NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
1. Business Activity
Overview
CarePayment Technologies, Inc. ("we," "us,"
"our," "CarePayment" or the "Company”) was incorporated as an Oregon corporation in 1991. Unless
otherwise indicated, all references to the Company in this Quarterly Report on Form 10-Q (this "Report") include our
99% owned subsidiary, CP Technologies LLC ("CP Technologies"), which was organized as an Oregon limited liability company
in 2009. The remaining 1% of CP Technologies is owned by Aequitas Capital Management, Inc. ("Aequitas") and CarePayment,
LLC, each of which are affiliates of ours.
Effective at the end of December 2009, we acquired certain assets
and rights that enabled us to begin building a business that originates and services healthcare accounts receivable for other parties,
including the development of innovative patient plans for more effective recovery of healthcare receivables. The assets and rights
that we acquired had been previously developed by Aequitas and its affiliate, CarePayment, LLC, under the CarePayment® brand
for servicing accounts receivable generated by healthcare providers in connection with providing healthcare services to their patients.
The assets and rights we acquired included the exclusive right to originate, administer, service and collect patient accounts receivable
generated by healthcare providers and purchased by CarePayment, LLC or its affiliates, to market our services under the CarePayment®
brand and a proprietary software product that is used to manage the servicing. Typically, CarePayment, LLC or one of its affiliates
purchases patient accounts receivables from hospitals and then we originate, administer, service and collect them on behalf of
CarePayment, LLC, or one of its affiliates, for a fee. Although we intend to grow our business to include servicing accounts receivable
on behalf of other parties, CarePayment, LLC is currently our only customer.
To facilitate building the business, on December 30, 2009 we,
Aequitas and CarePayment, LLC formed CP Technologies. We contributed shares of our newly authorized Series D Convertible Preferred
Stock ("Series D Preferred Stock") and warrants to purchase shares of our Class B Common Stock to CP Technologies. Aequitas
and CarePayment, LLC contributed to CP Technologies the CarePayment® assets and rights described in the foregoing paragraph.
CP Technologies then distributed the shares of Series D Preferred Stock to Aequitas and CarePayment, LLC, and the warrants to purchase
shares of our Class B Common Stock to CarePayment, LLC, to redeem all but half of one membership unit held by each of them. Following
these transactions, we own 99% of CP Technologies, and Aequitas and CarePayment, LLC each own 0.5% of CP Technologies.
The Healthcare Receivables Servicing Industry and Our
Business
On January 1, 2010, and as a result of the transactions described
above, CP Technologies began building a business to service healthcare patient receivables for an affiliate of the Company, CarePayment,
LLC.
Generally, the majority of an account receivable that a healthcare
provider (for example, a hospital) generates in connection with providing healthcare services is paid by private medical insurance,
Medicare or Medicaid. The balance of an account receivable that is not paid by those sources is due directly from the patient.
Often, healthcare providers do not prioritize collecting that balance as a result of the effort and expense required to collect
directly from a patient.
Our affiliate, CarePayment, LLC, offers healthcare providers
a receivables servicing alternative. CarePayment, LLC, either alone or through an affiliate, purchases from healthcare providers
the balance of their accounts receivable that are due directly from patients. A patient whose healthcare receivable is acquired
by CarePayment, LLC is offered the opportunity to participate in the CarePayment® program, which includes a line of credit
for payment of future healthcare expenses. If the patient accepts the terms of the program, the patient becomes a CarePayment®
customer. The patient's CarePayment® account has an initial outstanding balance equal to the receivable amount purchased by
CarePayment, LLC or one of its affiliates from the healthcare provider. Balances due on the CarePayment® account are generally
payable over 25 months or more with no interest (0% APR).
On December 31, 2009, CP Technologies entered into a Servicing
Agreement (the "Servicing Agreement") with CarePayment, LLC under which CP Technologies has the exclusive right to originate,
collect, administer and service all accounts receivable purchased or controlled by CarePayment, LLC or its affiliates. CarePayment,
LLC also appointed CP Technologies as a non-exclusive originator of receivables purchased or controlled by CarePayment, LLC, including
the right to deal with healthcare providers on behalf of CarePayment, LLC with respect to originating, collecting, administering
and servicing receivables purchased or controlled by CarePayment, LLC or its affiliates. While CP Technologies services the receivables,
CarePayment, LLC or its affiliates retain ownership of the receivables. In addition to servicing receivables on behalf of CarePayment,
LLC, CP Technologies recommends a course of action when it determines that collection efforts for existing receivables are no longer
effective and it may also analyze potential receivables acquisitions for CarePayment, LLC.
In exchange for its services, CarePayment, LLC pays CP Technologies
certain fees, including (i) an origination fee at the time CarePayment, LLC purchases and delivers receivables to CP Technologies
for servicing based upon the balance of the receivables to be serviced, (ii) a monthly servicing fee based upon the principal amount
of purchased receivables that CP Technologies is servicing, and (iii) a quarterly servicing fee based upon a percentage of CarePayment,
LLC's quarterly net income from operating activities, as adjusted for certain items.
On July 30, 2010, the Company entered into an Agreement and
Plan of Merger with Vitality Financial, Inc. (“Vitality”) pursuant to which Vitality became a wholly owned subsidiary
of the Company. Under the terms of the Merger Agreement, the stockholders of Vitality received, collectively, 97,500 shares of
Series E Convertible Preferred Stock of the Company in consideration for all the outstanding stock of Vitality. Vitality provides
payment and receivables management to a limited number of medical providers and patients.
Liquidity
Substantially all of the Company’s revenue and cash receipts
are generated from the Servicing Agreement with CarePayment, LLC. Origination and servicing revenues are generated based upon the
volume of receivables that CarePayment, LLC or its affiliates purchase and service.
During 2010 and 2011, the Company added headcount and trained
to manage the servicing operation in preparation for projected receivables volume increases.
On March 31, 2011, Aequitas Holdings, LLC (“Holdings”)
purchased an additional 1.5 million shares of the Company’s Class B Common Stock for $1.00 per share. Holdings, an affiliate
of Aequitas, now owns 7,910,092 shares of Class B Common Stock, which equates to approximately 92% of the voting shares of the
Company as of the date of this Report.
On September 29, 2011, the Company entered into a $3 million
Business Loan Agreement and Promissory Note (“Business Loan”) with Aequitas Commercial Finance, LLC (“ACF”),
an affiliate of Aequitas. On December 29, 2011, the Business Loan was amended to increase the aggregate principal amount that the
Company may borrow under the Business Loan from $3,000,000 to $4,500,000. On March 5, 2012, the Business Loan was further amended
to increase the aggregate principal amount the Company may borrow from $4,500,000 to $8,000,000, and to increase the interest rate
on the outstanding principal balance owing under the Business Loan from 11% to 12.5% per annum. On April 12, 2012, the Company
and ACF further amended the Business Loan to convert, effective April 30, 2012, $2,000,000 of the aggregate principal amount owing
under the Business Loan into shares of the Company's Class A Common Stock at a price of $1.00 per share, to decrease the aggregate
principal amount the Company may borrow under the Business Loan from $8,000,000 to $6,000,000 and to extend the maturity date of
the Business Loan from December 31, 2012 to December 31, 2013.
Should the Business Loan be insufficient to meet the Company’s
liquidity needs over the next year or until such time as the Company has positive cash flow, Holdings has advised the Company that
it is prepared to provide additional liquidity, either in the form of an additional equity infusion or an additional line of credit.
As of September 30, 2012, the Company had taken net advances on the Business Loan of $4,831,000.
2. Summary of Significant Accounting Policies
Basis of Presentation:
The Condensed Consolidated Financial Statements included herein
have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The Company’s
management believes that the disclosures are adequate to make the information presented not misleading. These condensed financial
statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2011.
The interim period information included in this Quarterly Report
on Form 10-Q reflects all adjustments, consisting of normal recurring adjustments, that are, in the opinion of the Company’s
management, necessary for a fair statement of the results of the respective interim periods. Results of operations for interim
periods are not necessarily indicative of results to be expected for an entire year.
Principles of consolidation:
The Condensed Consolidated Financial Statements (Unaudited)
include the accounts of the Company, its wholly owned subsidiaries, Moore and Vitality, and its 99% owned subsidiary, CP Technologies.
All intercompany transactions have been eliminated.
Estimates and assumptions:
The preparation of the Condensed Consolidated Financial Statements
(Unaudited) in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the Condensed Consolidated Financial Statements (Unaudited) and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.
Concentration of credit risk:
Revenue from one source
—
The Company currently generates substantially all its revenue through one servicing agreement with a related party.
Cash and investments
—
The Company maintains its cash in bank accounts; at times, the balances in these accounts may exceed
federally insured limits. The Company has not experienced any losses in such accounts and has taken measures to limit exposure
to any significant risk.
Cash and cash equivalents:
Cash and cash equivalents are stated at cost, which approximates fair value, and include investments with maturities of three
months or less at the date of acquisition. Cash and cash equivalents consist of bank deposits.
Related party receivables:
Related party receivables arise due to revenue earned in conjunction
with the Servicing Agreement with CarePayment, LLC. The Company makes ongoing estimates of the collectability of these receivables.
At September 30, 2012 and December 31, 2011, there was no allowance for doubtful accounts.
Property and equipment:
Property and equipment is comprised of servicing software
and computer equipment, which are stated at original estimated fair value, and office equipment and leasehold improvements,
which are stated at cost, net of accumulated amortization and depreciation. Additionally, the Company has construction in
progress for capitalizable software. Internal and external costs incurred to develop internal use computer software during
the application development stage are capitalized in accordance with ASC 350. Depreciation and amortization expense is
computed using the straight-line method over the estimated useful lives of the assets beginning at the time the asset is
placed in service. The estimated useful life of the software and the software licenses is three years, the estimated useful
life of the office furniture is five years and the estimated useful life of computer equipment is three years. Leasehold
improvements are amortized over the life of the lease, which is five years. The Company evaluates long-lived assets for
impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable.
Intangible assets:
Servicing rights:
Servicing rights represent the fair value of the identifiable
intangible asset associated with the acquisition of certain business assets on December 31, 2009. The cost associated with this
asset is being amortized on a straight line basis over an estimated useful life of 25 years based on the term of the Servicing
Agreement which expires in 2034.
Other intangible assets:
Intangible assets acquired as part of the Vitality acquisition
include a proprietary credit scoring algorithm and customer lists that are being amortized over the estimated useful lives of 1.5
to 5 years. Additionally, Vitality’s lender’s licenses are considered to have an indefinite life and are not subject
to amortization. See Note 4.
Goodwill:
Goodwill is recorded at historical cost and is tested for impairment
annually or more frequently if events or changes in circumstances indicate that goodwill might be impaired. We did not recognize
impairment losses on goodwill for the quarter ended September 30, 2012.
Revenue recognition:
Receivables servicing:
The Company recognizes revenue in conjunction with the Servicing
Agreement between CP Technologies and CarePayment, LLC. CP Technologies receives a monthly servicing fee equal to 0.4167% of the
receivables balances that have been purchased by CarePayment, LLC, and an origination fee equal to 6% annually of the original
balance of newly generated receivables that are purchased by CarePayment, LLC. The Servicing Agreement also provides that the
Company is to be paid 25% of the quarterly net income of CarePayment, LLC from operating activities, as adjusted for certain items
(the “back-end servicing fee”). The Company recognizes revenue related to the Servicing Agreement at the time the
services are rendered. The servicing fee is recognized as revenue monthly at 0.4167% of funded receivables CP Technologies is
servicing for the month; the origination fee is recognized as revenue at the time CarePayment, LLC funds its purchased receivables
and CP Technologies assumes responsibility for servicing these receivables; and the back-end servicing fee is recognized as revenue
in the quarter that CarePayment, LLC records its net income. The collectability of the revenue recognized from these related party
transactions is considered reasonably assured.
Installation services:
In addition, the Company earns revenue from implementation fees
paid by healthcare providers. These fees are charged to cover consulting services and materials provided to healthcare providers
during the period when the CarePayment® program is being implemented with healthcare providers. The Company recognizes the
revenue on completion of the implementation.
Royalty fees:
Royalty revenue is recognized as earned in accordance with the
Royalty Agreement. See Note 12.
Cost of revenue:
Cost of revenue is comprised primarily of costs for servicing
contractors, costs associated with outsourcing billing, collections and payment processing services and the amortization of servicing
rights and servicing software.
Advertising expense:
Advertising costs are expensed in the period incurred and are
included in selling, general and administrative expenses. Total advertising expense was $2,018 and $18,549 for the nine months
ended September 30, 2012 and 2011, respectively.
Income taxes:
The Company accounts for income taxes under an asset and liability
approach that requires the recognition of deferred tax assets and liabilities that are determined based on the differences between
the financial statement basis and tax basis of assets and liabilities using enacted tax rates. A valuation allowance is recorded
to reduce a deferred tax asset to that portion of the deferred tax asset that is expected to more likely than not be realized.
The Company reports a liability, if any, for unrecognized tax
benefits resulting from uncertain income tax positions taken or expected to be taken in an income tax return. Estimated interest
and penalties, if any, are recorded as a component of interest expense and other expense, respectively.
Stock-based compensation:
Stock-based compensation cost is estimated at the grant date
based on the award’s fair value and is recognized as expense over the requisite service period using the straight-line attribution
method. Stock-based compensation for stock options granted is estimated using the Black-Scholes option pricing model.
Warrants to purchase the Company’s stock:
The fair value of warrants to purchase the Company’s stock
issued for services or in exchange for assets is estimated at the issue date using the Black-Scholes model.
Earnings (loss) per common share:
Basic earnings (loss) per common share (“EPS”) is
calculated by dividing net income (loss) attributable to the Company by the weighted average number of shares of common stock outstanding
during the period. Fully diluted EPS assumes the conversion of all potentially dilutive securities and is calculated by dividing
net income by the sum of the weighted average number of shares of common stock outstanding plus potentially dilutive securities
determined using the treasury stock method. Dilutive loss per share does not consider the impact of potentially dilutive securities
in periods in which there is a loss because the inclusion of the potentially dilutive securities would have an anti-dilutive effect.
Comprehensive income (loss):
The Company has no components of Other Comprehensive Income
(Loss) and, accordingly, no statement of Comprehensive Income (Loss) is included in the accompanying Condensed Consolidated Financial
Statements.
Operating segments and reporting units:
The Company operates as a single business segment and reporting
unit.
Recently adopted accounting standards:
The Company reviews recently adopted and proposed accounting
standards on a continual basis. For the nine months ended September 30, 2012, no new pronouncements had a significant impact on
the Company’s financial statements.
3. Property and Equipment
A summary of the Company's property and equipment as of September
30, 2012 and December 31, 2011 is as follows:
|
|
2012
|
|
|
2011
|
|
Servicing software
|
|
$
|
1,429,123
|
|
|
$
|
507,200
|
|
Office furniture and equipment
|
|
|
46,967
|
|
|
|
46,967
|
|
Leasehold improvements
|
|
|
195,548
|
|
|
|
195,548
|
|
Assets not yet in service – software
|
|
|
149,490
|
|
|
|
583,368
|
|
Total fixed assets
|
|
|
1,821,128
|
|
|
|
1,333,083
|
|
Accumulated depreciation and amortization
|
|
|
(833,727
|
)
|
|
|
(383,173
|
)
|
Property and equipment, net
|
|
$
|
987,401
|
|
|
$
|
949,910
|
|
Depreciation and amortization expense for property and equipment
was $203,933 and $54,885 for the three months ended September 30, 2012 and 2011, respectively, and $450,554 and $159,464 for the
nine months ended September 30, 2012 and 2011, respectively.
4. Intangible Assets
A summary of the Company's intangible assets as of September
30, 2012 and December 31, 2011 is as follows:
|
|
2012
|
|
|
2011
|
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
Servicing rights (amortized over 25 years)
|
|
$
|
9,550,000
|
|
|
$
|
9,550,000
|
|
Customer lists (amortized over 1.5 years)
|
|
|
34,700
|
|
|
|
34,700
|
|
IP Scoring Algorithm (amortized over 5 years)
|
|
|
20,000
|
|
|
|
20,000
|
|
Gross carrying value
|
|
|
9,604,700
|
|
|
|
9,604,700
|
|
Accumulated amortization
|
|
|
(1,109,289
|
)
|
|
|
(802,440
|
)
|
Net carrying value of intangible assets subject to amortization
|
|
|
8,495,411
|
|
|
|
8,802,260
|
|
Intangible assets not subject to amortization:
|
|
|
|
|
|
|
|
|
Lender’s licenses
|
|
|
10,000
|
|
|
|
10,000
|
|
Net carrying value of intangible assets
|
|
$
|
8,505,411
|
|
|
$
|
8,812,260
|
|
Amortization expense was $102,283 and $102,887 for the three
months ended September 30, 2012 and 2011, respectively, and $306,849 and $308,662 for the nine months ended September 30, 2012
and 2011, respectively.
5. Note Payable
On September 29, 2011, the Company entered into the Business
Loan with ACF, the outstanding loan balance of which originally accrued interest at the rate of 11% per annum, payable monthly,
and had a scheduled maturity date of December 31, 2012. The Business Loan is collateralized by substantially all of the Company’s
assets. On December 29, 2011, the Company and ACF entered into Amendment No. 1 to the Business Loan pursuant to which the aggregate
principal amount that the Company could borrow under the Business Loan was increased from $3,000,000 to $4,500,000. On March 5,
2012, the Company and ACF entered into Amendment No. 2 to the Business Loan pursuant to which the aggregate principal amount that
the Company could borrow under the Business Loan was increased from $4,500,000 to $8,000,000, and the interest rate on the outstanding
principal balance owing under the Business Loan was increased from 11% per annum to 12.5% per annum beginning on the effective
date of Amendment No. 2. On April 12, 2012, the Company and ACF entered into Amendment No. 3 to the Business Loan pursuant to which
$2,000,000 of the aggregate principal balance owing under the Business Loan converted, effective April 30, 2012, into shares of
the Company's Class A Common Stock at a price of $1.00 per share, the aggregate principal amount the Company may borrow under the
Business Loan was decreased from $8,000,000 to $6,000,000, and the maturity date of the Business Loan was extended from December
31, 2012 to December 31, 2013.
As of September 30, 2012, the Company had received net advances
on the Business Loan of $4,831,000. Interest expense of $386,757 was paid during the nine months ended September 30, 2012.
6. Mandatorily Redeemable Convertible
Preferred Stock
Holders of Series D Preferred Stock are entitled to receive
a preferred dividend of $0.50 per share per annum, when, as and if declared by our Board of Directors. To date, no such dividend
has been declared. Series D Preferred Stock holders are also entitled to a liquidation preference of $10 per share, plus cumulative
unpaid dividends. The Company may redeem all outstanding Series D Preferred Stock at any time upon 30 days prior written notice,
and the Company is required to redeem all outstanding Series D Preferred Stock in January 2013 at a purchase price equal to the
liquidation preference in effect on January 1, 2013. If the Company is unable to redeem the Series D Preferred Stock with cash
or other immediately available funds for any reason, the holders of Series D Preferred Stock will have the right to exchange all
shares of Series D Preferred Stock for an aggregate 99% ownership interest in CP Technologies. The Company may not be able to
redeem the Series D Preferred Stock in January 2013. See Item 2 – Potential Inability to Redeem Series D Preferred Stock.
The difference between the fair value of Series D Preferred
Stock at issuance and the redemption value of $12,000,000 will be accreted to interest expense over the period to redemption in
January 2013 using the level yield method. The carrying value at September 30, 2012 is $3,300,961.
7. Shareholders’ Equity
Preferred Stock:
Each share of Series D Preferred Stock is convertible into such
number of fully paid and nonassessable shares of Class A Common Stock of the Company as is determined by dividing the amount of
$10.00 per share (as adjusted for stock splits, stock dividends, reclassification and the like) by the Conversion Price (defined
in the following sentence) applicable to such share in effect on the date the certificate is surrendered for conversion. The Conversion
Price per share of Series D Preferred Stock is 80% of the volume weighted average price per share of Class A Common Stock, but
in no event less than $1.00 per share. Through September 30, 2012, no shares of Series D Preferred Stock have been converted into
shares of Class A Common Stock.
Each share of Series E Convertible Preferred Stock (“Series
E Preferred Stock”) is convertible into such number of fully paid and nonassessable shares of Class A Common Stock of the
Company as is determined by dividing the amount of $10.00 per share (as adjusted for stock splits, stock dividends, reclassification
and the like) by the Conversion Price (defined in the following sentence) applicable to such share in effect on the date the certificate
is surrendered for conversion. The Conversion Price per share of Series E Preferred Stock is 80% of the volume weighted average
price per share of Class A Common Stock, but in no event less than $1.00 per share. Shares of Series E Preferred Stock became convertible,
at the option of the holder thereof, into shares of Class A Common stock in January 2012 and are mandatorily convertible into shares
of Class A Common Stock 36 months after issuance, in July 2013. Through September 30, 2012, 4,081 shares of Series E Preferred
Stock have been converted into 35,520 shares of Class A Common Stock.
Stock Warrants:
As of September 30, 2012, the Company had warrants outstanding
to purchase 3,676 shares of Class A Common Stock, which are exercisable as follows:
Warrants
|
|
Exercise Price
Per Share
|
|
Expiration Date
|
3,189
|
|
|
$
|
37.50
|
|
|
April 2015
|
487
|
|
|
$
|
72.00
|
|
|
June 2016
|
Common Stock:
The Company’s Second Amended and Restated Articles of
Incorporation, as amended (the "Articles"), provide for two classes of common stock, Class A Common Stock and Class B
Common Stock. The Articles authorize 75 million shares of common stock, of which 65 million shares are designated as Class A Common
Stock and 10 million shares are designated as Class B Common Stock. Holders of Class A Common Stock are entitled to one vote per
share, and holders of Class B Common Stock are entitled to ten votes per share, on any matter submitted to the shareholders.
On March 31, 2011, the Company entered into a Subscription Agreement
with Holdings pursuant to which Holdings purchased 1,500,000 shares of the Company's Class B Common Stock at $1.00 per share for
aggregate consideration of $1,500,000.
On April 30, 2012, $2,000,000 of the aggregate principal amount
owing under the Business Loan was converted into shares of the Company's Class A Common Stock at a price of $1.00 per share resulting
in the issuance of 2,000,000 shares of Class A Common Stock.
8. Earnings (Loss) per Common Share
The shares used in the computation of the Company’s basic
and diluted loss per common share are reconciled as follows:
|
|
Three Months Ended
September 30
|
|
|
Nine Months Ended
September 30
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
Weighted average basic common
shares outstanding
|
|
|
12,675,634
|
|
|
|
10,600,879
|
|
|
|
11,782,715
|
|
|
|
10,106,374
|
|
Dilutive effect of convertible
preferred stock (a)
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Dilutive effect of warrants (a)
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Dilutive effect of employee stock options (a)
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Weighted average diluted common shares outstanding (a)
|
|
|
12,675,634
|
|
|
|
10,600,879
|
|
|
|
11,782,715
|
|
|
|
10,106,374
|
|
(a) Common stock equivalents
outstanding for the three and nine months ended September 30, 2012 and 2011 excluded in the computation of diluted EPS because
their effect would be anti-dilutive as a result of applying the treasury stock method are: warrants to purchase 3,676 and 4,417
shares of Class A Common Stock, respectively; 1,200,000 shares of Series D Preferred Stock convertible into shares of Class A Common
Stock; and 93,419 and 97,500 shares of Series E Preferred Stock convertible into shares of Class A Common Stock, respectively,
based on the conversion calculation described in Note 7
9. Employee Benefit Plans
Stock Incentive Plan
In February 2010, the Company adopted the 2010 Stock Option
Plan (the “Plan”) pursuant to which the Company may grant restricted stock and stock options for the benefit of selected
employees and directors. The Plan was amended in September 2010 to increase the number of shares of Class A Common Stock that may
be issued under the Plan to 1,000,000 shares. Grants are issued at prices equal to the estimated fair market value of the stock
as defined in the plan on the date of the grant, vest over various terms (generally three years), and expire ten years from the
date of the grant. The Plan allows vesting based upon performance criteria. Certain option and share awards provide for accelerated
vesting if there is a change in control of the Company (as defined in the Plan). The fair value of stock-based options granted
is calculated using the Black-Scholes option pricing model. At September 30, 2012, there were no options outstanding under to the
Plan.
The Company’s policy is to issue new shares of stock on
exercise of stock options.
A summary of option activity under the Plan during the nine
months ended September 30, 2012 is presented below:
|
|
Number of Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual Life (years)
|
|
Options outstanding at December 31, 2011
|
|
|
754,139
|
|
|
$
|
0.20
|
|
|
|
7.7
|
|
Forfeited
|
|
|
735,652
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
18,487
|
|
|
|
|
|
|
|
|
|
Options outstanding at September 30, 2012
|
|
|
–
|
|
|
|
|
|
|
|
|
|
The Company recorded compensation expense of $263 and $4,527,
respectively, for the three months ended September 30, 2012 and 2011, and $2,363 and $13,583 for the nine months ended September
30, 2012 and 2011, respectively, for the estimated fair value of options vested.
During the nine months ended September 30, 2012, in a cashless
exercise transaction, options to purchase a total of 18,487 Class A Common shares were exercised resulting in the issuance of
6,004 shares and the cancellation of 12,483 option shares as consideration for the exercise price. The intrinsic value of options
exercised during the nine months ended September 30, 2012 totaled $4,806. The Company issues new shares as settlement of options
exercised. There were no options exercised during the nine months ended September 30, 2011.
401(k) Savings Plan
During 2011, employees of the Company were eligible to participate
in a 401(k) Savings Plan and the Company matched 100% of the first 3% of eligible compensation and 50% of the next 2% of eligible
compensation that employees contributed to the plan; the Company’s matching contributions vested immediately. Beginning
January 1, 2012, the Company leases its employees from Aequitas pursuant to the Restated ASA (see Note 12 below). Under the
Restated ASA, employees providing services to CP Technologies under the Restated ASA are eligible to participate in a 401(k) Savings
Plan sponsored by Aequitas, and Aequitas matches 100% of the first 3% of eligible compensation and 50% of the next 2% of eligible
compensation that such employees contribute to the plan; matching contributions made by Aequitas vest immediately. CP Technologies
is obligated under the Restated ASA to reimburse Aequitas for the matching contributions it makes with respect to employees providing
services to CP Technologies under the Restated ASA. The Company recorded expense of $31,447 for the three months ended September
30, 2011, and $74,992 for the nine months ended September 30, 2011 with respect to its matching contributions during that period.
For the three and nine months ended September 30, 2012, the Company recorded expense of $5,495 and $40,994, respectively, for reimbursement
of the matching contributions Aequitas made during those periods with respect to employees providing services to CP Technologies
under the Restated ASA.
10. Commitments and Contingencies
Operating Leases:
The Company and its subsidiaries
lease office space and personal property used in their operations from
Aequitas.
The Company
holds a lease for office space in San Francisco, California; this office space has been sub-leased to a third party effective July
13, 2012. At September 30, 2012, the Company's aggregate future minimum payments for operating leases
having initial or
non-cancelable lease terms greater than one year are payable as follows:
Year
|
|
|
Required Minimum Payment
|
2012
|
|
|
|
$ 82,488
|
2013
|
|
|
|
$ 339,440
|
2014
|
|
|
|
$ 303,244
|
2015
|
|
|
|
$ 108,585
|
2016
|
|
|
|
$ 18,240
|
For the three and nine months ended September 30, 2012, the
Company incurred rent expense of $84,488 and $246,597 respectively, and incurred rent expense for the three and nine months ended
September 30, 2011, of $88,925 and $243,464, respectively.
Off-Balance Sheet Arrangements:
The Company does not have any off-balance sheet arrangements.
Litigation:
From time to time, the Company may become involved in ordinary,
routine or regulatory legal proceedings incidental to the Company’s business. As of the date of this Report, we are not engaged
in any such legal proceedings nor are we aware of any other pending or threatened legal proceeding that, singly or in the aggregate,
could have a material adverse effect on the Company.
11. Fair Value Measures
Fair Value:
Fair value is defined as the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date. It establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on
market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market
participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The
fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three
levels of the fair value hierarchy are described below:
Level 1 – Unadjusted
quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities.
Level 2 – Observable
inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of
the assets or liabilities.
Level 3 – Valuations
derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
Fair Value of Financial Instruments:
The carrying value of the Company's cash and cash equivalents,
related party receivables, accounts receivable, accounts payable and other accrued liabilities approximate their fair values due
to the relatively short maturities of those instruments.
The fair value of the Series D Preferred Stock at September
30, 2012 is $13,405,001 based on a discounted cash flow model.
The fair value of the note payable is calculated using our estimated
borrowing rate for similar types of borrowing arrangements. The carrying amount reflected in the consolidated balance sheet for
the note payable approximates fair value.
12. Related-Party Transactions
Effective January 1, 2010, Aequitas began
providing CP Technologies certain management support services, such as accounting, financial, human resources and information
technology services, under the terms of an Administrative Services Agreement (the “ASA”) dated December 31, 2009.
For 2011, the fee under the ASA payable to Aequitas was $46,200 per month. Effective January 1, 2012, the ASA was amended and
restated (the “Restated ASA”) to revise the ASA fee payable to Aequitas to be approximately $56,200 per month for
2012 and to provide for an annual 3% increase to the fee effective January 1 of each year thereafter unless otherwise agreed by
the parties. Either party may change the services provided under the Restated ASA by Aequitas (including terminating a particular
service) upon 180 days’ prior written notice to the other party, and the Restated ASA is terminable by either party on 180
days’ notice to the other party.
Effective December 31, 2011, CP Technologies
terminated all of its employees (the "Former CPT Employees") and each Former CPT Employee was hired by Aequitas. Pursuant
to the Restated ASA: (i) Aequitas loans the Former CPT Employee to CP Technologies for the purpose of providing services
to CP Technologies, and (ii) CP Technologies has the right to designate additional persons to be hired by Aequitas, and to
terminate the employment of any persons employed by Aequitas for the purpose of providing services to CP Technologies under the
Restated ASA. The Restated ASA requires CP Technologies to reimburse Aequitas for the actual costs that Aequitas incurs to provide
employees to CP Technologies. CP Technologies paid fees under the ASA and Restated ASA to Aequitas of $169,980 and $138,576 for
the three months ended September 30, 2012 and 2011, respectively, and $477,655 and $415,728 for the nine months ended September
30, 2012 and 2011, respectively, which fees are included in sales, general and administrative expense. Additionally, CP Technologies
reimbursed Aequitas $0 and $50,000 during the three months ended September 30, 2012 and 2011, respectively, and $ 46,550 and $50,000
during the nine months ended September 30, 2012 and 2011, respectively, for legal compliance work performed by Aequitas in-house
legal personnel.
CP Technologies leases certain office space and personal property
from Aequitas pursuant to a Sublease dated December 31, 2009 (the “Sublease”). Real property rent was fixed at $13,115
per month for 2011 and 2012 and personal property rent was set at $6,116 per month. The Company paid rent and fees under the Sublease
to Aequitas of $173,079 for the nine months ended September 30, 2012 and 2011, which rent and fees are included in sales, general
and administrative expense.
Effective December 31, 2009, the Company and Aequitas entered
into an Amended and Restated Advisory Services Agreement (the “Advisory Agreement”). Under the terms of the Advisory
Agreement, Aequitas provides services to the Company relating to strategy development, strategic planning, marketing, corporate
development and such other advisory services as the Company reasonably requests from time to time. The Company pays Aequitas a
monthly fee of $15,000 for such services. In addition, Aequitas will receive a success fee in the event of certain transactions
entered into by the Company. The Company paid fees under the Advisory Agreement to Aequitas of $45,000 and $45,000 for the three
months ended September 30, 2012 and 2011, respectively, and $135,000 and $135,000 for the nine months ended September 30, 2012
and 2011, respectively, which fees are included in sales, general and administrative expense.
CP Technologies and Aequitas entered into a Royalty Agreement,
as amended effective July 31, 2010 (the “Royalty Agreement”). Under the terms of the Royalty Agreement, CP Technologies
pays Aequitas a royalty based on new products ("Products") developed by CP Technologies or its affiliates or co-developed
by CP Technologies or its affiliates and Aequitas or its affiliates and that are based on or use the CarePayment® software
system and platform that Aequitas transferred to CP Technologies (the “Software”). The royalty is equal to (i) 1.0%
of the net revenue received by CP Technologies or its affiliates and generated by Products that utilize funding provided by Aequitas
or its affiliates, and (ii) 7.0% of the face amount, or such other percentage as the parties may agree, of receivables that do
not utilize such funding but that are serviced by CP Technologies or its affiliates using the Software. Effective January 1, 2011,
the Royalty Agreement was further amended, whereby Aequitas agreed to pay CP Technologies a $500,000 fee for improvements to the
existing CarePayment® program platform to accommodate additional portfolio management capability and efficiency as mutually
agreed in writing. Fees paid or received under the Royalty Agreement with Aequitas were $0 and $500,000 for the nine months ended
September 30, 2012 and 2011, respectively.
The Company recognizes revenue in conjunction with the Servicing
Agreement between CarePayment, LLC and CP Technologies. CarePayment, LLC pays CP Technologies an origination fee at the time CarePayment,
LLC purchases and delivers receivables to CP Technologies for servicing based upon the balance of the receivables to be serviced,
a monthly servicing fee based upon the principal amount of purchased receivables that CP Technologies is servicing, and a quarterly
servicing fee based upon a percentage of CarePayment, LLC’s quarterly net income from operating activities, as adjusted
for certain items. CP Technologies received fee revenue under the Servicing Agreement of $1,385,285 and $1,551,154 for the three
months ended September 30, 2012 and 2011, respectively, and $4,045,277 and $4,681,182 for the nine months ended September 30,
2012 and 2011. Additionally the Company recorded implementation revenue of $7,500 and $30,000 for the three months ended September
30, 2012 and 2011, respectively and $47,500 and $110,000 for the nine months ended September 30, 2012 and 2011, respectively,
for implementation services provided to CarePayment, LLC.
Effective September 29, 2011 the Company established the Business
Loan with ACF, which accrued interest at the rate of 11% per annum until March 4, 2012. Beginning on March 5, 2012, the interest
rate on the outstanding principal balance owing on the Business Loan was increased to 12.5% pursuant to Amendment No. 2 to the
Business Loan. The unpaid principal balance on the Business Loan at September 30, 2012 was $4,831,000. Interest paid on the Business
Loan for the three months ended September 30, 2012 was $140,830 and for the nine months ended September 30, 2012 was $386,757,
with no interest accrued and unpaid at September 30, 2012.
The Company had a receivable of $110,545 and $277,120 due from
CarePayment, LLC for servicing fees as of September 30, 2012 and December 31, 2011, respectively. The Company had a receivable
of $3,143 due from Aequitas Income Opportunity Fund, LLC, an affiliate of ACF, for servicing fees as of December 31, 2011; there
was no such receivable as of September 30, 2012. Additionally, the Company has received an advance payment from CarePayment, LLC
in the amount of $0 and $42,664, and a deposit of $37,727 and $4,917, on the purchase of loans receivable from an Aequitas affiliate,
both of which are recorded as a related party liability in the Condensed Consolidated Financial Statements, as of September 30,
2012 and December 31, 2011, respectively.
Vitality provides loans to hospital patients to satisfy healthcare
receivables owed to hospitals. Vitality sells the loans to an affiliate of Aequitas at the net book value of the loans and CP Technologies
continues to service the loans. As of September 30, 2012 and December 31, 2011, there were no loans owned by Vitality, although
CP Technologies was servicing, as of those dates, $50,146 and $68,000 of loans receivable, respectively, which had been sold to
an affiliate of Aequitas.
13. Subsequent Events
Management evaluated subsequent events
through the date of this Report.
In October 2012, Aequitas CarePayment
Founders Fund, LLC, the previous sole owner of outstanding Series D Preferred Stock, distributed 1,132,398 shares to its 22 members
and retained ownership of 67,602 of such shares.