (losses)*
|
11,500 | |||
|
Balance
as of December 31, 2008
|
$ | 10,072 | ||
*
Reflects other-than-temporary loss on auction-rate
securities.
As
discussed above, there have been continued auction failures with our ARS
portfolio. As a result, quoted prices for our ARS did not exist as of December
31, 2008 and, accordingly, we concluded that Level 1 inputs were not available
and unobservable inputs were used. We determined that use of a valuation model
was the best available technique for measuring the fair value of our ARS
portfolio and we based our estimates of the fair value using valuation models
and methodologies that utilize an income-based approach to estimate the price
that would be received if we sold our securities in an orderly transaction
between market participants. The estimated price was derived as the present
value of expected cash flows over an estimated period of illiquidity, using a
risk adjusted discount rate that was based on the credit risk and liquidity risk
of the securities. Based on the valuation models and methodologies, and
consideration of other factors, we wrote-down our ARS portfolio to its estimated
fair value as of December 31, 2008 and considered the $1.4 million reduction in
value as “other than temporary.” Accordingly, we recognized a charge of $1.4
million, which is included in our Consolidated Statement of Operations for the
year ended December 31, 2008. While our valuation model was based on both Level
II (credit quality and interest rates) and Level III inputs, we determined that
the Level III inputs were the most significant to the overall fair value
measurement, particularly the estimates of risk adjusted discount rates and
estimated periods of illiquidity.
Fair
Value Information about Financial Instruments Not Measured at Fair
Value
FASB
Statement 107, Disclosures
about Fair Value of Financial Instruments requires disclosure of fair
value information about certain financial instruments for which it is practical
to estimate that value. The carrying amounts reported in our balance sheet
for cash, cash equivalents, marketable securities, accounts receivable, notes
receivable, accounts payable and accrued liabilities approximate fair value
because of the immediate or short-term maturity of these financial
instruments. The carrying values of our outstanding short and long-term
debt were $12.2 million and $6.8 million and the fair values were $10.7 million
and $4.4 million as of December 31, 2008 and 2007, respectively.
Considerable judgment is required to develop estimates of fair value.
Accordingly, the estimates are not necessarily indicative of the amounts we
could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
Goodwill
In
accordance with SFAS 141, Business Combinations, the
purchase price for the CompCare acquisition was allocated to the fair values of
the assets acquired, including identifiable intangible assets, in accordance
with our proportionate share of ownership interest, and the excess amount of
purchase price over the fair values of net assets acquired resulted in $10.8
million of goodwill that is not deductible for tax purposes. The entire balance
of goodwill
was
assigned to our healthcare services reporting unit, except for the portion of
CompCare’s preacquisition goodwill attributable to the minority interest
($493,000), since we believed our association with CompCare created synergies to
facilitate the use of PROMETA Treatment Program by managed care treatment
providers and to provide access to an infrastructure for our planned disease
management product offerings. During 2007, we recorded a $192,000 adjustment to
reduce the balance of goodwill for the favorable resolution of assumed,
pre-acquisition liabilities and a $98,000 reduction related to a change in
minority shareholders’ interests. During 2008, we recorded a $289,000 reduction
related to a change in minority shareholders’ interests. The change in the
carrying amount of goodwill by reporting unit is as follows:
|
Behavioral
|
||||||||||||
|
Health
|
||||||||||||
|
Healthcare
|
Managed
|
|||||||||||
|
(Dollars
in thousands)
|
Services
|
Care
|
Total
|
|||||||||
|
Balance
as of January 1, 2008
|
$ | 10,064 | $ | 493 | $ | 10,557 | ||||||
|
Change
in minority interest
|
(289 | ) | - | (289 | ) | |||||||
|
Goodwill
impairment charge
|
(9,775 | ) | - | (9,775 | ) | |||||||
|
Balance
as of December 31, 2008
|
$ | - | $ | 493 | $ | 493 | ||||||
In
accordance with SFAS 142, Goodwill and Other Intangible
Assets, goodwill is not amortized, but instead is subject to impairment
tests. Our policy is to evaluate goodwill for impairment annually, at each
year-end, and between annual evaluations if events occur or circumstances change
that would more likely than not reduce the fair value of goodwill below its
carrying amount. Due to continued net losses and negative cash flows, the
decline in trading price of Hythiam’s and CompCare’s common stock during 2008
and the resulting lower valuation of our reporting units relative to their book
values, we have tested goodwill for impairment at each
quarter-end. We concluded that the goodwill in our healthcare
services reporting unit had been impaired as part of our fourth quarter
impairment testing, mainly resulting from the decline in the value of the
reporting unit that arose from the downward re-pricing of risk that occurred
broadly in the equity markets and affected the reporting unit in the
quarter. The decline in fair value of the healthcare services caused
a failure in step 1 of the SFAS 142 impairment test and it was necessary to
conduct step 2 of the impairment test. As part of our step 2 impairment test, we
estimated an implied fair value of the goodwill in healthcare services of $0 and
the $9.8 carrying value was recorded as an impairment charge in our Consolidated
Statement of Operations for the year ended December 31, 2008. The implied fair
value of the goodwill was determined after allocating the estimated fair value
of the healthcare services reporting unit, utilizing the income approach, to all
the assets and liabilities of that unit, in accordance with paragraph 21 of SFAS
142.
Intangible
Assets
Intellectual
Property
Intellectual
property consists primarily of the costs associated with acquiring certain
technology, patents, patents pending, know-how and related intangible assets
with respect to programs for treatment of dependence to alcohol, cocaine,
methamphetamines and other addictive stimulants. These long-term assets are
stated at cost and are being amortized on a straight-line basis over the
life of the respective patents, or patent applications, which range from 12 to
20 years.
Other
Intangible Assets
Other
intangible assets consist primarily of identified intangible assets acquired as
part of the CompCare acquisition, representing the value of managed care
contracts and marketing-related assets associated with its managed care
business, including the value of the healthcare provider network and the
professional designation from the NCQA. Such assets are being amortized on a
straight-line basis over their estimated lives, which approximate the rate at
which we believe the economic benefits of these assets will be realized, which
is generally three years.
Impairment
of Long-Lived Assets
In
accordance with SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, long-lived assets such as property,
equipment and intangible assets subject to amortization are reviewed for
impairment whenever events or circumstances indicate that the carrying amount of
these assets may not be recoverable. In reviewing for impairment, we
compare the carrying value of such assets to the estimated undiscounted future
cash flows expected from the use of the assets and their eventual
disposition. When the estimated undiscounted future
cash
flows are less than their carrying amount, an impairment loss is recognized
equal to the difference between the assets’ fair value and their carrying
value.
In August
2007, we recorded an impairment charge of $2.4 million when we recognized the
fair value of 310,000 shares of our common stock that had been previously issued
as additional consideration related to the purchase of an opiate patent. The
shares had been subject to a stock pledge agreement pending the resolution of
certain contingencies until we agreed to release the shares as a result of a
settlement agreement reached in August 2007 with the seller of the patent. The
fair value of these shares was based on the closing stock price on the date of
the settlement.
At
December 31, 2008, CompCare’s intangible assets of $642,000 were likewise
evaluated for possible impairment. In our evaluation of our
intangible assets, we considered the subsequent sale of our interest in CompCare
for $1.5 million in proceeds, and other factors, in concluding that no
impairment charge was necessary.
No other
impairments were identified in our reviews at December 31, 2008 and
2007.
Property
and Equipment
Property
and equipment are stated at cost, less accumulated depreciation. Additions and
improvements to property and equipment are capitalized at cost. Expenditures for
maintenance and repairs are charged to expense as incurred. Depreciation is
computed using the straight-line method over the estimated useful lives of the
related assets, which range from two to seven years for furniture and equipment.
Leasehold improvements are amortized over the lesser of the estimated useful
lives of the assets or the related lease term, which is typically five to seven
years.
Capital
Leases
Assets
held under capital leases include furniture and computer equipment, and are
recorded at the lower of the net present value of the minimum lease payments or
the fair value of the leased asset at the inception of the lease. Depreciation
expense is computed using the straight-line method over the estimated useful
lives of the assets. All lease agreements contain bargain purchase
options at termination of the lease.
Variable
Interest Entities
Generally,
an entity is subject to FIN 46R and is called a Variable Interest Entity (VIE)
if it has (a) equity that is insufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
or (b) equity investors that cannot make significant decisions about the
entity’s operations, or that do not absorb the expected losses or receive the
expected returns of the entity. When determining whether an entity that is a
business qualifies as a VIE, we also consider whether (i) we participated
significantly in the design of the entity, (ii) we provided more than half of
the total financial support to the entity, and (iii) substantially all of the
activities of the VIE either involve us or are conducted on our behalf. A VIE is
consolidated by its primary beneficiary, which is the party that absorbs or
receives a majority of the entity’s expected losses or expected residual
returns.
As
discussed in Note 2 – Management Services
Agreements, we have management services agreements with managed medical
corporations. Under these management services agreements, the equity owner of
the affiliated medical group has only a nominal equity investment at risk, and
we absorb or receive a majority of the entity’s expected losses or expected
residual returns. We participate significantly in the design of these management
services agreements. We also agree to provide working capital loans to allow for
the medical group to pay for its obligations. Substantially all of the
activities of these managed medical corporations either involve us or are
conducted for our benefit, as evidenced by the facts that (i) the operations of
the managed medical corporations are conducted primarily using our licensed
protocols and (ii) under the management services agreements, we agree to provide
and perform all non-medical management and administrative services for the
respective medical group. Payment of our management fee is subordinate to
payments of the obligations of the medical group, and repayment of the working
capital loans is not guaranteed by the equity owner of the affiliated medical
group or other third party. Creditors of the managed medical corporations do not
have recourse to our general credit.
Based on
the design and provisions of these management services agreements and the
working capital loans provided to the medical groups, we have determined that
the managed medical corporations are VIEs, and that we are the primary
beneficiary as defined in FIN 46R. Accordingly, we are required to consolidate
the revenues and expenses of the managed medical corporations.
Accrued
Claims Payable
The
accrued claims payable liability represents the estimated ultimate net amounts
owed for all behavioral healthcare services provided through the respective
balance sheet dates, including estimated amounts for claims IBNR to
CompCare. The unpaid claims liability is estimated using an actuarial
paid completion factor methodology and other statistical analyses and is
continually reviewed and adjusted, if necessary, to reflect any change in the
estimated liability. These estimates are subject to the effects of trends in
utilization and other factors. However, actual claims incurred could
differ materially from the estimated accrued claims payable amount reported.
Although considerable variability is inherent in such estimates, CompCare
management believes that the unpaid claims liability is adequate.
Accrued
Reinsurance Claims Payable
The
accrued reinsurance claims payable liability represents amounts payable to
providers under a state reinsurance program associated with CompCare’s contract
to provide behavioral healthcare services to members of a Connecticut HMO.
CompCare’s contract with the HMO ended December 31, 2005. At December 31, 2008,
$2.5 million of reinsurance claims payable remains and is attributable to
providers having submitted claims for authorized services with incorrect service
codes or otherwise incorrect information that has caused payment to be denied by
CompCare. In such cases, there are statutory provisions that allow
the provider to appeal a denied claim. If no appeal is received by
CompCare within the prescribed amount of time, it is probable that CompCare will
be required to remit the reinsurance funds back to the appropriate
party. Although CompCare believes it has materially complied with
applicable federal and state laws related to the reinsurance program, there can
be no assurance that a determination that CompCare has violated such laws will
not be made, and any such determination could have a material adverse effect on
CompCare’s financial position and results of operations.
Warrant
Liabilities
We issued
five-year warrants to purchase approximately 2.4 million additional shares
of our common stock at an exercise price of $5.75 per share in connection
with a registered direct stock placement completed on November 7, 2007. The
proceeds attributable to the warrants, based on the fair value of the warrants
at the date of issue, amounted to approximately $6.3 million and were
accounted for as a liability in accordance with EITF 00-19 based on an
evaluation of the terms and conditions related to the warrant agreement. The
warrant liability was revalued at $49,000 and $2.8 million at December 31, 2008
and 2007, respectively, resulting in non-operating gains in our Consolidated
Statement of Operations of $2.7 million and $3.5 million for the years ended
December 31, 2008 and 2007, respectively.
We issued
a warrant to purchase up to approximately 250,000 shares of our common stock, in
January 2007, in connection with the senior secured note (see Note 6 – Debt Outstanding). The
original warrant issued had a term of five years, and was initially exercisable
at $12.01 per share, or 120% of the $10.01 closing price of our common stock on
January 16, 2007. Pursuant to an anti-dilution adjustment clause in the
note, the exercise price of the warrant was subsequently adjusted to $10.52 per
share and the number of shares was adjusted to 285,185. The warrant was valued
at $1.4 million on the date of issuance, based on the Black-Scholes valuation
method, and was recorded in additional paid-in capital within stockholders’
equity. In conjunction with amending the senior secured note on July 31, 2008,
we amended the existing warrant by issuing a new warrant to Highbridge
exercisable for 1.3 million shares of our common stock at a price per share of
$2.15 (priced based on the $2.14 closing price of our common stock on July 22,
2008) and the amended warrant expires five years from the amendment date. The
original warrant is no longer outstanding.
In
connection with evaluating the accounting for the new warrant, the
classification of the original warrant was reassessed and it was determined that
it should have been classified as a
liability
and marked to market from the date of issuance. We quantified and evaluated the
qualitative and quantitative effects of this on prior periods and concluded that
they were not material to our financial statements and did not warrant a
restatement of prior periods’ financial statements. The impact of not timely
recording gains from the diminution in value of the liability on net loss per
share in the prior quarters ranges from $.00 to $.02 per share. The net effect
of not timely reducing our stockholders’ equity was less than 5% in all prior
quarters. Also, there was no effect on our revenue or cash flows for any
quarter. Accordingly, the January 2007 proceeds from issuing the original
warrant of $1.4 million were reclassified from additional-paid-in-capital to
warrant liabilities at July 31, 2008. The warrant was then re-valued and
adjusted to its July 31, 2008 estimated value of $89,000 using the Black-Scholes
valuation method, resulting in a $1.3 million change in fair value, recorded as
a non-operating gain in the Consolidated Statement of Operations for the three
months ended September 30, 2008.
The fair
value of the amended warrant amounted to $1.8 million at the date of issuance,
using the Black-Scholes valuation method, and the terms of the warrant agreement
required that it be accounted for as a liability in accordance in EITF
00-19. The amended warrant was revalued at $714,000 as of September 30,
2008, and $107,000 at December 31, 2008, resulting in a $1.7 million
non-operating gain to the Consolidated Statement of Operations for the year
ended December 31, 2008.
Both
warrants are being valued at each reporting period using the Black-Scholes
pricing model to determine the fair value per warrant. We will
continue to mark these warrants to market value each quarter-end until they are
completely settled.
Minority
Interest
Minority
interest represents the minority stockholders’ proportionate share of CompCare’s
equity. We acquired a majority controlling interest in CompCare as part of our
Woodcliff acquisition, and we had the ability to control 48.9% of CompCare’s
common stock as of December 31, 2008 from our ownership of 1,739,130 shares of
common stock and 14,400 shares of CompCare’s Series A Convertible Preferred
Stock (assuming conversion). As part of the acquisition, we obtained
anti-dilution protection and the right to designate a majority of the Board of
Directors of CompCare, giving us control. Our ownership percentage as of
December 31, 2008 has decreased from the 50.3% as of the date of our acquisition
due to additional common stock issued by CompCare during the period. Our
controlling interest requires that CompCare’s operations be included in our
consolidated financial statements, with the remaining 51.1% being attributed to
minority stockholder interest. Due to CompCare’s accumulated deficit on the date
of our acquisition, a deficit minority stockholders’ balance in the amount of
$544,000 existed at the time of the acquisition which was valued at zero,
resulting in an increase in the amount of goodwill recognized in the
acquisition. The minority stockholders’ interest in any further net losses has
not been recorded due to the accumulated deficit. The unrecorded minority
stockholders’ interest in net loss amounted to $4.2 million and $1.6
million for the year ended December 31, 2008 and the period January 13, 2007
through December 31, 2007, respectively.
Recent
Accounting Pronouncements
Recently
Adopted
In
September 2006, the FASB issued SFAS 157, Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value in
GAAP, 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. In February
2008, FASB Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No.
157, which delays the effective date of SFAS 157 to fiscal years and
interim periods within
those
fiscal years beginning after November 15, 2008 for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
We elected to defer the adoption of the Standard for these non-financial assets
and liabilities, and are currently evaluating the impact, if any, that the
deferred provisions of the Standard will have on our consolidated financial
statements. Because we did not elect to apply the fair value accounting option,
the adoption of SFAS 157 for our financial assets and liabilities did not have
an impact on our financial position or operating results.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 allows companies to measure
many financial assets and liabilities at fair value. It also establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types
of assets and liabilities. SFAS 159 is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. The adoption of SFAS No. 159 did not affect our
financial position, results of operations or cash flows.
In
October 2008, FASB Staff Position (FSP) on FAS 157-3 was issued, which clarifies
the application of SFAS 157 in an inactive market and provides an example to
demonstrate how the fair value of a financial asset is determined when the
market for that financial asset is inactive. FSP FAS 157-3 was effective upon
issuance, including prior periods for which financial statements had not been
issued. The adoption of this standard as of September 30, 2008 did not have
a material impact on our financial position, results of operations or cash
flows.
In
December 2008, the FASB issued FSP FAS 140-4 and FASB Interpretation No. (FIN)
46R-8, Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities. This FSP amends FASB Statement No. 140 Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities to
require public entities to provide additional disclosures about transfers of
financial assets. It also amends FIN 46, Consolidation of Variable Interest
Entities as revised to require public enterprises to provide additional
disclosures about their involvement with VIEs. FSP FAS 140-4 and FIN 46(R)-8 are
effective for the Company's fiscal year ending December 31, 2008. We
are required to consolidate the revenues and expenses of the managed medical
corporations. The financial results of managed treatment centers are
included in our consolidated financial statements under accounting standards
applicable to VIEs. Disclosures regarding our involvement with VIEs
are appropriately included in our financial statements under Summary of
Significant Accounting Policies – Variable Interest Entities, according to the
guidance.
Recently
Issued
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51. 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. SFAS 160 will have no material impact on our financial
position, results of operations or cash flows.
In March
2008, the FASB issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS
133. SFAS 161 requires enhanced disclosures about an entity’s
derivative and hedging activities, including how an entity uses derivative
instruments, how derivative instruments and related hedged items are accounted
for under SFAS 133, Accounting
for Derivative Instruments and Hedging Activities, and how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. The provisions of SFAS 161 are effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008. We do not expect the adoption of SFAS 161 to have a
material impact on our consolidated financial statements.
In
December 2007, the FASB issued SFAS 141R, Business Combinations. SFAS
141R replaces SFAS 141, Business Combinations, and
retains the requirement that the purchase method of accounting for acquisitions
be used for all business combinations. SFAS 141R 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 141R also requires
an acquirer to record an adjustment to income tax expense for changes in
valuation allowances or uncertain tax positions related to acquired businesses.
SFAS 141R 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 have adopted this statement as of January 1, 2009. The impact that
the adoption of SFAS 141R will have on our consolidated financial statements
will depend on the nature, terms and size of our business combinations that
occur after the effective date.
In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets. FSP 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible
Assets. This change is intended to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the period
of expected cash flows used to measure the fair value of the asset under SFAS
No. 141R and other GAAP. FSP 142-3 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. The requirement for determining useful lives must be applied
prospectively to intangible assets acquired after the effective date and the
disclosure requirements must be applied prospectively to all intangible assets
recognized as of, and subsequent to, the effective date. We do not expect the
adoption of this statement to have a material impact on our consolidated results
of operations, financial position or cash flows.
Note 2. Management Services
Agreements
We have
executed management services agreements with medical professional corporations
and related treatment centers, with terms generally ranging from five to ten
years and
provisions to continue on a month-to-month basis following the initial term,
unless terminated for cause.
Under
each of these management services agreements, we generally license to the
medical group or treatment center the right to use our proprietary treatment
programs and related trademarks and provide all required day-to-day business
management services, including, but not limited to:
|
●
|
general
administrative support services
|
|
●
|
information
systems
|
|
●
|
recordkeeping
|
|
●
|
scheduling
|
|
●
|
billing
and collection
|
|
●
|
marketing
and local business development
|
|
●
|
obtaining
and maintaining all federal, state and local licenses, certifications and
regulatory permits
|
The
medical group or treatment facility retains the sole right and obligation to
provide medical services to its patients and to make other medically related
decisions, such as the choice of medical professionals to hire or medical
equipment to acquire and the ordering of drugs.
In
addition, we provide medical office space to each medical group on a
non-exclusive basis, and we are responsible for all costs associated with rent
and utilities. The medical group pays us a monthly fee equal to the aggregate
amount of (a) our costs of providing management services (including reasonable
overhead allocable to the delivery of our services and including start-up costs
such as pre-operating salaries, rent, equipment, and tenant improvements
incurred for the benefit of the medical group, provided that any capitalized
costs will be amortized over a five year period), (b) 10%-15% of the foregoing
costs, and (c) any performance bonus amount, as determined by the medical group
at its sole discretion. The medical group’s payment of our fee is subordinate to
payment of the medical group's obligations, including physician fees and medical
group employee compensation.
We have
also agreed to provide a credit facility to each medical practice to be
available as a working capital loan, with interest at the Prime Rate plus
2%. Funds are advanced pursuant to the terms of the management
services agreement described above. The notes are due on demand, or upon
termination of the respective management
services
agreement. At December 31, 2008, there were three outstanding credit
facilities under which $9.2 million was outstanding.
Based on
the provisions of these agreements, we have determined that the managed medical
corporations are VIEs and that we are the primary beneficiary as defined in FIN
46R. Accordingly, we are required to consolidate the assets,
liabilities, revenues and expenses of the managed treatment centers as discussed
in Note 1 – Summary of
Significant Accounting Policies under Variable Interest Entities.
The amounts and classification of assets and liabilities of the VIEs included in
our Consolidated Balance Sheets at December 31, 2008 and 2007 are as
follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Cash
and cash equivalents
|
$ | 274 | $ | 172 | ||||
|
Receivables,
net
|
281 | 146 | ||||||
|
Prepaids
and other current assets
|
3 | 13 | ||||||
|
Total
assets
|
$ | 558 | $ | 331 | ||||
|
Accounts
payable
|
$ | 30 | $ | 12 | ||||
|
Intercompany
loans
|
9,238 | 6,117 | ||||||
|
Accrued
compensation and benefits
|
54 | 168 | ||||||
|
Accrued
liabilities
|
13 | 45 | ||||||
|
Total
liabilities
|
$ | 9,335 | $ | 6,342 | ||||
Note
3. Accounts Receivable
Accounts
receivables consisted of the following as of December 31:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
License
fees
|
$ | 1,624 | $ | 2,100 | ||||
|
Patient
fees receivable
|
348 | 282 | ||||||
|
Managed
care contracts
|
1,583 | 35 | ||||||
|
Other
|
29 | 21 | ||||||
|
Total
Receivables
|
3,584 | 2,438 | ||||||
|
Less
allowance for doubtful accounts
|
(1,350 | ) | (651 | ) | ||||
|
Total
Receivables, net
|
$ | 2,234 | $ | 1,787 | ||||
We use
the specific identification method for recording the provision for doubtful
accounts, which was $1.0 million, $528,000, and $281,000 for the years ended
December 31, 2008, 2007 and 2006, respectively. Accounts written off
against the allowance for doubtful accounts totaled $335,000 and $177,000
for the years ended December 31, 2008 and 2007, respectively. There were no
accounts written off against the allowance for doubtful accounts during the year
ended December 31, 2006.
Note
4. Property and Equipment
Depreciation
of property and equipment is recorded using the straight-line method, generally
over two to seven years. Leasehold improvements are amortized over
the term of the lease. Construction in progress is not depreciated
until the related asset is placed into service.
Property
and equipment consisted of the following as of December 31:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Furniture
and equipment
|
$ | 6,218 | $ | 6,363 | ||||
|
Leasehold
improvements
|
3,018 | 3,558 | ||||||
|
Total
Property and Equipment
|
9,236 | 9,921 | ||||||
|
Less
accumulated depreciation and amortization
|
(6,376 | ) | (5,630 | ) | ||||
|
Total
Property and Equipment, net
|
$ | 2,860 | $ | 4,291 | ||||
Depreciation
expense was $1.8 million, $1.5 million and $1.1 million for the years ended
December 31, 2008, 2007 and 2006, respectively.
In
accordance with SFAS 144, we performed an impairment test and re-evaluated the
recoverability of our property and equipment at December 31, 2008, determining
that no indication of impairment existed.
Note
5. Intangible Assets
Intangible
assets consist of intellectual property, managed care contracts and provider
networks associated with the CompCare acquisition. Intangible assets
are stated at cost, net of accumulated amortization. Intellectual
property consists primarily of the costs associated with acquiring certain
technology, patents, patents pending, know-how and related intangible assets
with respect to programs for treatment of dependence to alcohol, cocaine,
methamphetamine, and other addictive stimulants. Intellectual property is being
amortized on a straight-line basis from the date costs are incurred over the
remaining life of the respective patents or patent applications, which range
from 12 to 20 years. Other intangible assets are being amortized on a
straight-line basis from the date of acquisition over the remaining lives of the
managed care contracts to which they relate, which ranges from two to seven
years. As of December 31, 2008 and 2007, intangible assets were as
follows:
|
Amortization
Period
|
|||||||||
|
(Dollars
in thousands)
|
2008
|
2007
|
(in
years)
|
||||||
|
Intellectual
property (I/P)
|
$ | 4,508 | $ | 4,308 |
12
to 20
|
||||
|
Managed
care contracts
|
831 | 832 |
3
to 7
|
||||||
|
Provider
networks
|
1,305 | 1,305 |
2
to 3
|
||||||
|
Total
Intangibles
|
6,644 | 6,445 | |||||||
|
Less
accumulated amortization - I/P
|
(1,250 | ) | (832 | ) | |||||
|
Less
accumulated amortization - other
|
(1,495 | ) | (777 | ) | |||||
|
Accumulated
Amortization
|
(2,745 | ) | (1,609 | ) | |||||
|
Total
Intangibles, net
|
$ | 3,899 | $ | 4,836 | |||||
Amortization
expense for all intangible assets amounted to $1.0 million, $1.0 million and
$217,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Estimated amortization expense for intellectual property for the next five years
ending December 31, is as follows:
|
(Dollars
in thousands)
|
||||
|
Year
|
Amount
(1)
|
|||
|
2009
|
$ | 276 | ||
|
2010
|
276 | |||
|
2011
|
276 | |||
|
2012
|
276 | |||
|
2013
|
276 | |||
(1) Excludes
amortization for intangibles related to CompCare, which was sold on January
20, 2009.
PROMETA
Treatment Program
In
March 2003, we entered into a Technology Purchase and License Agreement
(Technology Agreement) with Tratamientos Avanzados de la Adicción
S.L. (Tavad), a Spanish corporation, to acquire, on an exclusive basis, all
of the rights, title and interest to use and/or sell the products and
services. In addition, the Technology Agreement gave us the right to
license the intellectual property owned by Tavad with respect to a method for
the treatment of alcohol and cocaine dependence, known as the PROMETA Treatment
Program, on a worldwide basis except in Spain (as amended in
September 2003). We have granted Tavad a security interest in the
intellectual property to secure the payments and performance obligations under
the Technology Agreement. As consideration for the intellectual property
acquired, we issued to Tavad approximately 836,000 shares of our common stock in
September 2003 at a fair market value of $2.50 per share, plus warrants to
purchase approximately 532,000 shares of our common stock at an exercise price
of $2.50 per share, valued at approximately $192,000. Warrants for 160,000
shares were exercisable at any time through September 29, 2008, and the
remaining warrants for 372,000 shares become exercisable equally over five years
and expire ten years from date of grant.
In
addition to the purchase price for the above intellectual property, we agreed to
pay a royalty fee to Tavad equal to three percent (3%) (six percent (6%) in
Europe) of gross revenues from the PROMETA Treatment Program using the acquired
intellectual property for so long as we (or any licensee) use the acquired
intellectual property. For purposes of the royalty calculations, gross
revenue is defined as all payments made by patients for the treatment, including
payments made to our licensees. Royalty fees, which totaled $231,000, $192,000
and $71,000 for the years ended December 31, 2008, 2007, and 2006, respectively,
are reflected in cost of services expense in the Consolidated Statements of
Operations as revenues are recognized.
In
October 2004, the Technology Agreement was amended (Amendment) to expand
the definition of “Processes,” limited to alcohol and cocaine in the original
agreement dated March 2003, to also include crack cocaine and methamphetamine
treatment processes, and the term “Intellectual Property” was expanded to
include all improvements through September 14, 2004. As consideration for
the Amendment, we paid $75,000 and issued 83,221 shares of our common stock,
valued at $354,000.
In May
2006, we issued 105,000 shares of our common stock valued at $738,000 to Tavad
as initial consideration for a further amendment to the Technology
Agreement. The amendment expands the definition of “Processes” to
include additional indications for the use of the PROMETA Treatment Program. The
amendment requires us to issue 35,000 shares for each indication for which we
file a patent application claim, plus an additional 50,000 shares for each
indication from which we derive revenues in the future.
Under the
Technology Agreement, we are obligated to allocate each year a minimum of 50% of
the funds we expend on sales, marketing, research and development to such
activities relating to the use of the intellectual property acquired. If we do
not expend at least the requisite percentage on such activities, Tavad has the
right to reclaim the intellectual property. We may terminate Tavad’s reversion
rights by making an additional payment of an amount which, taken together with
previously paid royalties and additional payments, would aggregate $1.0 million.
In 2006, 2007 and 2008 we met our obligations with respect to this
requirement.
The total
cost of the assets acquired, plus additional costs incurred by us related to
filing patent applications on such assets, have been reflected on our
Consolidated Balance Sheets in long-term assets as intangible assets. Related
amortization, which commenced on July 1, 2003, is being recorded on a
straight-line basis over a 20-year estimated useful life.
Patent
for Opiate Addiction Treatment
In
August 2003, we acquired a patent for a treatment method for opiate
addiction at a foreclosure sale held by Reserva Capital, LLC, a company owned
and controlled by our chief executive officer and majority shareholder. The
foreclosure sale was for purposes of satisfaction of debt owed to Reserva by
XINO, a medical technology development company. We paid approximately $314,000
in cash and agreed to issue 360,000 shares of our common stock to XINO at a
future date conditional upon the occurrence of certain events, including a full
release of claims by all of the technology development company’s
creditors.
In
December 2005, we evaluated our potential use of this patent and determined that
it would not likely be utilized in our current business plan. Accordingly, we
recorded an impairment charge of $272,000 in 2005 to write off the remaining
capitalized costs of intellectual property relating to this patent.
On August
8, 2007, we reached an agreement with XINO to release 310,000 of the 360,000
shares of our common stock previously issued to XINO. In consideration for a
full release from the stock pledge agreement, XINO relinquished 50,000 of the
previously issued shares and agreed not to sell or transfer any of its 310,000
shares through January 2008. We recorded the fair market value of the 310,000
shares issued as an additional impairment loss amounting to $2.4 million, based
on the closing stock price of $7.70 per share on August 8, 2007.
Other
Intangible Assets
In
accordance with SFAS 141, Business Combinations, the
purchase price for the CompCare acquisition was allocated to the fair values of
the assets acquired, including identifiable intangible assets, in accordance
with our proportionate share of ownership interest. These identified intangible
assets include the value of managed care contracts and marketing-related assets
associated with its managed care business, including the value of the healthcare
provider network and the professional designation from the NCQA. Such assets
will be amortized on a straight-line basis over their estimated remaining lives,
which approximates the rate at which we believe the economic benefits of these
assets will be realized.
In
accordance with SFAS 144, we performed an impairment test and re-evaluated the
useful lives and amortization methods on intellectual property and other
intangible assets as of December 31, 2008. We determined that no indication of
impairment existed and the estimated useful lives of intellectual property and
other intangible assets properly reflected the current remaining economic useful
lives of these assets.
Note
6. Debt Outstanding
Senior
Secured Note
On
January 17, 2007, in connection with the Woodcliff acquisition, we entered
into a securities purchase agreement pursuant to which we issued and sold to
Highbridge International LLC (Highbridge) a $10 million senior secured note and
a warrant to purchase up to approximately 250,000 shares of our common stock
(together, the financing). The note bears interest at a rate of prime plus 2.5%,
interest payable quarterly commencing on April 15, 2007 and matures on
January 15, 2010. The note was redeemable at our option anytime prior to
maturity and was originally redeemable at the option of Highbridge beginning on
July 18, 2008.
Total
original funds received of $10,000,000 were allocated to the warrant and the
senior secured note in the amounts of $1,380,000 and $8,620,000, respectively,
in accordance with their relative fair values as determined at the date of
issuance. The value allocated to the warrant was treated as a discount to the
note and was amortized to interest expense over the 18 month period between the
date of issuance (January 17, 2007) and the date that Highbridge first had the
right to redeem the note (July 18, 2008), using the effective interest method.
In addition, we paid a $150,000 origination fee and incurred approximately
$150,000 in other costs associated with the financing, which were allocated to
the warrant and senior secured note in accordance with the relative fair values
assigned to these instruments. The amount allocated to the senior secured note
was deferred and also amortized over the same 18 month period.
The
original warrant issued had a term of five years, and was initially exercisable
at $12.01 per share, or 120% of the $10.01 closing price of our common stock on
January 16, 2007. Pursuant to an anti-dilution adjustment clause in the
note, the exercise price of the warrant was adjusted to $10.52 per share and the
number of shares was adjusted to 285,185 as of December 31, 2007.
As
discussed more fully in Note 9 – Equity Financings, we entered
into a redemption agreement with Highbridge to redeem $5 million in principal
related to the senior secured note as part of our securities offering
completed on November 7, 2007. Included in the gross proceeds received on that
date was $5.35 million for the conversion of $5 million of the senior note,
which also included payment of $350,000 for an early redemption penalty, based
on a redemption price of 107% of the principal amount being redeemed pursuant to
the redemption agreement. The $350,000 was included as part of the reacquisition
cost of the notes and the difference between the
reacquisition
price and the net carrying amount of the principal amount redeemed was
recognized as a loss of $741,000 on extinguishment of debt in our statement of
operations during the year ended December 31, 2007.
On July
31, 2008, we amended the note to extend, from July 18, 2008 to July 18, 2009,
the optional redemption date exercisable by Highbridge for the $5 million
remaining under the Note, and remove certain restrictions on our ability to
obtain a margin loan on our ARS. In connection with this extension, we granted
Highbridge additional redemption rights in the event of certain strategic
transactions or other events generating additional liquidity for us, including,
without limitation, the conversion of some or all of our ARS into cash. We also
granted Highbridge a right of first refusal relating to the disposition of our
ARS and amended the existing warrant held by Highbridge for 285,185 shares of
our common stock at $10.52 per share. The amended warrant expires five years
from the amendment date and is exercisable for 1,300,000 shares of our common
stock at a price per share of $2.15, priced based on the $2.14 closing price of
our common stock on July 22, 2008. The warrant is subject to further adjustments
if we sell or are deemed to have sold shares at a price below the adjusted
exercise price per share, and will be proportionately adjusted for stock splits
or dividends. Similarly, if we were to issue convertible debt, the
anti-dilution adjustment would also be triggered should the conversion price be
less than its current price per share. The terms of the amended
warrant required that it be accounted for as a liability in accordance in EITF
00-19 and the fair value amounted to $1.8 million at the date of amendment. The
interest terms of the note remained unchanged at a rate of prime plus 2.5%,
which amounted to a current interest rate at December 31, 2008 of 7.0% and the
note is classified in short-term liabilities on our Consolidated Balance
Sheet.
Pursuant
to EITF 96-19, Debtor’s
Accounting for a Modification or Exchange of Debt Instruments, the
amended note was considered to have substantially different terms and the
amendment was accounted for in the same manner as a debt extinguishment. The
fair value of the amended debt was $1.7 million less than the carrying value of
the original debt, and the difference was recognized as a debt extinguishment
gain. The incremental fair value of the amended warrant compared to the original
warrant, treated as consideration granted by us for the amendment, amounted to
$1.7 million on the date of amendment and was accounted for as a debt
extinguishment loss since the amendment is being accounted for as a debt
extinguishment. The gain and loss on the debt extinguishment offset each other
and netted to a zero amount. The difference between the fair value and principal
amount of the amended debt, amounting to $1.7 million, is being treated as a
discount to the note and is being amortized to interest expense over a 12-month
period, until the July 18, 2009 optional redemption date. The warrant liability
was revalued at $107,000 at December 31, 2008, resulting in a $1.7 million
non-operating gain included in our Consolidated Statement of Operations for the
year ended December 31, 2008. We will continue to re-measure the amended
warrants at fair value each reporting period until it is completely settled or
expires.
The
senior secured note restricts any new debt offerings so that we are only able to
issue unsecured, subordinated debt so long as the principal payments are beyond
the maturity of the senior secured note (January 15, 2010), and the
interest rate is not greater than the senior secured note rate (Prime+2.5%). The
new debt cannot have call rights during the senior secured note term and
Highbridge must consent to the issuance of new debt.
In
connection with the financing, we entered into a security agreement granting
Highbridge a first-priority perfected security interest in all of our assets
owned at the date of the original note or acquired thereafter. We also entered
into a pledge agreement with Highbridge, as collateral agent, pursuant to which
we delivered equity interests evidencing 65% of our ownership of our foreign
subsidiaries. In the event of a default, the collateral agent is given broad
powers to sell or otherwise deal with the pledged collateral. There are no
material financial covenant provisions associated with the senior secured
note.
UBS
Line of Credit
In May
2008, our investment portfolio manager, UBS, provided us with a demand margin
loan facility collateralized by our ARS, which allowed us to borrow up to 50% of
the UBS-determined market value of our ARS.
In
October 2008, UBS made a “rights” offering to its clients, pursuant to which we
are entitled to sell our ARS to UBS. The rights permit us to require UBS to
purchase our ARS for a price equal to original par value plus any accrued but
unpaid interest beginning on June 30, 2010 and ending on July 2, 2012, if the
securities are not earlier redeemed or sold. As part of the offering, UBS would
provide us a line of credit (replacing the aforementioned margin loan), subject
to certain restrictions, equal to 75% of the market value of the ARS, until they
are purchased by UBS. We accepted the UBS offer on November 6,
2008.
As of
December 31, 2008, the outstanding balance on our line of credit was $5.7
million. The loan is subject to a rate of interest based upon the current 91-day
U.S. Treasury bill rate plus 120 basis points, payable monthly, and is
classified in short-term liabilities on our Consolidated Balance
Sheet.
CompCare
Debt
outstanding at December 31, 2008 also includes 7.5% convertible subordinated
debentures of CompCare with a remaining principal balance of $2,244,000. As part
of the acquisition-related purchase price allocation, an adjustment of $266,000
was made at the date of acquisition to reduce the carrying value of this debt to
its estimated fair value. This adjustment was treated as a discount and is being
amortized over the remaining contractual maturity term of the note (April 2010)
using the effective interest method.
On
September 3, 2008, CompCare entered into a purchase agreement with an investor,
in which it issued 200,000 shares of CompCare common stock and a $200,000
convertible promissory note for aggregate consideration of $250,000. The
promissory note matures August 31, 2011 and bears interest at the rate of 8.5%
per annum, payable monthly in arrears. The promissory note is convertible into
CompCare common stock at the rate of $0.25 per share.
The
following table shows the total principal amount, related interest rates and
maturities of debt outstanding as of December 31, 2008 and 2007:
|
(dollars
in thousands, except where otherwise noted)
|
2008
|
2007
|
||||||
|
Short-term
Debt
|
||||||||
|
Senior
secured note due January, 2010; callable by the holder on July 18,
2009;
|
||||||||
|
interest
payable quarterly at prime plus 2.5% (7.0% and 9.25% at December
31,
|
||||||||
|
2008
and 2007, respectively), $5 million principal; net of $899 and $258
unamortized
|
$ | 4,101 | $ | 4,742 | ||||
|
discount
at December 31, 2008 and 2007, respectively.
|
||||||||
|
UBS
line of credit, payable on demand, interest payable monthly at 91-day
T-bill
|
||||||||
|
rate
plus 120 basis points (1.675% at December 31, 2008)
|
5,734 | - | ||||||
|
Total
Short-term Debt
|
$ | 9,835 | $ | 4,742 | ||||
|
Long-term
Debt
|
||||||||
|
Convertible
promissory note due August 2011, interest payable monthly
(1)
|
$ | 200 | $ | - | ||||
|
Convertible
subordinated debentures due April 2010, interest payable
semi-annually
|
||||||||
|
at
7.5%, $2.2 million principal, net of $103 and $187 unamortized
discount
|
2,141 | 2,057 | ||||||
|
at
December 31, 2008 and 2007, respectively (2)
|
||||||||
|
Total
Long-term Debt
|
$ | 2,341 | $ | 2,057 | ||||
|
(1)
|
The
promissory note is convertible into 800,000 shares of common stock
of CompCare at a conversion price of $0.25 per
share.
|
|
(2)
|
At
December 31, 2008, the debentures are convertible into 15,873 shares of
common stock of CompCare at a conversion price of $141.37 per
share.
|
Note
7. Capital Lease Obligations
We lease
certain furniture and computer equipment under agreements entered into during
2006, 2007 and 2008 that are classified as
capital leases. The cost of furniture and computer equipment under capital
leases is included in the Consolidated Balance Sheets in furniture and equipment
and was $692,000 at December 31, 2008. Accumulated depreciation of the leased
equipment at December 31, 2008 was approximately $430,000.
The
future minimum lease payments required under the capital leases and the present
values of the net minimum lease payments, as of December 31, 2008, are as
follows:
|
(Dollars
in thousands)
|
Amount
|
|||
|
Year
Ending December 31,
|
||||
|
2009
|
$ | 191 | ||
|
2010
|
98 | |||
|
2011
|
62 | |||
|
Total
minimum lease payments
|
351 | |||
|
Less
amounts representing interest
|
(41 | ) | ||
|
Capital
Lease Obligations, net of interest
|
310 | |||
|
Less
current maturities of capital lease obligations
|
(166 | ) | ||
|
Long-term
Capital Lease Obligations
|
$ | 144 | ||
Note
8. Income Taxes
As of
December 31, 2008, we had net federal operating loss carryforwards and state
operating loss carryforwards of approximately $126.4 million and
$118.1 million, respectively. The net federal operating loss carryforwards begin
to expire in 2023 and the net state operating loss carryforwards begin to expire
in 2013. Foreign net operating loss carryforwards were approximately
$6.4 million,
virtually all of which will expire over the next seven years.
The
primary components of temporary differences which give rise to our net deferred
tax assets are as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Federal,
state and foreign net operating losses
|
$ | 49,810 | $ | 39,542 | $ | 25,454 | ||||||
|
Stock-based
compensation
|
3,646 | 3,259 | 2,810 | |||||||||
|
Accrued
liabilities
|
362 | 746 | 481 | |||||||||
|
Other
temporary differences
|
(1,866 | ) | (666 | ) | 1,212 | |||||||
|
Valuation
allowance
|
(51,952 | ) | (42,881 | ) | (29,957 | ) | ||||||
| $ | - | $ | - | $ | - | |||||||
We have
provided a valuation allowance in full on net deferred tax assets, in accordance
with SFAS No. 109, Accounting
for Income Taxes. Because of our continued losses, management
assessed the realizability of the Company’s net deferred tax assets as being
less than the "more-likely-than-not"
criterion set forth by SFAS No. 109. Furthermore, Section 382 of the
Internal Revenue Code limits the use of net operating loss and tax credit
carryforwards in certain situations where changes occur in the stock ownership
of a company. In the event we have a change in ownership, utilization of
the carryforward could be restricted. We have not provided deferred taxes on
less than 80% owned subsidiaries or investments accounted for under FIN 46R, as
those investments have accumulated book losses and we do not believe we can
realize those losses for tax purposes in the foreseeable future.
A
reconciliation between the statutory federal income tax rate and the effective
income tax rate for the years ended December 31 is as follows:
|
2008
|
2007
|
||
|
Federal
statutory rate
|
-34.0%
|
-34.0%
|
|
|
Share-based
compensation
|
4.8%
|
0.0%
|
|
|
State
taxes
|
-1.8%
|
-4.4%
|
|
|
Other
|
1.2%
|
1.6%
|
|
|
Nondeductible
goodwill
|
8.0%
|
0.0%
|
|
|
Change
in valuation allowance
|
21.9%
|
36.8%
|
|
|
Effective
Rate
|
0.1%
|
0.0%
|
In
June 2006, the FASB issued 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 de-recognition,
classification, interest and penalties, accounting in interim periods and
disclosure. The provisions of FIN 48 are effective for years beginning after
December 15, 2006. We adopted FIN 48 on January 1, 2007 with no impact to our
consolidated financial statements. We file income tax returns in the U.S.
federal jurisdiction and various state and foreign jurisdictions. Tax years that
remain subject to examinations by tax authorities are 2004 through
2007. The federal and material foreign jurisdictions statutes of
limitations begin to expire in 2009. There are no current income tax
audits in any jurisdictions for open tax years and, as of December 31, 2008,
there have been no material changes to our FIN 48 position.
Note
9. Equity Financings
In
December 2006, we issued 3,573,000 shares of common stock at a price of
$7.30 per share in a private placement for a total of $26.1 million in proceeds.
We paid approximately $1.8 million in fees to placement agents and for
other transaction costs.
In
November 2007, we entered into securities purchase agreements with select
institutional investors in a registered direct placement, in which we issued an
aggregate of 9,635,000 shares of common stock at a price of $4.79 per share, for
gross proceeds of approximately $46.2 million. We also issued five-year
warrants to purchase an aggregate of approximately 2.4 million additional
shares of our common stock at an exercise price of $5.75 per share. The fair
value of the warrants at the date of issuance was estimated at $6.3 million
and was accounted for as a liability pursuant to EITF 00-19. We incurred $3.2
million in fees to placement agents and other offering expenses in connection
with the transaction. Included in the gross proceeds was $5.35 million from
the conversion of $5.0 million of the senior secured notes issued to Highbridge,
pursuant to a redemption agreement entered into with Highbridge on November 7,
2007. See Note 6 - Debt
Outstanding.
We had no
equity financings during 2008.
Note
10. Share-based Compensation
The
Hythiam, Inc. 2003 and 2007 Stock Incentive Plans (the Plans) provide for the
issuance of up to 15 million shares of our common stock. Incentive stock
options (ISOs), under Section 422A of the Internal Revenue Code,
non-qualified options (NSOs), stock appreciation rights, limited stock
appreciation rights and restricted stock grants are authorized under the Plans.
We grant all such share-based compensation awards at no less than the fair
market value of our stock on the date of grant, and have granted stock and stock
options to executive officers, employees, members of our Board of Directors and
certain outside consultants. The terms and conditions upon which options become
exercisable vary among grants; however, option rights expire no later than ten
years from the date of grant and employee and board of director awards generally
vest over three to five years on a straight-line basis. At December
31, 2008, we had 10,355,000 vested and unvested stock options outstanding and
4,042,000 shares reserved for future awards. Total share-based compensation
expense amounted to $9.2 million, $2.6 million and $3.7 million for the years
ended December 31, 2008, 2007 and 2006. The
expense in 2008 includes $596,000 related to costs associated with streamlining
our operations. See Note 1 – Significant Accounting
Policies.
Stock
Options – Employees and Directors
During
2008, 2007 and 2006, we granted options to employees and directors for
5,427,000, 732,000 and 1,657,000 shares, respectively, at the weighted average
per share exercise prices of $2.27, $7.08 and $6.27, respectively, the fair
market value of our common stock on the dates of grants. The
estimated fair value of options granted to employees and directors during 2008,
2007 and 2006 was $8.0 million, $3.3 million and $6.6 million, respectively,
calculated using the Black-Scholes pricing model with the assumptions described
in Note 1 – Summary of
Significant Accounting Policies, Share-based Compensation.
Stock
option activity for employees and directors grants is summarized as
follows:
|
Weighted
Avg.
|
||||||||
|
Shares
|
Exercise
Price
|
|||||||
|
Balance,
December 31, 2005
|
4,898,000 | $ | 3.78 | |||||
|
2006
|
||||||||
|
Granted
|
1,657,000 | 6.27 | ||||||
|
Exercised
|
(80,000 | ) | 3.75 | |||||
|
Cancelled
|
(647,000 | ) | 5.34 | |||||
|
Balance,
December 31, 2006
|
5,828,000 | 4.32 | ||||||
|
2007
|
||||||||
|
Granted
|
732,000 | 7.08 | ||||||
|
Transferred
*
|
(695,000 | ) | 5.10 | |||||
|
Exercised
|
(483,000 | ) | 3.14 | |||||
|
Cancelled
|
(230,000 | ) | 6.47 | |||||
|
Balance,
December 31, 2007
|
5,152,000 | 4.61 | ||||||
|
2008
|
||||||||
|
Granted
|
5,427,000 | 2.27 | ||||||
|
Transferred
*
|
(970,000 | ) | 3.55 | |||||
|
Exercised
|
- | - | ||||||
|
Cancelled
|
(1,349,000 | ) | 5.29 | |||||
|
Balance,
December 31, 2008
|
8,260,000 | 3.07 | ||||||
* Options
transferred due to status changes from employee to non-employee.
The
weighted average remaining contractual life and weighted average exercise price
of options outstanding as of December 31, 2008 were as follows:
|
Options
Outstanding
|
Options
Exercisable
|
|||||||||||||||||||||
|
Weighted
|
||||||||||||||||||||||
|
Average
|
Weighted
|
Weighted
|
||||||||||||||||||||
|
Range
of
|
Remaining
|
Average
|
Average
|
|||||||||||||||||||
|
Exercise
Prices
|
Shares
|
Life
(yrs)
|
Price
|
Shares
|
Price
|
|||||||||||||||||
| $ | 0.51 to $1.50 | 850,000 | 9.8 | $ | 0.60 | 24,000 | $ | 0.62 | ||||||||||||||
| $ | 1.51 to $2.50 | 1,280,000 | 6.5 | 2.36 | 857,000 | 2.48 | ||||||||||||||||
| $ | 2.51 to $3.50 | 4,506,000 | 7.1 | 2.67 | 2,484,000 | 2.69 | ||||||||||||||||
| $ | 3.51 to $4.50 | 61,000 | 7.7 | 4.06 | 26,000 | 4.16 | ||||||||||||||||
| $ | 4.51 to $5.50 | 557,000 | 7.6 | 4.77 | 223,000 | 4.77 | ||||||||||||||||
| $ | 5.51 to $6.50 | 366,000 | 6.7 | 6.20 | 267,000 | 6.12 | ||||||||||||||||
| $ | 6.51 to $7.50 | 378,000 | 7.0 | 7.26 | 212,000 | 7.27 | ||||||||||||||||
| $ | 7.51 to $8.50 | 258,000 | 4.7 | 7.90 | 183,000 | 7.89 | ||||||||||||||||
| $ | 8.51 to $9.50 | 4,000 | 8.0 | 9.20 | 4,000 | 9.20 | ||||||||||||||||
| 8,260,000 | 7.2 | 3.09 | 4,280,000 | 3.42 | ||||||||||||||||||
At
December 31, 2008 and 2007, the number of options exercisable was 2,701,000 and
2,419,000, respectively, at weighted-average exercise prices of $3.64 and $3.76,
respectively.
Share-based
compensation expense relating to stock options granted to employees and
directors was $7.2 million, $2.4 million and $2.3 million for the years ended
December 31, 2008, 2007 and 2006, respectively.
As of
December 31, 2008, there were $10.3 million of unrecognized compensation costs
related to non-vested share-based compensation arrangements granted under the
Plans. These costs are expected to be recognized over a weighted-average period
of 3.9 years.
Stock
Options and Warrants – Non-employees
In
addition to stock options granted under the Plans, we have also granted options
and warrants to purchase our common stock to certain non-employees that have
been approved by our Board of Directors. During 2008, 2007 and 2006,
we granted options and warrants for 190,000, 65,000 and 368,000 shares,
respectively.
Stock
option and warrant activity for non-employee grants for services is summarized
as follows:
|
Weighted
Avg.
|
||||||||
|
Shares
|
Exercise
Price
|
|||||||
|
Balance,
December 31, 2005
|
1,383,000 | $ | 3.14 | |||||
|
2006
|
||||||||
|
Granted
|
368,000 | 4.96 | ||||||
|
Exercised
|
(623,000 | ) | 2.53 | |||||
|
Cancelled
|
(372,000 | ) | 3.78 | |||||
|
Balance,
December 31, 2006
|
756,000 | 4.22 | ||||||
|
2007
|
||||||||
|
Granted
|
65,000 | 7.47 | ||||||
|
Transfered
*
|
695,000 | 5.10 | ||||||
|
Exercised
|
(104,000 | ) | 4.57 | |||||
|
Cancelled
|
(42,000 | ) | 6.24 | |||||
|
Balance,
December 31, 2007
|
1,370,000 | 4.73 | ||||||
|
2008
|
||||||||
|
Granted
|
190,000 | 2.59 | ||||||
|
Transfered
*
|
970,000 | 3.55 | ||||||
|
Exercised
|
- | - | ||||||
|
Cancelled
|
(435,000 | ) | 5.13 | |||||
|
Balance,
December 31, 2008
|
2,095,000 | 3.91 | ||||||
|
* Options
transferred due to status changes from employee to
non-employee.
|
Stock
options and warrants granted to non-employees for services (inclusive of
warrants issued for intellectual property, a debt agreement and equity
offerings) outstanding at December 31, 2008 are summarized as
follows:
|
Weighted
|
||||||||||||
|
Average
|
Weighted
|
|||||||||||
|
Remaining
|
Average
|
|||||||||||
|
Contractual
|
Exercise
|
|||||||||||
|
Description
|
Shares
|
Life
(yrs)
|
Price
|
|||||||||
|
Warrants
issued for intellectual property
|
372,000 | 4.7 | $ | 2.50 | ||||||||
|
Warrants
issued in connection with equity offering
|
2,511,000 | 3.7 | 5.63 | |||||||||
|
Warrants
issued in connection with debt agreement
|
1,300,000 | 4.3 | 2.15 | |||||||||
|
Options
and warrants issued to consultants
|
2,095,000 | 5.5 | 3.91 | |||||||||
| 6,278,000 | 4.5 | 4.15 | ||||||||||
Share-based
expense relating to stock options and warrants granted to non-employees amounted
to $176,000, ($14,000) and $1.2 million for 2008, 2007 and 2006,
respectively. At December 31, 2008, unvested options and warrants had
an estimated value of approximately $72,000, using the Black-Scholes pricing
model.
Common
Stock
During
2008, 2007 and 2006, we issued 601,000, 30,000 and 51,000 shares of common
stock, respectively, for consulting services valued at $1.7 million, $231,000
and $326,000, respectively. Generally, these costs are amortized to share-based
expense on a straight-line basis over the related service periods, generally
ranging from six months to one year. Share-based expense relating to all common
stock issued for consulting services was $1.7 million, $118,000 and $229,000 in
2008, 2007 and 2006, respectively.
Employee
Stock Purchase Plan
In June
2006, we adopted a qualified employee stock purchase plan (ESPP), approved by
our Board of Directors and shareholders, which provides that eligible employees
(employed at least 90 days) have the option to purchase shares of our common
stock at a price equal to 85% of the lesser of the fair market value as of the
first day or the last day of each offering period. Purchase options are granted
semi-annually and are limited to the number of whole shares that can be
purchased by an amount equal to up to 10% of a participant’s annual base
salary. As of December 31, 2008, there were 56,000 shares of our
common stock issued pursuant to the ESPP. Share-based expense relating to the
ESPP was $4,000, $15,000 and $4,000 for the years ended December 31, 2008, 2007
and 2006, respectively.
Stock
Options – CompCare Employees, Directors and Consultants
Stock
Option Plans
CompCare
issues stock options to its employees and non-employee directors allowing them
to purchase CompCare’s common stock, pursuant to shareholder-approved stock
option plans. CompCare currently has two active incentive plans, the
1995 Incentive Plan and the 2002 Incentive Plan (the CompCare Plans), that
provide for the granting of stock options, stock appreciation rights, limited
stock appreciation rights, and restricted stock grants to eligible employees and
consultants. Grants issued under the CompCare Plans may qualify as ISOs under
Section 422A of the Internal Revenue Code. Options for ISOs may be
granted for terms of up to ten years and are generally exercisable in cumulative
increments of 50% each six months. The exercise price for ISOs must
equal or exceed the fair market value of the shares on the date of
grant. The CompCare Plans also provide for the full vesting of all
outstanding options under certain change of control events. The
maximum number of shares authorized for issuance is 1,000,000 under the 2002
Incentive Plan and 1,000,000 under the 1995 Incentive Plan. As of December 31,
2008, under the 2002 Incentive Plan, there were 422,000 options available for
grant and 538,000 options outstanding, of which 306,000 were
exercisable. Additionally, as of December 31, 2008, under the 1995
Incentive Plan, there were 185,000 options outstanding and
exercisable. There are no further options available for grant under
the 1995 Incentive Plan.
CompCare
also has a non-qualified stock option plan for its non-employee directors. Each
non-qualified stock option is exercisable at a price equal to the average of the
closing bid and ask prices of the common stock in the over-the-counter market
for the most recent preceding day there was a sale of the stock prior to the
grant date. Grants of options vest in accordance with vesting schedules
established by CompCare’s Board of Director’s Compensation and Stock Option
Committee. Upon joining the board, directors receive an initial grant
of 25,000 options. Annually, directors are granted 15,000 options on
the date of CompCare’s annual meeting. As of December 31, 2008, under
the CompCare directors’ plan, there were 777,000 shares available for option
grants and 125,000 options outstanding and exercisable.
CompCare’s
stock option activity for the year ended December 31, 2008 and period January 13
through December 31, 2007 was as follows:
|
Weighted
Avg.
|
||||||||
|
Shares
|
Exercise
Price
|
|||||||
|
Balance,
January 12, 2007
|
1,166,000 | $ | 1.32 | |||||
|
2007(January
13 to December 31)
|
||||||||
|
Granted
|
145,000 | 1.05 | ||||||
|
Exercised
|
(37,000 | ) | 0.51 | |||||
|
Cancelled
|
(204,000 | ) | 1.82 | |||||
|
Balance,
December 31, 2007
|
1,070,000 | 1.23 | ||||||
|
2008
|
||||||||
|
Granted
|
300,000 | 0.54 | ||||||
|
Exercised
|
(125,000 | ) | 0.26 | |||||
|
Cancelled
|
(398,000 | ) | 1.85 | |||||
|
Balance,
December 31, 2008
|
847,000 |
(a)
|
0.88 | |||||
|
(a) Includes
615,000 options exercisable at 12/31/08.
|
||||||||
The
following table summarizes information about options granted, exercised and
vested for the year ended December 31, 2008 and period January 13 through
December 2007.
|
January
13
|
||||||||
|
through
|
||||||||
|
December
31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Options
granted
|
300,000 | 145,000 | ||||||
|
Weighted-average
grant-date fair value
|
$ | 0.47 | $ | 0.76 | ||||
|
Options
exercised
|
125,000 | 37,000 | ||||||
|
Total
intrinsic value of exercised options
|
$ | 50,000 | $ | 13,000 | ||||
|
Fair
value of vested options
|
$ | 132,000 | $ | 78,000 | ||||
Stock
options were granted to CompCare Board of Director members and certain employees
during the years ended December 31, 2008 and 2007. Options exercised
during the years ended December 31, 2008 and 2007, were 125,000 and 37,000,
respectively. Total intrinsic value of exercised options during the
years ended December 31, 2008 and 2007 was $50,000 and $13,000,
respectively. During the year ended December 31, 2008, 398,000 of
stock options expired unexercised. These options had been granted to
employees and officers.
At
December 31, 2008, there was approximately $65,000 of total unrecognized
compensation cost related to unvested options, which was recognized in January
2009 due to accelerated vesting provisions triggered a change in
control. Total recognized compensation costs during the year ended
December 31, 2008 were approximately $130,000. Sale discussed in Note
15 – Subsequent
Events. CompCare recognized approximately $19,000 of tax
benefits attributable to stock-based compensation expense recorded during the
year ended December 31, 2008. This benefit was fully offset by a
valuation allowance of the same amount due to the likelihood of future
realization.
A summary
of options outstanding and exercisable as of December 31, 2008 is as
follows:
|
Options
Outstanding
|
Options
Exercisable
|
|||||||||||||||||||||
|
Weighted
|
||||||||||||||||||||||
|
Average
|
Weighted
|
Weighted
|
||||||||||||||||||||
|
Range
of
|
Remaining
|
Average
|
Average
|
|||||||||||||||||||
|
Exercise
Prices
|
Shares
|
Life
(yrs)
|
Price
|
Shares
|
Price
|
|||||||||||||||||
| $ | 0.25 to $0.39 | 66,000 | 2.09 | $ | 0.27 | 66,000 | $ | 0.27 | ||||||||||||||
| $ | 0.43 to $0.43 | 100,000 | 9.31 | 0.43 | 50,000 | 0.43 | ||||||||||||||||
| $ | 0.51 to $0.52 | 52,000 | 3.06 | 0.51 | 52,000 | 0.51 | ||||||||||||||||
| $ | 0.55 to $0.55 | 100,000 | 9.04 | 0.55 | - | - | ||||||||||||||||
| $ | 0.56 to $0.56 | 95,000 | 0.52 | 0.56 | 95,000 | 0.56 | ||||||||||||||||
| $ | 0.65 to $0.66 | 90,000 | 9.17 | 0.66 | 7,000 | 0.65 | ||||||||||||||||
| $ | 0.78 to $1.10 | 56,000 | 7.10 | 0.96 | 56,000 | 0.96 | ||||||||||||||||
| $ | 1.11 to $1.11 | 100,000 | 8.50 | 1.11 | 100,000 | 1.11 | ||||||||||||||||
| $ | 1.40 to $1.78 | 133,000 | 5.80 | 1.62 | 133,000 | 1.62 | ||||||||||||||||
| $ | 1.80 to $2.16 | 55,000 | 6.16 | 1.98 | 56,000 | 1.98 | ||||||||||||||||
| $ | 0.25 to $2.16 | 847,000 | 6.33 | 0.88 | 615,000 | 1.00 | ||||||||||||||||
Warrants
CompCare
periodically issues warrants to purchase common stock as compensation for the
services of consultants and marketing employees. At December 31, 2008,
306,000 warrants were outstanding, having been issued in prior years to two
consultants and two employees as compensation for introducing strategic
business partners to the Company. All such warrants have five-year
terms. No warrants were issued during the year ended December 31, 2008 and
the period January 13, 2007 to December 31, 2007.
Note
11. Segment Information
We manage
and report our operations through two business segments: healthcare services and
behavioral health managed care services.
Our
healthcare services segment provides our Catasys integrated substance
dependence, autism and ADHD solutions to health plans, employers and unions
through a network of licensed and company managed healthcare providers, and
provides licensing, administrative and management services to licensees that
administer PROMETA and other treatment programs, including managed treatment
centers that are licensed and/or managed by us.
Our
healthcare services segment also comprises international and government sector
operations; however, these operating segments are not separately reported as
they do not meet any of the quantitative thresholds under SFAS 131, Disclosures about Segments of an
Enterprise and Related Information.
The
behavioral health managed care services segment is comprised entirely of the
operations of our consolidated subsidiary, CompCare, and provides managed care
services in the behavioral health, psychiatric and substance abuse fields.
Most of our consolidated revenues and assets are earned or located within
the United States.
We
evaluate segment performance based on total assets, revenues and net income or
loss before taxes. Our assets are included within each discrete reporting
segment. In the event that any services are provided to one reporting segment by
the other, the transaction is valued at the market price. No such services were
provided during the years ended December 31, 2008 and 2007.
Summary
financial information for our two reportable segments is as
follows:
|
(Dollars
in thousands)
|
Year
Ended December 31,
|
|||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Behavioral health managed care
services (1)
|
||||||||||||
|
Revenues
|
$ | 35,156 | $ | 36,306 | $ | - | ||||||
|
Loss
before provision for income taxes
|
(6,139 | ) | (4,105 | ) | - | |||||||
|
Assets
*
|
4,747 | 8,896 | - | |||||||||
|
Healthcare
services
|
||||||||||||
|
Revenues
|
$ | 6,074 | $ | 7,695 | $ | 3,906 | ||||||
|
Loss
before provision for income taxes
|
(44,252 | ) | (41,270 | ) | (38,296 | ) | ||||||
|
Assets
*
|
27,119 | 61,750 | 52,205 | |||||||||
|
Consolidated
operations
|
||||||||||||
|
Revenues
|
$ | 41,230 | $ | 44,001 | $ | 3,906 | ||||||
|
Loss
before provision for income taxes
|
(50,391 | ) | (45,375 | ) | (38,296 | ) | ||||||
|
Total
assets *
|
31,866 | 70,646 | 52,205 | |||||||||
|
*
|
Assets
are reported as of December
31.
|
|
(1)
|
2007
results for this segment are for the period January 13 through December
31, 2007.
|
Note
12. Major Customers/Contracts
Our Santa
Monica (California) PROMETA Center accounted for approximately 15%, 18% and
29% of healthcare services revenues, and 2%, 3% and 29% of consolidated revenues
in 2008, 2007 and 2006, respectively. In 2008, the Dallas (Texas) PROMETA Center
accounted for approximately 17% of healthcare services revenues, and 3% of
consolidated revenues. No other licensee or managed medical practice
accounted for over 10% of healthcare services or consolidated revenues in 2008,
2007 or 2006.
Typically,
CompCare’s contracts provide for an initial one-year term with automatic annual
extensions. Such contracts generally provide for cancellation by
either party with 60 to 90 days written notice.
Effective
December 31, 2008, CompCare ceased providing behavioral health services to
approximately 11,000 members of a Medicare Advantage HMO in the state of
Maryland. CompCare had previously served 39,000 of this HMO’s members
in Pennsylvania until the contract for the membership in this state ended on
July 31, 2008, due to the HMO’s selection of another behavioral health
vendor. Services provided to members in both states accounted for
$6.1 million, or 17.3%, and $5.5 million, or 14.7% of CompCare’s operating
revenues for the years ended December 31, 2008 and 2007,
respectively.
In
December 2008, CompCare experienced the loss of a major contract to provide
behavioral healthcare services to approximately 278,000 Medicaid recipients in
Indiana. The contract generated $17.8 million, or 50.6%, and $15.0
million, or 40.2% of CompCare revenues for the years ended December 31, 2008 and
2007, respectively.
CompCare
currently furnishes behavioral healthcare services to approximately 243,000
members of a health plan providing Medicaid, Medicare, and children’s health
insurance plans (CHIP) benefits in Michigan, Texas and
California. Services are provided on a fee-for-service and ASO
basis. The contracts accounted for $3.7 million, or 10.6%, and $4.3
million, or 11.6%, of CompCare revenues for the years ended December 31, 2008
and 2007, respectively. The health plan has been a customer since June of
2002. The initial contract was for a one-year period and has been
automatically renewed on an annual basis. Termination by either party
may occur with 90 day written notice to the other party.
Note
13. Commitments and Contingencies
Operating
Lease Commitments
We
incurred rent expense of approximately $1.4 million, $1.4 million, and $0.9
million for the years ended December 31, 2008, 2007 and 2006, respectively.
In September 2003, we signed a lease agreement for our
corporate
offices at an initial lease cost of approximately $33,000 per month, with
increases scheduled annually over the lease term. The term of the lease is seven
years, commencing December 15, 2003, and includes a right to extend the
lease for an additional five years. In April 2005 we amended the lease to
expand our corporate office facilities at an additional base rent of
approximately $11,000 per month, subject to annual adjustment over the remaining
term. In September 2008, the lease was amended once more, concurrent
with our restructuring, to include an additional 2,000 square feet in office
space and an increase in monthly base rent of approximately
$10,000. The new rent is similarly scheduled to increase annually
over the remaining term of the lease. As a condition to the lease
agreement, we secured a letter of credit collateralized by a certificate of
deposit at the current amount of $87,000 for the landlord as a security deposit.
The letter of credit is included in deposits and other assets in the
Consolidated Balance Sheets as of December 31, 2008.
In April
2005 we entered into a five year lease for approximately 5,400 square feet of
medical office space at an initial base rent of approximately $19,000 per month,
commencing in August 2005. The space is occupied by The PROMETA
Center, a managed medical practice, under a full business service management
agreement. As a condition to signing the lease, we secured a $90,000
letter of credit for the landlord as a security deposit, which, as of October
2008, has been subsequently reduced to $45,000. The letter of credit is
collateralized by a certificate of deposit in the amount of $45,000, which is
included in deposits and other assets in the Consolidated Balance Sheet as of
December 31, 2008.
In August
2006, we entered into a 62-month lease for 4,000 square feet of medical office
space, located in San Francisco, California, at an initial base rent of
approximately $11,000 per month, commencing in January 2007. The
space was occupied by the PROMETA Center through January 31, 2008 under an
amendment to our management service agreement. We are currently seeking to
sublease the vacant space.
In
connection with a management services agreement that we executed with a medical
professional corporation in Dallas, Texas, we assumed the obligation for two
lease agreements at a current combined amount of approximately $9,000 per month,
which expires in May 2011.
In
November 2006, we entered into a five-year lease for office space in Switzerland
at an initial base rent of 4,052 Swiss Francs per month (approximately US$3,800
using the December 31, 2008 conversion rate).
CompCare
leases certain office space and equipment. The Texas office lease
contains escalation clauses based on the Consumer Price Index and provisions for
payment of real estate taxes, insurance and maintenance and repair
expenses. Total rental expense for all operating leases was $259,000
and $269,000, respectively, for the years ended December 31, 2008 and
2007.
Rent
expense is calculated using the straight-line method based on the total minimum
lease payments over the initial term of the lease. Landlord tenant improvement
allowances and rent expense exceeding actual rent payments are accounted for as
deferred rent liability in the balance sheet and amortized on a straight-line
basis over the initial term of the respective leases.
Future
minimum payments, by year and in the aggregate, under non-cancelable operating
leases with initial or remaining terms of one year or more, consist of the
following at December 31, 2008:
|
(Dollars
in thousands)
|
||||
|
Year
Ending December 31,
|
Amount
|
|||
|
2009
|
$ | 1,756 | ||
|
2010
|
1,955 | |||
|
2011
|
251 | |||
|
2012
|
15 | |||
| $ | 3,977 | (a) | ||
|
(a)
|
Includes
approximately $1.1 million related to CompCare operating
leases. We sold our interest in CompCare on January 10,
2009.
|
Clinical
Research Commitments
In 2006
and 2007, we committed to a number of unrestricted grants for clinical research
studies by preeminent researchers in the field of substance dependence and
leading research institutions to evaluate the efficacy of our PROMETA Treatment
Program in treating alcohol and stimulant dependence. As of December 31, 2008,
we had approximately $2.7 million committed to such clinical research
studies. We anticipate that approximately $1.4 million and $1.3
million will be paid in 2009 and 2010, respectively.
Other
Commitments and Contingencies
Related
to CompCare’s discontinued hospital operations, Medicare guidelines allow the
Medicare fiscal intermediary to re-open previously filed cost
reports. CompCare’s fiscal 1999 cost report, the final year CompCare
was required to file a cost report, is being reviewed, in which case the
intermediary may determine that additional amounts are due to or from
Medicare. CompCare management believes cost reports for fiscal years
prior to fiscal 1999 are closed and considered final.
CompCare
has insurance for a broad range of risks as it relates to CompCare’s business
operations. CompCare maintains managed care errors and omissions,
professional and general liability coverage. These policies are
written on a claims-made basis and are subject to a $10,000 per claim
self-insured retention. The managed care errors and omissions and
professional liability policies include limits of liability of $1 million per
claim and $3 million in the aggregate. The general liability has a limit of
liability of $5 million per claim and $5 million in the aggregate. CompCare is
responsible for claims within the self-insured retentions or if the policy
limits are exceeded. CompCare management is not aware of any claims
that could have a material adverse impact on their 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 December 31, 2008, we
were not involved in any legal proceeding that we believe would have a material
adverse effect on our business, financial condition or operating
results.
Note
14. Related Party Transactions
Andrea
Grubb Barthwell, M.D., a member of our Board of Directors, is the founder and
chief executive officer of a healthcare and policy consulting firm providing
consulting services to us. In 2008, 2007 and 2006 we paid or accrued
approximately $4,000, $156,000 and $189,000, respectively, in fees to the
consulting firm.
There
were no other material related party transactions in 2008, 2007 or
2006.
Note
15. Subsequent Events (Unaudited)
Pursuant
to a Stock Purchase Agreement between WoodCliff (our wholly-owned subsidiary)
and Core Corporate Consulting Group, Inc., dated January 14, 2009, and effective
as of January 20, 2009, we have disposed of our entire interest in our
majority-owned, controlled subsidiary CompCare, consisting of 14,400 shares of
Class A Series Preferred Stock, and 1,739,130 shares of common stock of CompCare
held by Woodcliff, for aggregate gross proceeds of $1.5 million.
We expect
to recognize a gain of approximately $11.2 million from the sale of our CompCare
interest, which will be included in our Consolidated Statement of Operations for
the three month period ending March 31, 2009. The following is a
summary of the net assets sold on the closing date of January 20,
2009:
|
(Dollars
in thousands)
|
At
January 20, 2009
|
|||
|
Cash
and cash equivalents
|
$ | 523 | ||
|
Other
current assets
|
940 | |||
|
Property
and equipment, net
|
230 | |||
|
Goodwill
|
403 | |||
|
Intangible
assets
|
608 | |||
|
Other
non-current assets
|
230 | |||
|
Total
assets
|
2,934 | |||
|
Accounts
payable and accrued liabilities
|
(2,065 | ) | ||
|
Accrued
claims payable
|
(5,637 | ) | ||
|
Accrued
reinsurance claims payable
|
(2,527 | ) | ||
|
Long-term
capital lease obligation
|
(2,346 | ) | ||
|
Other
liabilities
|
(63 | ) | ||
|
Total
liabilities
|
(12,638 | ) | ||
|
Net
assets (liabilities) of discontinued operations
|
$ | (9,704 | ) | |
In
accordance with FAS 144, CompCare’s results of operations will be presented as
Income from Discontinued Operations, and its assets and liabilities will be
separately classified as relating to discontinued operations beginning in the
Quarterly Report on Form 10-Q for the three months ended March 31,
2009.
Note
16. Interim Financial Information (Unaudited)
Summarized
quarterly supplemental financial information is as follows:
|
Quarter
Ended
|
Total
|
|||||||||||||||||||||
|
March
|
June
|
September
|
December
|
Year
|
||||||||||||||||||
|
(Dollars
in thousands, except per share amounts)
|
||||||||||||||||||||||
|
2008
|
||||||||||||||||||||||
|
Revenues
|
$ | 11,339 | $ | 11,613 | $ | 9,658 | $ | 8,620 | $ | 41,230 | ||||||||||||
|
Loss
from operations
|
(13,074 | ) |
(a)
|
(12,659 | ) |
(a)
|
(9,443 | ) |
(a)
|
(18,427 | ) |
(a)
|
(53,603 | ) | ||||||||
|
Net
loss
|
(10,711 | ) |
(a)
|
(14,093 | ) |
(a)
|
(6,277 | ) |
(a)(b)
|
(19,337 | ) |
(a)(b)
|
(50,418 | ) | ||||||||
|
Basic
and diluted loss per share
|
$ | (0.20 | ) |
(a)
|
$ | (0.26 | ) |
(a)
|
$ | (0.11 | ) |
(a)(b)
|
$ | (0.35 | ) |
(a)(b)
|
$ | (0.92 | ) | |||
|
2007
|
||||||||||||||||||||||
|
Revenues
|
$ | 8,857 | $ | 11,340 | $ | 12,020 | $ | 11,784 | $ | 44,001 | ||||||||||||
|
Loss
from operations
|
(10,772 | ) | (12,020 | ) | (13,473 | ) |
(c)
|
(11,266 | ) |
|
(47,531 | ) | ||||||||||
|
Net
loss
|
(10,743 | ) | (12,252 | ) | (13,843 | ) |
(c)
|
(8,624 | ) |
(d)
|
(45,462 | ) | ||||||||||
|
Basic
and diluted loss per share
|
$ | (0.25 | ) | $ | (0.28 | ) | $ | (0.31 | ) |
(c)
|
$ | (0.15 | ) |
(d)
|
$ | (0.99 | ) | |||||
|
(a)
|
Includes
i) costs related to streamlining our operations of $1.1 million, $1.2
million, $199,000 and $510,000 for the 2008 quarters ended March, June,
September and December, respectively. See further discussion in Note
1 – Summary of
Significant Accounting Policies, “Costs Associated with
Streamlining our Operations” and ii) Goodwill impairment loss of $9.8
million recorded in December 2008. See Note 1 – Summary of Significant
Accounting Policies,
“Goodwill.”
|
|
(b)
|
Includes
i) non-operating gains of $3.7 million and $1.0 million for the 2008
quarters ended September and December, respectively, for the change in
fair value of warrants. See further discussion in Note 1 – Summary of Significant
Accounting Policies, “Warrant Liabilities” and ii) a $1.4 million
‘Other-than-temporary’ loss on marketable securities recorded in December
2008 - See Note 1 – Summary of Significant
Accounting Policies, “Marketable
Securities.”
|
|
(c)
|
Includes
a $2.4 million non-cash stock settlement reached with XINO Corporation,
recorded in August 2007 - See Note 5 – Intangible
Assets.
|
|
(d)
|
Includes
i) a non-operating gain of $3.5 million for the quarter ended December
2007, for the change in fair value of warrants and ii) a loss of $741,000
on extinguishment of debt resulting from the redemption of $5 million of
the Highbridge senior secured notes in November 2007. See further
discussion in Note 6 – Debt
Outstanding.
|
F-41