10-K 1 anci10k2013q4.htm 10-K ANCI 10K 2013 Q4


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
 
x ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2013

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-33094

AMERICAN CARESOURCE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

 
DELAWARE
 
20-0428568
 
 
(State or other jurisdiction of
 
(I.R.S. employer
 
 
incorporation or organization)
 
identification no.)
 
 
 
 
 
 
 
 
5429 LYNDON B. JOHNSON FREEWAY
 
 
 
 
SUITE 850
 
 
 
 
DALLAS, TEXAS
 
 
 
 
75240
 
 
 
 
(Address of principal executive offices)
 
 
 
 
(Zip code)
 
 

(972) 308-6830
(Registrant’s telephone number, including area code)


 Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $.01 per share
 
The NASDAQ Capital Market
 


Securities registered pursuant to Section 12(g) of the Exchange Act:
None


Indicate by checkmark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933 (the “Securities Act”). Yes o No x

Indicate by checkmark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”). Yes o No x





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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Non-accelerated filer o
Accelerated filer  o 
Smaller Reporting Company x

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

The aggregate market value of the voting and nonvoting Common Stock held by non-affiliates of the Registrant was $12,202,396 computed by reference to the price at which the Common Stock was last sold on The NASDAQ Capital Market on the last business day of the Registrant’s most recently completed second fiscal quarter (June 28, 2013).
 
The number of shares of the Registrant’s Common Stock, par value $.01 per share, outstanding as of February 24, 2014 was 5,713,960.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive proxy statement for the 2014 annual meeting of stockholders or the Registrant's annual report on Form 10-K/A, to be filed with the Securities and Exchange Commission not later than April 30, 2014, are incorporated by reference into Part III of this Form 10-K.



AMERICAN CARESOURCE HOLDINGS, INC.
 
FORM 10-K
 
TABLE OF CONTENTS
 
PART I
 
    
 
 
 
PART II
 
 
 
 
 
PART III
 
 
 
 
 
PART IV
 
   
 
 
 
Index to Financial Statements
 




Special Note Regarding Forward-Looking Statements
 
This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These statements can be identified by forward-looking words such as “may,” “will,” “expect,” “intend”, “anticipate,” “believe,” “estimate” and “continue” or similar words and discuss the Company’s plans, objectives and expectations for future operations, including its services, contain projections of the Company’s future operating results or financial condition, and discuss its expectations with respect to the growth in healthcare costs in the United States, the demand for ancillary benefits management and cost containment services, and the Company’s competitive advantages, or contain other “forward-looking” information.

Such forward-looking statements are based on current information, assumptions and belief of management, and are not guarantees of future performance.  Substantial risks and uncertainties could cause actual results to differ materially from those indicated by such forward-looking statements, including, but not limited to, the Company’s inability to attract or maintain providers or clients or achieve its financial results, changes in national healthcare policy, federal or state regulation, and/or rates of reimbursement including without limitation the impact of the Patient Protection and Affordable Care Act, Health Care and Educational Affordability Reconciliation Act and medical loss ratio regulations, general economic conditions (including economic downturns and increases in unemployment), lower than anticipated demand for ancillary services, pricing, market acceptance/preference, the Company’s ability to integrate with its clients, the Company's ability to maintain a network of ancillary service providers that is adequate to generate significant claims volume, consolidation in the industry that may affect the Company’s key clients, changes in the business decisions by significant clients, increased competition from major carriers, increased competition from cost containment vendors and solutions, implementation and performance difficulties, and other risk factors detailed from time to time in the Company’s periodic filings with the Securities and Exchange Commission, including in this annual report on Form 10-K for the year ended December 31, 2013.

Do not place undue reliance on these forward-looking statements, which speak only as of the date this document was prepared.  All forward-looking statements included herein are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  Except to the extent required by applicable securities laws and regulations, the Company undertakes no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.


ii


PART I
 
Item 1.                    Business.
 
Overview

American CareSource Holdings, Inc. ("ACS,” "the Company,” the “Registrant,” “we,” “us,” or “our”) works to help its clients control healthcare costs by offering cost containment strategies, primarily through the utilization of a comprehensive national network of ancillary healthcare service providers.  The Company markets its services to a number of healthcare companies including third party administrators (“TPAs”), insurance companies, large self-funded organizations, various employer groups and preferred provider organizations ("PPOs").  The Company offers payors this solution by:

lowering its payors’ ancillary care costs through its network of high quality, cost effective providers that the Company has under contract at more favorable terms than they could generally obtain on their own;

providing payors with a comprehensive network of ancillary healthcare service providers that is tailored to each payor’s specific needs and is available to each payor’s members for covered services;

providing payors with claims management, reporting, processing and payment services;

performing network/needs analysis to assess the benefits to payors of adding additional/different service providers to the payor-specific provider networks; and

credentialing network service providers for inclusion in the payor-specific provider networks.
 
The Company has assembled a network of ancillary healthcare service providers that supplement or support the care provided by hospitals and physicians and includes 31 service categories. We have a dedicated provider development function, whose primary responsibility is to contract with providers and strategically grow our network of ancillary service providers.
    
We secure contracts with ancillary service providers by offering them the following:
    
inclusion in a nationwide network that provides exposure to our client payors and their aggregate member lives;

an array of administrative and back-office services, such as collections and appeals;

increased claims volume through various "soft steerage" mechanisms; and    

advocacy in the claims appeals process.

Because we have the ability to add new clients and increase the coverage and penetration of our network of ancillary service providers, we can grow revenue by increasing demand as well as increasing supply. New client relationships add new member lives that will seek ancillary services, while new service provider relationships create opportunities for new and existing member lives to receive additional incremental services.

The Company has experienced significant revenue declines over the past four years, primarily related to the declines in the business of our two significant legacy clients, both of which are PPOs. Due to a variety of factors affecting the healthcare industry, including but not limited to healthcare legislation, the economy, industry consolidation, change in strategic direction of our clients and for other reasons, revenue from each of our two significant legacy clients continued to decline resulting in year-over-year declines in our revenue from those accounts. Because of the significance of the revenue concentration from these two clients (from approximately 98% in 2008 to 26% 2013), the declines of their business have had a significant negative impact on our operating results and cash position over the past four years, despite our new business development efforts. Revenue recognized from one of these clients was $1.0 million in 2013 and we do not expect any revenue from this client in 2014. While we have entered into a new agreement with the other, the agreement does not provide for any minimum level of volume, and we cannot be certain of any level of continued revenue from such relationship, despite our efforts to create new revenue streams. During the period from 2008 to 2013 (excluding the addition of any entities affiliated with either of our two significant legacy clients), we added 40 new clients, which contributed $19.4 million and $20.4 million of gross revenue in 2013 and 2012, respectively.

    

1


The Company believes that it has a unique business model and offers a solid value proposition to our client payors, as well as our providers, by delivering superior discounts through our network of contracted ancillary healthcare service providers. During 2013, we made progress in adding new client relationships, but do not believe that the revenue from those accounts will offset the losses from our two significant client relationships and declines from our other legacy accounts. We will continue to opportunistically investigate strategic initiatives that will grow our revenue base, while controlling non-variable costs consistent with our existing revenue streams. Nevertheless, until we can replace a greater amount of the revenue than we have lost from our two significant legacy clients, we will continue to experience operating losses and we will continue to reduce our existing cash reserves for operating and investing activities.
    
ACS was incorporated under the laws of the State of Delaware on November 24, 2003 as a wholly-owned subsidiary of Patient Infosystems, Inc. (“Patient Infosystems”) in order to facilitate Patient Infosystems’ acquisition of substantially all of the assets of American CareSource Corporation.  American CareSource Corporation had been in operation since 1997.  The predecessor company to American CareSource Corporation, Physician’s Referral Network, had been in operation since 1995.  On December 23, 2005, the Company became an independent company when Patient Infosystems distributed by dividend to its stockholders substantially all of its shares of the Company. Ancillary Care Services, Inc. is a wholly owned subsidiary of the Company.

The Company’s principal executive offices are located at 5429 Lyndon B. Johnson Freeway, Suite 850, Dallas, TX 75240. Our Common Stock is listed on The NASDAQ Capital Market under the symbol “ANCI.” Our telephone number is (972) 308-6830.  Our Internet address is www.anci-care.com.
 
Services and Capabilities
 
Ancillary care services
 
Ancillary healthcare services include a broad array of services that supplement or support the care provided by hospitals and physicians, including the non-hospital, non-physician services associated with surgery centers, free-standing diagnostic imaging centers, home health and infusion, supply of durable medical equipment, orthotics and prosthetics, laboratory and other services.

Ancillary healthcare services include, but are not limited to, the following categories:
 
·      Acupuncture
·      Occupational Therapy
·      Cardiac Monitoring
·      Orthotics and Prosthetics
·      Chiropractor
·      Pain Management
·      Diagnostic Imaging
·      Physical Therapy
·      Dialysis
·      Podiatry
·      Durable Medical Equipment
·      Rehabilitation: Outpatient
·      Genetic Testing
·      Rehabilitation: Inpatient
·      Hearing Aids
·      Sleep
·      Home Health
·      Skilled Nursing Facility
·      Hospice
·      Speech Therapy
·      Implantable Devices
·      Surgery Center
·      Infusion
·      Transportation
·      Laboratory
·      Urgent Care
·      Lithotripsy
·      Vision
·      Long-term Acute Care
·      Walk-in Clinics
·      Massage Therapy
 
 
The Company has agreements with approximately 5,000 ancillary healthcare service providers operating in approximately 33,500 sites nationwide.


2


Provider Network
 
The Company views its ability to manage, organize and maintain its provider network and to recruit new providers as critical elements in its long-term success because its network is one of the most important reasons healthcare payors engage the Company.  The Company has agreements with its network of ancillary healthcare service providers for the purpose of meeting contractual obligations to its healthcare payors to make available a comprehensive and client-specific ancillary healthcare provider network.  The agreements define the scope of services to be provided to covered persons by each ancillary healthcare provider and the amounts to be charged for those services and are negotiated independently from the agreements reached with the Company’s client payors.  The terms of each agreement between the Company and ancillary healthcare service providers make it clear that the Company is solely obligated to the service provider under the contract between them and do not contemplate any contractual relationship between the service providers and the Company’s payors or permit the service providers to pursue claims directly against the Company’s payors.  
 
When providers initially enter the ACS provider network, the Company credentials them for inclusion in the credentialed ACS Network.  The Company also re-credentials its providers on a periodic basis.  From time to time, the Company reviews its provider relationships to determine whether any changes to the relationship are appropriate through sanction monitoring and other methods.  The Company believes that credentialing providers represents a valuable service to both its payors and the providers in the network, who would, in the absence of such service, be forced to undergo the credentialing process with respect to each payor with whom they enter into a service relationship.

During 2013 and 2012, we generated revenue from ancillary healthcare services as follows:

Category
 
2013
 
2012
Laboratory
 
21
%
 
17
%
Dialysis
 
15

 
24

Durable Medical Equipment
 
15

 
15

Infusion
 
15

 
13

Surgery Center
 
11

 
7

Rehabilitation (outpatient & inpatient)
 
6

 
6

Diagnostic Imaging
 
5

 
6

Long-term Acute Care/Skilled Nursing Facilities
 
2

 
3

Chiropractor
 
2

 
2

Orthotics and Prosthetics
 
2

 
2

Cardiac Monitoring
 
2

 
1

Other
 
4

 
4

 
 
100
%
 
100
%


3


Our Model
 
The Company’s business model, illustrating the relationships among the persons involved, directly or indirectly, in the Company’s business and its generation of revenue and expenses is depicted below:


Payors route healthcare claims to us after service has been performed by participant providers in our network.  We process those claims and charge the payor according to its contractual rate for the services according to our contract with the payor.  In processing the claim, we are paid directly by the payor or the insurer for the service.  We then pay the provider of service according to its independently-negotiated contractual rate.  We assume the risk of generating positive margin, the difference between the payment we receive for the service and the amount we are obligated to pay the provider of service.
 
The Company may receive a claims submission from a payor either electronically or via a paper based claim.  As part of its relationship with the payors, the Company may pay an administrative fee to the payors for the modifications that may be required to the payor’s technology, systems and processes to create electronic connectivity with the Company, as well as for the aggregation of claims and the electronic transmission of those claims to us.

How We Deliver Services
 
Ancillary network analysis.  The Company performs an analysis of the available claims history from each client payor and partners with the client to develop a specific plan to meet each payor’s needs.  This analysis identifies service providers that are not already in our network.  We attempt to enter into agreements with such service providers to maximize discount levels and capture a significant volume of previously out-of-network claims. In addition, the analysis enables the Company to set a client fee schedule that will bring value through incremental savings on the ancillary service charges.
 
Ancillary custom network.   ACS customizes its network to meet the needs of each payor.  In particular, when a new payor joins and periodically for each existing payor, we review the payor’s “out-of-network” claims history through our network analysis service and develop a strategy to create a network that efficiently serves the payor’s needs.  This may involve adding additional service providers for a payor or removing service providers if we determine it is beneficial for them to be excluded from the client’s network.
 
Ancillary network management.  The Company manages ancillary service provider contracts, reimbursement and credentialing for its payors.  This not only provides administrative benefits to our payors, but reduces the burden on our contracted service providers who typically must supply credentialing documentation to payors and engage in contract negotiations with separate payors.
 

4


Ancillary systems integration.  The Company has created a proprietary software system that enables us to manage many different customized accounts and includes the following modules:
 
Provider network management

Credentialing
 
Data transfer management/electronic data interface
 
Multi-level reimbursement management
 
Posting, Explanation of Benefits, check, and e-funds processes
 
Client service management
 
Claims pricing
 
Advanced data reporting
 
Ancillary reporting.  ACS offers a complete suite of reports to each payor on a monthly basis.  These reports cover contracting efforts and capture rates, client savings, volumes by service category and complete claims and utilization reports and other information of value to the client.
 
Ancillary healthcare claims management.  The Company can manage ancillary healthcare claims flow, both electronic and paper based, and integrate with a payor’s process electronically or through paper claims.  The Company has the capability of performing a number of customized processes that may add additional value for each payor.  As part of the claims management process, we manage the documentation requirements specific to each payor.  In the event claims are submitted to us by a payor without the complete required documentation, we will work with the payor and/or service provider to obtain the required documentation so that the claim will be accepted by the payor.  This service provides a labor cost savings to the payors and providers.
 
Ancillary claims collections management.  The Company facilitates an expedited claims collection process by ensuring receipt of the claim by the payor, providing information to the payor required for processing the claim, tracking the status of the claim throughout the process and maintaining a team of customer service representatives to resolve any issues that might delay the collections process.  The Company believes that the providers in its network are paid more effectively and efficiently than would otherwise be the case.
 
Business Strategy
 
The Company’s focus is strictly on the ancillary healthcare services market, a market that accounts for between 20-30% of total annual healthcare spending in the United States and was estimated at $574 billion (as derived from 2006 data published by the Center for Medicare and Medicaid Services, National Health Statistics Group, U.S. Department of Commerce and Bureau of Economic Analysis and Census).   Ancillary healthcare services are cost effective alternatives to physician and hospital-based services and ancillary providers offer services in 31 different categories, including those listed under “-- Services and Capabilities--Ancillary care services.”  While most efforts are placed on managing outcomes and reducing healthcare costs associated with patient care in hospitals and in physician offices, the ancillary healthcare service market is an often over-looked, but very important emerging segment of the overall United States healthcare system.  As more and more care is delivered in highly cost effective out-patient and ancillary care settings, the need for better organization and cost containment will only increase over the next several years.  

    

5


We believe that companies who understand the nuances of the ancillary healthcare market and develop the expertise to manage this de-centralized system of patient care, are able to capitalize on this market opportunity.  For example, contracting with ancillary healthcare service providers is difficult without a specific focus on the market.  This is due to the disparate nature of ancillary healthcare services and the fact that these services are offered by a wide array of providers, ranging from small independent practitioners to regional specialty practices, national providers and providers within hospital systems.  Since this market is so diverse, it has historically not been a focus of the major health plans and payors.  In addition, many health plans are conflicted because their existing hospital contracts may encourage the use of the hospital systems’ more expensive in-house ancillary services.  The Company believes that because it has developed a substantial network of providers, because it has established a sustainable advantage in this market by becoming an aggregator of these services for health plans, and because it has been retained by substantial payors, it can offer healthcare providers a substantial number of patients who are entitled to receive services from payors.  In addition, our "ancillary only" contracting focus allows us to be independent of any hospital relationships that may encourage retaining all ancillary services within the more expensive hospital setting.

Because the Company is solely focused on the nation-wide ancillary healthcare system designed specifically to help regional and mid-market payors across the country, expanding and maintaining a nation-wide, high-quality, multiple specialty ancillary provider network is a critical component of the Company’s strategy.  The Company has invested to develop its ancillary service provider network both proactively, across geographical and healthcare specialties, and reactively to address specific client needs.  While we have a national footprint of service providers, our intention is to focus on specific geographic markets where we can have a significant impact on a service provider’s patient load.  With market strength in specific geographic areas, the Company has been able to develop favorable rates with ancillary service providers and create an attractive product offering (healthcare cost savings) to regionally-based clients in those areas.

In order to enhance its ability to recruit and manage its network of providers, the Company offers a suite of value added services specifically designed to help ancillary care service providers lower their cost of doing business by assuming the responsibility for the most complex and costly interactions with payors.  The services include those listed under “-- Services and Capabilities--Ancillary care services.”   The Company believes that by becoming an indispensable business partner to the ancillary healthcare service provider community, it will continue to grow its ancillary healthcare service provider network and continue to derive favorable contracting terms from these service providers.
 
The Company seeks growth by increasing its client payor-base and service provider relationships by focusing on providing in-network services for its payors and aggressively pursuing TPAs, insurance companies, large self-funded organizations and employer groups. The Company continues to derive a significant amount of its net revenues from its traditional PPO relationships, but we focus on TPAs and direct payors that represent self-insured employer groups.  According to research reported by the Employee Benefit Research Institute, as recently as 2011, approximately 59% of employees with health insurance were covered by a self-insured plan. Thus, the Company believes that there is a large market opportunity involved in providing a highly competitive ancillary care alternative to the standard service offered by the major national insurers in select regional markets across the country.  Due to the combination of our regionally specific networks of providers and the resulting contractual cost savings related to the competitive nature of each market we are able to assist ACS’ payors compete more effectively against the major national insurers in their local markets.
 
The Company aggregates the lives of its various clients into buying power that exceeds the market power of any one of its clients individually. During 2013, our relationships with TPAs and direct payors exposed us to approximately 1.0 million covered lives. While we are also exposed to additional covered lives through our PPO relationships (including our most significant client), because we do not have direct relationships with the individual payors, it is difficult to estimate the additional number of covered lives to which we have access. As a rapid aggregator of significant patient volume, the Company believes it will be able to continue to drive favorable contracting terms from the selected service providers in the ACS Network by directing patient volume through "soft steerage" mechanisms to their practices and it will have the ability to negotiate exclusive contracts that will allow the Company to manage the full spectrum of a payor client’s ancillary healthcare benefit offerings.  The volume of collective lives we manage allows us to obtain more favorable pricing than our clients can generally obtain on their own. 


6


Sales and Marketing
 
Our sales and marketing function consists of our sales and client services groups. Our sales group is primarily responsible for securing new client contracts, while our client services group maintains our existing client relationships, as well as attempts to generate incremental growth from those relationships.

The Company markets its services to PPOs on an opportunistic basis, but primarily targets direct payors such as TPAs, insurance companies, large self-funded organizations and employer groups.  Currently, the Company utilizes both a new business sales organization of two senior sales professionals as well as a client services team of three professionals to contract with new payor organizations and then maximize the revenue and margin potential of each new payor.  The new business sales team uses a variety of channels to reach potential clients including professional relationships, direct marketing efforts, attendance at industry-specific trade shows and conferences, and through strategic partnerships with market channel partners, independent brokers, and consultants.  The client services group is engaged with each new payor to help manage the implementation process.  In addition, a Client Services Director is generally assigned to each new payor organization and is responsible for all aspects of the Company’s relationship with the entity including the expanded utilization of the Company’s services over time and the enhancement of the Company’s relationship with the payor.
 
Clients
 
The Company’s healthcare payor clients engage the Company to manage a comprehensive array of ancillary healthcare services that they and their payors have agreed to make available to their insureds or beneficiaries or for which they have agreed to provide insurance coverage.  The typical services the healthcare payors require the Company to provide include:
 
providing a comprehensive network of ancillary healthcare services providers that is available to the payor’s covered persons for covered services;

providing claims management, reporting, and processing and payment services;

performing network/needs analysis to assess the benefits to payors of adding additional/different service providers to the payor-specific provider networks; and

credentialing network service providers for inclusion in the payor-specific provider networks.
 
The terms of the agreement between the Company and the payors do not contemplate that the payors will have any relationship with the service providers and, in fact, prohibit payors from claiming directly against the service providers.  The agreements between the Company and the payors provide that it is the Company’s obligation to deliver or make available the agreed-upon services.  The Company is responsible irrespective of the existence or terms of any agreement the Company has with the service providers.  The terms of the Company-payor agreement provide that the Company is obligated to provide or arrange for the provision of all of the services covered by such agreement and the Company is responsible for ensuring that the contractual terms are met and such services are provided (whether the services are those performed directly by the Company, such as claims management, processing and payment service, network/needs analysis and credentialing, or those performed by a service provider contracted by the Company).
 
The Company’s most significant client is HealthSmart Holdings (“HealthSmart”), which consists of HealthSmart and its affiliates.  For the years ended December 31, 2013 and 2012, ACS derived 22% and 31%, respectively, of its total net revenue from HealthSmart (including its affiliates). In addition, MultiPlan, Inc. ("MultiPlan") (which acquired our legacy clients Texas True Choice, Inc. and Viant Holdings Inc.) was historically one of our two most significant clients. As a result of market consolidation, revenue generated from the relationship has declined considerably over the past several years.

7


On December 31, 2012, the Company and HealthSmart entered into a three-year agreement to continue and expand the partnership between the two organizations. Under the agreement, the Company will enhance its network of ancillary service providers to address markets outside of the commercial group health space and it will utilize an administrative fee rate differential to encourage HealthSmart to add payors that will access the Company network of ancillary providers. As part of the agreement, the Company agreed to pay HealthSmart a monthly administrative services fee subject to an annual maximum of $4,000,000, to reimburse and to compensate HealthSmart for the work it is required to perform to support the Company’s program. The fee is based upon paid claims arising from the Company’s network of providers. The agreement is subject to an automatic two year renewal term. After this initial renewal term, the agreement will automatically renew for successive periods of one year unless earlier terminated by a party for breach or unless either party provides notice of non-renewal no less than ninety days prior to the expiration of the two year renewal term or any subsequent renewal term. However, although our relationship with HealthSmart will continue, our agreement does not provide that we are their exclusive ancillary care network and they could engage other ancillary care providers directly into their network. Accordingly, we cannot be certain of any level of continued volume from HealthSmart. As part of the new agreement, the agreement between the parties dated August 1, 2002, as amended through December 31, 2008, was terminated.

In March 2010, Viant Holdings Inc. was acquired by MultiPlan, a provider of PPO network and related transaction-based solutions. As part of that transition, MultiPlan moved its payors and employer groups to its existing networks. While we did not receive a formal termination notice from MultiPlan, the transition was substantially completed as of December 31, 2012. We recognized $1.0 million in revenue in 2013 as the final employer groups transitioned to MultiPlan networks. The expectation is that all claims volume and related revenue from this client will cease sometime in 2014.

We have generated a significant portion of our net revenues from these two clients (26% in 2013 and 39% in 2012), but because of the nature of the relationships, we do not have the ability to competitively impact the relationships these organizations have with their clients, which are direct payors. In 2010, we determined that it was in our best interest to pursue clients that are direct payors, primarily TPAs, as we believe we can have more of a direct impact on the relationship. We believe we can impact relationships with direct payors through various competitive avenues, such as assisting them with more competitive pricing and plan design. During 2010 through 2013, we have added 29 new clients, of which 25 were direct payors and TPAs. We believe that the ancillary savings and the reimbursement paid to clients for connectivity and maintaining electronic claims flow provide a solid value proposition to prospective clients.

Competition
 
The Company faces five types of direct competitors:
 
The first group of competitors consists of larger, national health plans and insurers such as Aetna, Blue Cross/Blue Shield plans, Cigna, Humana, and United HealthCare.  These larger carriers offer nation-wide, standardized products and often compete on a local level based of the cost-effectiveness of their national contracts.

The second group of competitors is our own payors.  Our payors have selected us based on our extensive network of service providers and cost-savings potential.  However, they may choose to develop their own network and contract directly with the providers instead of outsourcing ancillary management services to us in the future.

The third group of competitors is more regionally-focused and consists of smaller regional PPOs, payors and community-based provider-owned networks.  These regional competitors are generally managing their own home-grown network of ancillary care providers and are more likely to offer customized products and services tailored to the needs of the local community.  These regional groups will often use their ownership and/or management of the full continuum of care in a local market to direct patients to the provider groups within their network.

The fourth group of competitors focus on managing patients within a single ancillary specialty network (e.g. dialysis, imaging or infusion), and offer comprehensive payor and provider services within their chosen ancillary category.

The fifth group of competitors are cost containment organizations that focus on a single disease category (e.g. chronic kidney disease or end stage renal disease), and offer a "carve-out" management solution that include both networks and disease management to middle market payors, reinsurance carriers and others.


8


Research and Development
 
The Company invests in its information technology infrastructure to enhance the capabilities of its databases, data retrieval tools, data exchange capabilities and claims processing engine.  In addition, the Company believes that its extensive claims database of ancillary healthcare services and costs is a strategic asset.  The Company’s capitalized development costs totaled approximately $303,000 and $419,000 during 2013 and 2012, respectively. The development expenses during those periods were related primarily to enhancements made to our internally developed claims management application. The enhancements allow the Company to develop and launch a variety of innovative products and services as well as gain competitive market advantage through faster and more accurate claims processing.
 
Government Regulation
 
The healthcare industry is extensively regulated by both the federal and state governments.  A number of states have extensive licensing and other regulatory requirements applicable to companies that provide healthcare services.  Additionally, services provided to health benefit plans in certain cases are subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).
 
Furthermore, federal and state laws govern the confidentiality of patient information through statutes and regulations that safeguard privacy rights.  The Company is subject to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), which provides national standards for electronic health information transactions and the data elements used in such transactions, as well as privacy of medical records and data security.  ACS and its clients may be subject to federal and state laws and regulations that govern financial and other arrangements among healthcare providers.  Furthermore, the Company and its clients may be subject to federal and state laws and regulations governing the submission of false healthcare claims to the government and private payors, mail pharmacy laws and regulations, consumer protection laws and regulations, legislation imposing benefit plan design restrictions, various licensure laws, such as managed care and third party administrator licensure laws, drug pricing legislation, and Medicare and Medicaid reimbursement regulations.  Possible sanctions for violations of these laws and regulations include minimum civil penalties of between $5,000-$10,000 for each false claim and treble damages, as well as criminal penalties.

During 2010, President Obama signed the Patient Protection and Affordable Care Act (the "Affordable Care Act") and the Health Care and Educational Affordability Reconciliation Act legislating broad-based changes to the U.S. healthcare system. Among other things, the health reform legislation includes insurance industry reforms including, but not limited to guaranteed coverage requirements, elimination of pre-existing condition exclusions and annual and lifetime maximum limits, and restrictions on the extent to which policies can be rescinded; creation of new market mechanisms through the creation of health benefit exchanges; and creation of new and significant taxes on health insurers and, in some circumstances healthcare benefits.

Provisions of the health reform legislation become effective at various dates over the next several years.  The Department of Health and Human Services ("HHS"), the Department of Labor and the Treasury Department have yet to issue some of the necessary enabling regulations and guidance with respect to the health care reform legislation.
 
Due to the breadth and complexity of the health reform legislation, the scope of implementing regulations and interpretive guidance, in addition to regulations and guidance yet to be issued, and the phased-in nature of the implementation, it is difficult to predict the overall impact of the health reform legislation on our business over the coming years.  Possible adverse affects of the health reform legislation include reduced revenues, increased costs, exposure to expanded liability, and requirements for us to revise the ways in which we conduct business or risk of loss of business.  In addition, our results of operations, our financial position and cash flows could be materially adversely affected.

Section 1001 of the Affordable Care Act amended Title 27 of the Public Health Service Act of 1994, as amended (the "Public Health Service Act") to add, among other things, a new Section 2718, 'Bringing Down the Cost of Health Care Coverage.' This new provision requires health insurance issuers to publicly report “the ratio of the incurred loss (or incurred claims) plus the loss adjustment expense (or change in contract reserves) to earned premiums” and account for premium revenue related to reimbursement for clinical services, activities that improve health care quality, and all other non-claims costs. The law also requires issuers to provide annual rebates to their enrollees if their medical loss ratio ("MLR") does not meet specific targets. For issuers in the large group market, the MLR must be at least 85%, and for issuers in the small group and individual markets, the MLR must be at least 80%. The law also gives the National Association of Insurance Commissioners (“NAIC”), subject to certification of the Secretary of the HHS, authority to develop definitions and standards by which to determine compliance with the requirements in the new § 2718(a).

    

9


In December 2010, HHS published final MLR regulations and agency guidance, based upon the recommendations of the NAIC, implementing the new sections of the Public Health Service Act as mandated by the Affordable Care Act.  The new regulations apply to issuers offering group or individual health insurance coverage. Under the MLR regulations, an issuer's MLR is calculated as the ratio of (i) incurred claims plus expenditures for activities that improve health care quality to (ii) premium revenue.  The two key aspects to this calculation involve what comprises an 'incurred claim' and what qualifies as an 'expenditure for health care quality improvement.' 
 
Incurred claims are reimbursement for clinical services, subject to specific deductions and exclusions.  Specifically, incurred claims represent the total of direct paid claims, unpaid claim reserves, change in contract reserves, reserves for contingent benefits, the claim portion of lawsuits and any experience rating refunds. Prescription drug rebates received by the issuer and overpayment recoveries from providers must be deducted from incurred claims.  Also, the following amounts are explicitly excluded and therefore may not be included in the calculation of incurred claims:  (i) amounts paid to third party vendors for secondary network savings; (ii) amounts paid to third party vendors for network development, administrative fees, claims processing, and utilization management; or (iii) amounts paid, including amounts paid to a provider, for professional or administrative services that do not represent compensation or reimbursement for covered services provided to an enrollee. The regulation permits that some amounts “may” be included in incurred claims - market stabilization payments, state subsidies based on stop-loss methodologies, and incentive and bonus payments made to providers.  The regulations themselves provide examples of specifically excluded amounts. With regard to amounts paid for network development (as noted in (ii) above), if an issuer contracts with a behavioral health, chiropractic network, or high technology radiology vendor, or a pharmacy benefit manager, and the vendor reimburses the provider at one amount but bills the issuer a higher amount to cover its network development, utilization management costs, and profits, then the amount that exceeds the reimbursement to the provider must not be included in incurred claims. With regard to administrative services (as noted in (iii) above), medical record copying costs, attorneys' fees, subrogation vendor fees, compensation to paraprofessionals, janitors, quality assurance analysts, administrative supervisors, secretaries to medical personnel and medical record clerks must not be included in incurred claims.

In order to properly classify what activities 'improve health care quality', the activity must be designed to improve health quality, increase the likelihood of desired health outcomes, be directed toward individual enrollees or incurred for the benefit of specific segments of enrollees, or be grounded in evidence based medicine. In addition, the activity must be primarily designed to improve health outcomes, prevent hospital readmissions, improve patient safety and reduce medical errors, implement, promote and increase wellness activities and/or enhance the use of health care data to improve quality.  The regulations also contain a list of 14 expenditures that are specifically excluded from 'improvement of health care quality' activities. Among these excluded expenditures are: (1) those that are designed primarily to control or contain costs; (2) activities that can be billed or allocated by a provider for care delivery and which are, therefore, reimbursed as clinical services; (3) expenditures related to establishing or maintaining a claims adjudication system, including costs directly related to upgrades in health information technology that are designed primarily or solely to improve claims payment capabilities or to meet regulatory requirements for processing claims (for example, costs of implementing new administrative simplification standards and code sets adopted pursuant to HIPAA including the new ICD-10 requirements); (4) all retrospective and concurrent utilization review; (5) costs of developing and executing provider contracts and fees associated with establishing or managing a provider network, including fees paid to a vendor for the same reason; (6) provider credentialing; (7) marketing expenses; (8) costs associated with calculating and administering individual enrollee or employee incentives; (9) portions of prospective utilization that does not meet the definition of activities that improve health quality; and (10) any function or activity not expressly included, unless otherwise approved by and within the discretion of the Secretary.

It is possible that a portion of the fees our existing and prospective payors are contractually required to pay us and that do not qualify as 'incurred claims' may not be included as expenditures for activities that improve health care quality. Such a determination may make it more difficult for us to retain existing clients and/or add new clients, because our clients' or prospective clients' MLR may otherwise not meet the specified targets. This may reduce our net revenues and profit margins.

The Company must continually adapt to new and changing regulations in the healthcare industry. If we fail to comply with these applicable laws, we may be subject to fines, civil penalties, or criminal prosecution.  If an enforcement action were to occur, our business and financial condition may be adversely affected.

Employees
 
As of February 24, 2014, the Company had 51 full-time employees and one part-time employee.
 

10


Item 1A.                     Risk Factors.
 
The Company’s stockholders and any potential investor in the Company’s Common Stock should carefully review and consider each of the following risk factors, as well as all other information appearing in this Annual Report on Form 10-K, relating to investment in our Common Stock.  The Company’s business faces numerous risks and uncertainties, the most significant of which are described below.  If any of the following risks actually occur, the business, financial condition, results of operations or cash flows of the Company could be materially adversely affected, the market price of the Company’s Common Stock could decline significantly, and a stockholder could lose all or part of an investment in the Company’s Common Stock.
 
The Company has one client which accounts for a substantial portion of its business and one client which has historically comprised a significant portion of its business. Revenue from the former could likely continue to decline and revenue from the latter will likely be minimal in 2014.
 
Our largest client, HealthSmart Holdings, Inc. (together with its affiliates, “HealthSmart”) accounted for approximately 22% and 31% of our net revenue during 2013 and 2012, respectively. The loss of this client or significant declines in the level of use of our services by this client (as would be the case, for example, if our clients decide to contract directly with ancillary healthcare service providers), without replacement by new business, would have a material adverse effect on the Company’s business and results of operations.

On December 31, 2012, the Company and HealthSmart entered into a three-year agreement to continue and expand the partnership between the two organizations. Under the agreement, the Company will enhance its network of ancillary service providers to address markets outside of the commercial group health space and it will utilize an administrative fee rate differential to encourage HealthSmart to add payors that will access the Company network of ancillary providers. However, although our relationship with HealthSmart will continue, our agreement does not provide that we are their exclusive ancillary care network and they could engage other ancillary care providers directly into their network. Accordingly, we cannot be certain of any level of continued volume from HealthSmart. As part of the new agreement, the agreement between the parties dated August 1, 2002, as amended through December 31, 2008, was terminated.

The Company’s failure to maintain the relationship with HealthSmart could have a material adverse effect on its business and results of operations.  Additionally, an adverse change in the financial condition of HealthSmart, including an adverse change as a result of a change in governmental or private reimbursement programs, could have a material adverse effect on our business and results of operations. Lastly, revenue from this account has declined year-over-year for the past four years. We have no assurances that revenue from the account will not continue to decline in 2014.

Recent and pending healthcare reforms could materially adversely affect our revenues, financial position and our results of operations.
 
The enactment and implementation of healthcare reforms at the federal or state level may affect certain aspects of our business, including contracting with ancillary healthcare service providers; administrative, technology or other costs; provider reimbursement methods and payment rates; premium rates; coverage determinations; mandated benefits; minimum medical expenditures; claim payments and processing; drug utilization and patient safety efforts; collection, use, disclosure, maintenance and disposal of individually identifiable health information; personal health records; consumer-driven health plans and health savings accounts and insurance market reforms; and government-sponsored programs.

During 2010, President Obama signed the Patient Protection and Affordable Care Act (the "Affordable Care Act") and the Health Care and Educational Affordability Reconciliation Act legislating broad-based changes to the U.S. healthcare system. Among other things, the health reform legislation includes insurance industry reforms including, but not limited to guaranteed coverage requirements, elimination of pre-existing condition exclusions and annual and lifetime maximum limits, and restrictions on the extent to which policies can be rescinded; creation of new market mechanisms through the creation of health benefit exchanges; and creation of new and significant taxes on health insurers and, in some circumstances healthcare benefits.


11


In December 2010, HHS published final MLR regulations and agency guidance, based upon the recommendations of the NAIC, implementing the new sections of the Public Health Service Act as mandated by the Affordable Care Act.  The new regulations apply to issuers offering group or individual health insurance coverage. Under the MLR regulations, an issuer's MLR is calculated as the ratio of (i) incurred claims plus expenditures for activities that improve health care quality to (ii) premium revenue.  The two key aspects to this calculation involve what comprises an 'incurred claim' and what qualifies as an 'expenditure for health care quality improvement.'  It is possible that a portion of the fees our existing and prospective payors are contractually required to pay us and that do not qualify as 'incurred claims' may not be included as expenditures for activities that improve health care quality. Such a determination may make it more difficult for us to retain existing clients and/or add new clients, because our clients' or prospective clients' MLR may otherwise not meet the specified targets. This may reduce our net revenues and profit margins.

Other provisions of the health reform legislation become effective at various dates over the next several years.  The HHS, the Department of Labor and the Treasury Department have yet to issue some of the necessary enabling regulations and guidance with respect to the health care reform legislation. 

Due to the breadth and complexity of the health reform legislation, the scope of implementing regulations and interpretive guidance, in addition to regulations and guidance yet to be issued, and the phased-in nature of the implementation, it is difficult to predict the overall impact of the health reform legislation on our business over the coming years.  Possible adverse affects of the health reform legislation include reduced revenues, increased costs, exposure to expanded liability, and requirements for us to revise the ways in which we conduct business or risk of loss of business.  In addition, our results of operations, our financial position and cash flows could be materially adversely affected.

The Company has a history of losses.
 
With the exception of the three years from 2008 to 2010, the Company has incurred losses in each year of its existence. As of December 31, 2013, the Company has an accumulated deficit of approximately $15.1 million.  The Company will need to add incremental new revenue to become profitable based on its current cost structure. With the decline in revenues from its two significant legacy clients, and with less than equivalent increases from other clients, we cannot determine when or if the Company can return to profitability.  No assurances can be given that the Company's current operating volumes will not continue to decline in the future.  The Company’s prospects must be considered in light of the numerous risks, expenses, delays and difficulties frequently encountered in an industry characterized by intense competition, as well as the risks inherent in the development of new programs and the commercialization of new services. Our continuing losses will also continue to reduce our available cash. We have reduced our non-variable cost structure to preserve our existing cash balances for investments in the business model and/or other strategic initiatives. However; we will need to increase our client base significantly or identify alternative business opportunities in order to stop the reduction in our available cash. If we are unable to do so, we might be required to access additional capital either through debt or equity markets. If additional financing is required, there cannot be assurances that we would be successful in obtaining sufficient capital financing on commercially reasonable terms or at all, or, if we did obtain capital financing, that it would not be dilutive to current shareholders. We do not have any lines of credit, credit facilities or outstanding bank indebtedness as of December 31, 2013.

The length of the current sales cycle may impede the Company's efforts to add new client accounts.

The sales cycle has continued to lengthen over the past several years. While we establish our value proposition to the prospects early in the process, there can be a prolonged period to secure a contract and ultimately receive claims. The extended period is due to the obtrusive nature of our implementation process and prospects' conflicting priorities. Despite efforts to strategically improve our implementation process, we can give no assurances that it will not continue to be a lengthy process to convert a sales prospect into a new client account and that our revenues will not continue to decline due to the lack of new client accounts.

The current state of the global economy may reduce our revenue and profitability and harm our growth prospects.
 
The Company's results have been impacted by the state of the economy during the last several years.  First, plan participants, seeking to spend less money, appear to be making less frequent use of some ancillary services.  Second, client consolidation within our industry has adversely affected our business.  Third, the uncertainty surrounding healthcare reform is negatively impacting healthcare spending patterns. To the extent that these trends continue, or become worse, we may receive less revenue and our profitability and growth could be adversely affected, depending on the extent of the declines.  Finally, as with any business, the deterioration of the financial condition or sale or change of control of our significant clients and/or providers could have a corresponding adverse effect on us.


12


Large competitors in the healthcare industry could choose to compete with us, reducing our margins. Some of these potential competitors may be our current clients.
 
Traditional health insurance companies, specialty provider networks, and specialty healthcare services companies are potential competitors of the Company.  These entities include well-established companies that may have greater financial, marketing and technological resources than we have. Pricing pressure caused by competition has caused many of these companies to reduce the prices charged to clients for core services and to pass on to clients a larger portion of the formulary fees and related revenues received from service providers.  Increased price competition from such companies’ entry into the market could reduce our margins and have a material adverse effect on our financial condition and results of operations.  In fact, our clients could choose to establish their own network of ancillary care providers.  As a result, we would not only lose the benefit of revenue from such clients, but we could face additional competition in our market.

The Company is dependent upon payments from third party payors who may reduce rates of reimbursement.
 
The Company’s ability to achieve profitability depends on payments provided by third-party payors.  Competition for patients, efforts by traditional third party payors to contain or reduce healthcare costs and the increasing influence of managed care payors, such as health maintenance organizations, have resulted in reduced rates of reimbursement in recent years.  If continuing, these trends could adversely affect the Company’s results of operations unless it can implement measures to offset the loss of revenues and decreased profitability. In addition, changes in reimbursement policies of private and governmental third-party payors, including policies relating to the Medicare and Medicaid programs, could reduce the amounts reimbursed to the Company’s clients for the Company’s services provided through the Company, and consequently, the amount these clients would be willing to pay for the Company’s services. Also, under the MLR regulations included in the Affordable Care Act, it is possible that a portion of the fees our existing and prospective payors are contractually required to pay us and that do not qualify as 'incurred claims' may not be included as expenditures for activities that improve health care quality. Such a determination may make it more difficult for us to retain existing clients and/or add new clients, because our clients' or prospective clients' MLR may otherwise not meet the specified targets. This may reduce our net revenues and profit margins.
 
The Company is dependent upon its network of qualified providers and its provider agreements may be terminated at any time.
 
The development of a network of qualified providers is an essential component of our business strategy.   The typical form of agreement from ancillary healthcare providers provides that these agreements may be terminated at any time by either party with or without cause.  If these agreements are terminated, specifically with one of our significant provider relationships, such ancillary healthcare providers could enter into new agreements with our competitors which would have an adverse effect on our ability to continue our business as it is currently conducted.

For any given claim, the Company is subject to the risk of paying more to the provider than it receives from the payor.
 
The Company’s agreements with its payors, on the one hand, and the service providers, on the other, are negotiated separately.  The Company has complete discretion in negotiating both the prices it charges its payors and the financial terms of its agreements with the providers.  As a result, the Company’s profit is primarily a function of the spread between the prices it has agreed to pay the service providers and the prices the Company’s payors have agreed to pay the Company.  The Company bears the pricing/margin risk because it is responsible for providing the agreed-upon services to its payors, whether or not it is able to negotiate fees and other agreement terms with service providers that result in a positive margin for the Company.  For example, during 2013 and 2012, approximately 7.2% and 5.5%, respectively, of total number of claims were “loss claims” (that is, where the amount paid by the Company to the provider exceeded the amount received by the Company from the corresponding payor for that particular claim) and these loss claims, in the aggregate, comprised approximately $373,000 and $392,000 in 2013 and 2012, respectively. There can be no assurances that the loss claim percentage will not be higher in future periods.  If a higher percentage of the Company’s claims resulted in a loss, its results of operations and financial position would be adversely affected.

An interruption of data processing capabilities and telecommunications could negatively impact the Company’s operating results.
 
Our business is dependent upon our ability to store, retrieve, process and manage data and to maintain and upgrade our data processing capabilities.  An interruption of data processing capabilities for any extended length of time, loss of stored data, programming errors, other computer problems or interruptions of telephone service could have a material adverse effect on our business.
 

13


Changes in state and federal regulations could restrict our ability to conduct our business.
 
Numerous state and federal laws and regulations affect our business and operations. These laws and regulations include, but are not necessarily limited to:

Public Health Services Act, Patient Protection and Affordable Care Act and Health Care and Educational Affordability Reconciliation Act;
 
healthcare fraud and abuse laws and regulations, which prohibit illegal referral and other payments;

the Employee Retirement Income Security Act of 1974 and related regulations, which regulate many healthcare plans;

mail pharmacy laws and regulations;

privacy and confidentiality laws and regulations;

consumer protection laws and regulations;

legislation imposing benefit plan design restrictions;

various licensure laws, such as managed care and third party administrator licensure laws;

drug pricing legislation;

Medicare and Medicaid reimbursement regulations; and

Health Insurance Portability and Accountability Act of 1996.
 
We believe we are operating our business in substantial compliance with all existing legal requirements material to the operation of our business. There are, however, significant uncertainties regarding the application of many of these legal requirements to our business, and there cannot be any assurance that a regulatory agency charged with enforcement of any of these laws or regulations will not interpret them differently or, if there is an enforcement action, that our interpretation would prevail.
 
If the Company fails to comply with the requirements of HIPAA, it could face sanctions and penalties.
 
HIPAA provides safeguards to ensure the integrity and confidentiality of health information. Violation of the standards is punishable by fines and, in the case of wrongful disclosure of individually identifiable health information, fines or imprisonment, or both. Although we provide thorough training to our employees and we intend to comply with all applicable laws and regulations regarding medical information privacy, failure to do so could have an adverse effect on our business.

Limited barriers to entry into the ancillary healthcare services market could result in greater competition.
 
There are limited barriers to entering our market, meaning that it is relatively easy for other companies to replicate our business model and provide the same or similar services that we currently provide. Major benefit management companies and healthcare companies not presently offering ancillary healthcare services may decide to enter the market. These companies may have greater financial, marketing and other resources than are available to us.  Competition from other companies may have a material adverse effect on our financial condition and results of operations.
 
The Company may be unsuccessful in hiring and retaining skilled employees.
 
The future growth of our business depends on our ability to hire and retain skilled employees.  The Company may be unable to hire and retain the skilled employees needed to succeed in our business.  Qualified employees are in great demand throughout the healthcare industry. Our failure to attract and retain sufficient skilled employees may limit the rate at which our business can grow, which will result in harm to our financial performance.  
 

14


An inability to adequately protect our intellectual property could harm the Company’s competitive position.
 
We consider our methodologies, processes and know-how to be proprietary. We seek to protect our proprietary information through confidentiality agreements with our employees, as well as our clients and contracted service providers.  The Company’s policy is to have its employees enter into a confidentiality agreement at the time employment begins, with the confidentiality agreement containing provisions prohibiting the employee from disclosing our confidential information to anyone outside of the Company, requiring the employee to acknowledge, and, if requested, assist in confirming the Company’s ownership of new ideas, developments, discoveries or inventions conceived by the employee during his or her employment with the Company, and requiring the assignment by the employee to the Company of proprietary rights to such matters that are related to our business. There can be no assurance that the steps taken by the Company to protect its intellectual property will be successful. If the Company does not adequately protect its intellectual property, its competitors may be able to use its technologies and erode or negate the Company’s competitive advantage in the market.

Fluctuations in the number and types of claims processed by the Company could make it more difficult to predict the Company’s net revenues from quarter to quarter.
 
Monthly fluctuations in the number of claims we process and the types of claims we process will impact the quarterly and annual results of the Company.  Our margins vary depending on the type of ancillary healthcare service provided, the rates associated with those services and the overall mix of these claims, each of which will impact our profitability.  Consequently, it may be difficult to predict our net revenue from one quarter to another quarter.
 
Future sales of the Company’s Common Stock, or the perception that these sales may occur, could depress the price of the Company’s Common Stock. 
 
Sales of substantial amounts of our Common Stock, or the perception in the public that such sales may occur, could cause the market price of the Company’s Common Stock to decline.  This could also impair the Company’s ability to raise additional capital through the sale of equity securities.  As of February 24, 2014, the Company had 5,713,960 shares of its Common Stock outstanding.  The outstanding shares are either freely tradable without restriction or further registration under the Securities Act, unless the shares are held by one of our “affiliates” as such term is defined in Rule 144 of the Securities Act, or are “restricted shares” as that term is defined under the Securities Act, and may be sold from time to time pursuant to a registration statement which was declared effective on February 8, 2007 by the Securities and Exchange Commission (the “SEC”), or in reliance upon an exemption from registration available under the Securities Act.  At February 24, 2014, warrants to purchase 44,444 shares of Common Stock of the Company were outstanding, and options to purchase 826,701 shares of Common Stock of the Company had been granted and were outstanding under the Company’s Amended and Restated 2005 Stock Option Plan and the 2009 Equity Incentive Plan.  At February 24, 2014, restricted stock units (“RSUs”) relating to 51,093 shares of common stock were outstanding under our 2009 Equity Incentive Plan.  In addition, an aggregate of 405,183 shares of the Common Stock of the Company remain available for future grants of RSUs, options and other equity under the Company’s Amended and Restated 2005 Stock Option Plan and 2009 Equity Incentive Plan.  If all of the outstanding warrants are exercised, all options available under the Company’s Amended and Restated 2005 Stock Option Plan and 2009 Equity Incentive Plan are issued and exercised and all RSUs are converted, there will be approximately 7,041,381 shares of Common Stock of the Company outstanding.

Some of our existing stockholders can exert control over us and may not make decisions that further the best interests of all stockholders.
 
As of February 24, 2014, our executive officers, directors and principal stockholders (greater than 5% stockholders) together control beneficially approximately 54.6% of the outstanding Common Stock of the Company.  As a result, these stockholders, if they act individually or together, may exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions.  Furthermore, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and, accordingly, they could cause us to enter into transactions or agreements which we would not otherwise consider.  In addition, this concentration of ownership of the Company’s Common Stock may delay or prevent a merger or acquisition resulting in a change in control of the Company and might affect the market price of our Common Stock, even when such a change in control may be in the best interest of all of our stockholders.


15


We are subject to the listing requirements of the NASDAQ Capital Market and there can be no assurances that we will continue to satisfy these listing requirements.
 
Our common stock is listed on The NASDAQ Capital Market, and we are therefore subject to continued listing requirements, including requirements with respect to the market value of publicly-held shares and minimum bid price per share, among others, and requirements relating to board and audit committee independence.   If we fail to satisfy one or more of the requirements, we may be delisted from The NASDAQ Capital Market.  
    
If we are delisted from The NASDAQ Capital Market and we are not able to list our common stock on another exchange, our common stock could be quoted on the OTC Bulletin Board or on the “pink sheets”. As a result, we could face significant adverse consequences including, among others,
a limited availability of market quotations for our securities;
a determination that our common stock is a "penny stock" which will require brokers trading in our common stock to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for our securities;
a limited amount of news and analyst coverage for us; and
a decreased ability to issue additional securities (including pursuant to short-form registration statements on Form S-3) or obtain additional financing in the future.

On September 21, 2011, the Company received a letter from The NASDAQ Stock Market LLC (“NASDAQ”) stating that for 30 consecutive business days immediately preceding the date of the letter the Company's common stock did not maintain a minimum closing bid price of $1.00 per share (“Minimum Bid Price Requirement”) as required by NASDAQ Listing Rule 5550(a)(2). The Company was provided 180 calendar days, or until March 19, 2012, to regain compliance.

In a letter dated March 20, 2012, NASDAQ stated that although the Company had not regained compliance with the Minimum Bid Price Requirement by March 19, 2012, it is eligible for an additional 180-day compliance period, or until September 17, 2012, based on the Company meeting the continued listing requirements for market value of publicly held shares and all other applicable standards for initial listing on the NASDAQ Capital Market (except for the Minimum Bid Price Requirement) and having notified NASDAQ of its intention to cure the deficiency during the second compliance period by effecting a reverse stock split, if necessary.

At the Company's annual meeting of stockholders, held on June 11, 2012, the stockholders voted to amend the Company's certificate of incorporation for the purposes of effecting a reverse stock split and authorized its Board of Directors to determine, in its sole discretion, whether to effect the amendment, the timing of the amendment, and the specific ratio of the reverse stock split, provided that such ratio is 1-for-2, 1-for-2.5, 1-for-3, 1-for-3.5 or 1-for-4.  

On August 31, 2012 the Company filed a Certificate of Amendment to its Certificate of Incorporation, as amended (the “Amendment”) to effect a 1-for-3 reverse stock split (“reverse split”) of its common stock, par value $0.01 per share (the “Common Stock”), effective September 4, 2012 (the “Effective Day”). Because the Amendment did not result in a reduction in the number of authorized shares of Common Stock, its effect was to increase the number of shares of Common Stock available for issuance relative to the number of shares issued and outstanding.

On the Effective Day, every three shares of the Company's Common Stock issued and outstanding immediately prior to the Effective Day were automatically combined into one share of Common Stock. Stockholders that were left with a fraction of a share as a result of the reverse split received cash in lieu of the fractional share in an amount based on the closing sale price of the Common Stock on the business day immediately preceding the Effective Day as reported on the The Nasdaq Capital Market. In addition, any options, warrants and restricted stock units outstanding as of the Effective Day were adjusted accordingly. As a result of the reverse split, the Company had 5,706,443 shares of common stock issued and outstanding as of December 31, 2012.

On September 18, 2012, the Company received notification from NASDAQ that the Company was in compliance with the Minimum Bid Price Requirement. Nonetheless, there can be no assurances that we will continue to comply with these, or other, NASDAQ requirements. If we fail to so comply, our stock may be delisted.


16


Item 2.                     Properties.
 
The Company occupies a total of 16,449 square feet of office space, all of which is leased.  The leased space comprises our principal executive offices, which is located at 5429 Lyndon B. Johnson Freeway, Suite 850, Dallas, TX 75240. In January 2013, the Company executed an extension of its existing lease agreement for a term of 24-months, expiring on March 31, 2015, and reduced the annual cost per square foot to $18.50. The Company does not own or lease any other real property and believes its offices are suitable to meet its current needs.

Item 3.                     Legal Proceedings.

None.

Item 4.                     Mine Safety Disclosures.

Not applicable.


17


PART II

Item 5.                     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information
 
The Company’s Common Stock has traded on The NASDAQ Capital Market under the symbol ANCI since September 29, 2008.  Between October 19, 2006 and September 26, 2008, our stock traded on the American Stock Exchange (“Amex”) under the symbol XSI and between December 28, 2005 and October 19, 2006, public trading of our Common Stock occurred on the OTC Bulletin Board.
 
The following table sets forth, for the fiscal periods indicated, the range of the high and low sales prices for our Common Stock on NASDAQ from January 1, 2012 through December 31, 2013. For periods prior to September 4, 2012, sales prices have been adjusted to account for the 1-for-3 reverse split described below.
 
 
High
Low
2013
 
 
Fourth Quarter Ended December 31
$
1.85

$
1.32

Third Quarter Ended September 30
2.01

1.50

Second Quarter Ended June 30
2.10

1.62

First Quarter Ended March 31
2.01

1.50

2012
 

 
Fourth Quarter Ended December 31
$
1.66

$
1.38

Third Quarter Ended September 30
2.10

1.41

Second Quarter Ended June 30
2.10

1.35

First Quarter Ended March 31
2.07

1.23

 
The closing price on NASDAQ for our Common Stock on February 24, 2014 was $2.11.

On September 21, 2011, the Company received a letter from The NASDAQ Stock Market LLC (“NASDAQ”) stating that for 30 consecutive business days immediately preceding the date of the letter the Company's common stock did not maintain a minimum closing bid price of $1.00 per share (“Minimum Bid Price Requirement”) as required by NASDAQ Listing Rule 5550(a)(2). The Company was provided 180 calendar days, or until March 19, 2012, to regain compliance.

In a letter dated March 20, 2012, NASDAQ stated that although the Company had not regained compliance with the Minimum Bid Price Requirement by March 19, 2012, it is eligible for an additional 180-day compliance period, or until September 17, 2012, based on the Company meeting the continued listing requirements for market value of publicly held shares and all other applicable standards for initial listing on the NASDAQ Capital Market (except for the Minimum Bid Price Requirement) and having notified NASDAQ of its intention to cure the deficiency during the second compliance period by effecting a reverse stock split, if necessary.

At the Company's annual meeting of stockholders, held on June 11, 2012, the stockholders voted to amend the Company's certificate of incorporation for the purposes of effecting a reverse stock split and authorized its Board of Directors to determine, in its sole discretion, whether to effect the amendment, the timing of the amendment, and the specific ratio of the reverse stock split, provided that such ratio is 1-for-2, 1-for-2.5, 1-for-3, 1-for-3.5 or 1-for-4.  

On August 31, 2012 the Company filed a Certificate of Amendment to its Certificate of Incorporation, as amended (the “Amendment”) to effect a 1-for-3 reverse stock split (“reverse split”) of its common stock, par value $0.01 per share (the “Common Stock”), effective September 4, 2012 (the “Effective Day”). Because the Amendment did not result in a reduction in the number of authorized shares of Common Stock, its effect was to increase the number of shares of Common Stock available for issuance relative to the number of shares issued and outstanding.


18


On the Effective Day, every three shares of the Company's Common Stock issued and outstanding immediately prior to the Effective Day were automatically combined into one share of Common Stock. Stockholders that were left with a fraction of a share as a result of the reverse split received cash in lieu of the fractional share in an amount based on the closing sale price of the Common Stock on the business day immediately preceding the Effective Day as reported on the The Nasdaq Capital Market. In addition, any options, warrants and restricted stock units outstanding as of the Effective Day were adjusted accordingly. As a result of the reverse split, the Company had 5,706,443 shares of common stock issued and outstanding as of December 31, 2012.

On September 18, 2012, the Company received notification from NASDAQ that the Company was in compliance with the Minimum Bid Price Requirement. Nonetheless, there can be no assurances that we will continue to comply with these, or other, NASDAQ requirements. If we fail to so comply, our stock may be delisted.

 Holders
 
As of February 24, 2014, in accordance with the records of our transfer agent, there were 151 record holders of ACS Common Stock. The number of record holders is based on the actual number of holders registered on the books of our transfer agent and does not reflect holders of shares in “street name” or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies.
  
Dividends
 
We have not declared cash dividends on our Common Stock.  We intend to retain all earnings to finance future growth and do not anticipate that we will pay cash dividends for the foreseeable future.
 
Securities Authorized for Issuance Under Equity Compensation Plans and Sales of Unregistered Securities

The information required to be disclosed herein is incorporated by reference to "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters."

Repurchases of Securities
 
There were no repurchases of the Common Stock of the Company by or on behalf of the Company or any affiliated purchasers during the fourth quarter of the Company’s fiscal year ended December 31, 2013.


19


Item 7.                    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our consolidated financial statements, which present our results of operations for the twelve month periods ended December 31, 2013 and 2012 as well as our financial position at December 31, 2013 and 2012, contained elsewhere in this Annual Report on Form 10-K.  Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Special Note Regarding Forward Looking Statements” and “Risk Factors” sections of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Company Overview
 
American CareSource Holdings, Inc. ("ACS,” "the Company,” the “Registrant,” “we,” “us,” or “our”) works to help its clients control healthcare costs by offering cost containment strategies, primarily through the utilization of a comprehensive national network of ancillary healthcare service providers.  The Company markets its services to a number of healthcare companies including third party administrators (“TPAs”), insurance companies, large self-funded organizations, various employer groups and preferred provider organizations ("PPOs").  The Company offers payors this solution by:
 
lowering its payors’ ancillary care costs through its network of high quality, cost effective providers that the Company has under contract at more favorable terms than they could generally obtain on their own;

providing payors with a comprehensive network of ancillary healthcare service providers that is tailored to each payor’s specific needs and is available to each payor’s members for covered services;

providing payors with claims management, reporting, processing and payment services;

performing network/needs analysis to assess the benefits to payors of adding additional/different service providers to the payor-specific provider networks; and

credentialing network service providers for inclusion in the payor-specific provider networks.
 
The Company has assembled a network of ancillary healthcare service providers that supplement or support the care provided by hospitals and physicians and includes 31 service categories. We have a dedicated provider development function, whose primary responsibility is to contract with providers and strategically grow our network of ancillary service providers.
    
We secure contracts with ancillary service providers by offering them the following:
    
inclusion in a nationwide network that provides exposure to our client payors and their aggregate member lives;

an array of administrative and back-office services, such as collections and appeals;

increased claims volume through various "soft steerage" mechanisms; and    

advocacy in the claims appeals process.
  
Payors route healthcare claims to us after service has been performed by participant providers in our network.  We process those claims and charge the payor according to its contractual rate for the services according to our contract with the payor.  In processing the claim, we are paid directly by the payor or the insurer for the service.  We then pay the provider of service according to its independently-negotiated contractual rate.  We assume the risk of generating positive margin, the difference between the payment we receive for the service and the amount we are obligated to pay the provider of service.


20


The Company recognizes revenues for ancillary healthcare services when services by providers have been authorized and performed, the claim has been billed to the payor and collections from payors are reasonably assured.  Cost of revenues for ancillary healthcare services consist of amounts due to providers for providing ancillary healthcare services, client administration fees paid to our client payors to reimburse them for routing the claims to us for processing, and the Company’s related direct labor and overhead of processing invoices, collections and payments. The Company is not liable for costs incurred by independent contract service providers until payment is received by it from the payors. The Company recognizes actual or estimated liabilities to independent contract service providers as the related revenues are recognized.
 
The Company is seeking growth in the number of client payors and service provider relationships it secures by focusing on providing in-network services for its payors and aggressively pursuing additional TPAs, self-insured employers and other direct payors as its primary sales targets. The Company believes this strategy should increase the volume of claims the Company can process in addition to the expansion in the number of lives that are eligible to receive ancillary healthcare benefits.  No assurances can be given that the Company can expand its service provider or payor relationships, nor that any such expansion will result in an improvement in the results of operations of the Company.
 
In addition, under the medical loss ratio ("MLR") regulations included in the Affordable Care Act, it is possible that a portion of the fees our existing and prospective payors are contractually required to pay us and that do not qualify as 'incurred claims' may not be included as expenditures for activities that improve healthcare quality. Such a determination may make it more difficult for us to retain existing clients and/or add new clients, because our clients' or prospective clients' MLR may otherwise not meet the specified targets. This may reduce our net revenues and profit margins.
 
Financial and Operational Overview

The Company has experienced significant revenue declines over the past four years, primarily related to the declines in the business of our two significant legacy clients, both of which are PPOs. Due to a variety of factors affecting the healthcare industry, including but not limited to healthcare legislation, the economy, industry consolidation, change in strategic direction of our clients and for other reasons, revenue from each of our two significant legacy clients continued to decline resulting in year-over-year declines in our revenue from those accounts. Because of the significance of the revenue concentration from these two clients (from approximately 98% in 2008 to 26% 2013), the declines of their business have had a significant negative impact on our operating results and cash position over the past four years, despite our new business development efforts. Revenue recognized from one of these clients was $1.0 million in 2013 and we do not expect any revenue from this client in 2014. While we have entered into a new agreement with the other, the agreement does not provide for any minimum level of volume, and we cannot be certain of any level of continued revenue from such relationship, despite our efforts to create new revenue streams. During the period from 2008 to 2013 (excluding the addition of any entities affiliated with either of our two significant legacy clients), we added 40 new clients, which contributed $19.4 million and $20.4 million of gross revenue in 2013 and 2012, respectively.

In 2010, we began focusing our sales efforts on TPAs, insurance companies, self-funded organizations, employer groups and direct payors, as we believe we can more competitively impact those relationships. TPAs, in their fiduciary capacity, assist their clients (primarily employer groups) with cost containment; the ancillary network solution we provide is a valuable component to add to a TPA's portfolio. There are approximately 500 TPAs nationwide, with approximately 20% of those being our target market. According to research reported by the Employee Benefit Research Institute, as recently as 2011, approximately 59% of employees with health insurance were covered by a self-insured plan. In light of changes in healthcare legislation and the size of the self-insured market, we believe that TPAs are an important element of that market, with needs that we can address, primarily from a cost containment standpoint. Our client base currently includes 28 TPAs, which generated $15.6 million and $17.4 million of gross revenue in 2013 and 2012, respectively

The Company believes that it has a unique business model and offers a solid value proposition to our client payors, as well as our providers, by delivering superior discounts through our network of contracted ancillary healthcare service providers. During 2013, we made progress in adding new client relationships, but do not believe that the revenue from those accounts will offset the losses from our two significant client relationships and declines from our other legacy accounts. We will continue to opportunistically investigate strategic initiatives that will grow our revenue base, while controlling non-variable costs consistent with our existing revenue streams. Nevertheless, until we can replace a greater amount of the revenue than we have lost from our two significant legacy clients, we will continue to experience operating losses and we will continue to reduce our existing cash reserves for operating and investing activities.


21


Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
 
The following table sets forth a comparison of our results of operations for the following periods presented (in thousands):

 
 
 
 
 
 
Change
 
 
2013
 
2012
 
$
 
%
Net revenue
 
$
26,751

 
$
34,902

 
$
(8,151
)
 
(23.4
)%
 
 
 
 
 
 
 
 
 
Variable costs:
 
 
 
 
 
 
 
 
  Provider payments
 
19,762

 
25,660

 
5,898

 
23.0

  Administrative fees
 
1,083

 
1,551

 
468

 
30.2

Total variable costs
 
20,845

 
27,211

 
6,366

 
23.4

  Percent of net revenue
 
77.9
 %
 
78.0
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Variable flowthrough
 
5,906

 
7,691

 
(1,785
)
 
(23.2
)
  Variable margin
 
22.1
 %
 
22.0
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-variable costs:
 
 
 
 
 
 
 
 
  Claims administration
 
2,106

 
2,232

 
126

 
5.6

  Provider development
 
599

 
800

 
201

 
25.1

  Sales & marketing
 
1,900

 
2,268

 
368

 
16.2

  Finance & administration
 
4,266

 
4,573

 
307

 
6.7

Total non-variable costs
 
8,871

 
9,873

 
1,002

 
10.1

  Percent of net revenue
 
33.2
 %
 
28.3
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss before depreciation, amortization, and income taxes
 
(2,965
)
 
(2,182
)
 
(783
)
 
(35.9
)
  Percent of net revenue
 
(11.1
)%
 
(6.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
 
795

 
878

 
83

 
9.5

Income tax provision
 
25

 
31

 
6

 
(19.4
)
Net loss
 
$
(3,785
)
 
$
(3,091
)
 
$
(694
)
 
(22.5
)%

The following discussion compares the historical results of operations on a basis consistent with generally accepted accounting principles ("GAAP") for the years ended December 31, 2013 and 2012.

Net Revenues
 
The Company’s net revenues are generated from ancillary healthcare service claims.  Revenue is recognized when we bill our client payors for services performed and collection is reasonably assured. The Company estimates revenues using average historical collection rates.  When estimating collectibility, we assess the impact of items such as non-covered benefits, denied claims, deductibles and co-payments. Periodically, revenues and related estimates are adjusted to reflect actual cash collections so that revenues recognized accurately reflect cash collected. There are no assurances that actual cash collections will meet or exceed estimated cash collections.

22



The following table sets forth a comparison of our net revenues and billed claims for the years ended December 31, (in thousands):

 
Net Revenue
 
Billed Claims Volume
 
 
 
Change
 
 
 
Change
(in thousands)
2013
 
2012
 
$
 
%
 
2013
 
2012
 
Claims
 
%
Legacy clients:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Material Client Relationship
$
5,905

 
$
10,704

 
$
(4,799
)
 
(45
)%
 
19

 
35

 
(16
)
 
(46
)%
MultiPlan, Inc. (formerly Viant Holdings, Inc.)
1,008

 
2,941

 
(1,933
)
 
(66
)
 
4

 
14

 
(10
)
 
(71
)
All other clients
20,125

 
21,533

 
(1,408
)
 
(7
)
 
99

 
111

 
(12
)
 
(11
)
Total gross revenue
27,038

 
35,178

 
(8,140
)
 
(23
)
 
122

 
160

 
(38
)
 
(24
)
Provision for refunds
(287
)
 
(276
)
 
(11
)
 
4

 

 

 

 
nm

Net Revenue
$
26,751

 
$
34,902

 
$
(8,151
)
 
(23
)%
 
122

 
160

 
(38
)
 
(24
)%

In addition, the following table sets forth a comparison of processed and billed claims for the years ended December 31, (in thousands):

 
 
 
 
 
 
Change
(in thousands)
 
2013
 
2012
 
Claims
 
%
Processed
 
149

 
201

 
(52
)
 
(26
)%
Billed
 
122

 
160

 
(38
)
 
(24
)


Following is a discussion of the changes in net revenue for the year ended December 31, 2013 as compared to 2012:

Material Client Relationship

The decline in billed claims volume from our relationship with one of our material clients for the year ended December 31, 2013 is due to, among others, the following factors:

The client continues to suffer attrition in its network client base, as it continues to re-focus its business strategy resulting in declines in claims volume.

Revenue from the client specifically related to dialysis services declined 78%, or approximately $2.7 million, for the year ended December 31, 2013, as compared to 2012.

Laboratory service claims from the client declined 72% for the year ended December 31, 2013, as compared to 2012. The declines in claim count resulted in estimated declines in revenue of approximately $313,000 in 2013, as compared to 2012.

Under our new agreement executed on December 31, 2012, the client has more flexibility to utilize ancillary care providers with which it is directly contracted or that are accessible through other provider networks.

The performance of the client account during 2013 was, and will continue to be, affected by attrition in its own network client base, its internal strategic initiatives and the actual utilization of our network of ancillary healthcare providers over other networks the client has access to. Despite the new agreement the Company and this client entered into on December 31, 2012, and our continued efforts to secure new revenue-generating opportunities, we cannot be certain of any level of continued volume from this client.


23


MultiPlan, Inc. (formerly Viant Holdings, Inc.)

The decline in net revenue and billed claims volume from our relationship with MultiPlan, Inc. ("MultiPlan") is due to the acquisition by MultiPlan of Viant Holdings, Inc. As part of that transition, MultiPlan moved its payors and employer groups to its existing networks. While we did not receive a formal termination notice from MultiPlan, the transition was substantially completed as of December 31, 2012. We recognized $1.0 million in revenue in 2013 as the final employer groups transitioned to MultiPlan networks. The expectation is that all claims volume and related revenue from this client will cease sometime in 2014.

All Other Clients

Our other clients consist of various relationships with PPOs, TPAs, insurance companies and direct payors which we have contracted from 2005 through the current period. Through our client service group, we maintain contact with these clients to determine if opportunities exist to serve the accounts and generate incremental revenue. Such opportunities include the addition of incremental employer groups by our clients that previously did not access our network of ancillary service provider, addressing system and work-flow issues that will improve claims volume and/or collections, focusing sales efforts on certain specialties that provide greater savings for our clients and development of our ancillary service provider network to address specific client needs.

For the year ended December 31, 2013, revenue for this client group decreased 7%, or $1.4 million, when compared to the prior year. The decrease in revenue for this client group during 2013 is due to the following factors:

Revenue from one of our PPO clients declined $1.3 million, which is primarily attributable to their employer groups not utilizing our network of ancillary providers, as well as experiencing attrition within its own client base.

Revenue from five of our other clients declined $2.7 million related to increased competition from the national carriers, attrition within their client bases and increased price competition.

The aforementioned declines were partially offset by the following:

Revenue from two of our clients increase a combined $2.0 million as a direct result of efforts from our client services group, which resulted in one client adding employer groups that previously were not utilizing our network of ancillary providers and improvement to the other client's collection percentage, and related revenue, during 2013 as compared to 2012.

One of the clients we implemented at the end of the third quarter of 2012, which was a TPA, contributed incremental revenue of $625,000 in 2013 compared to the prior year.

The following tables detail the change in revenue generated from different client types for the years ended December 31,:
 
2013
 
2012
 
Change
($ in thousands)
Count
 
Revenue
 
% of revenue
 
Count
 
Revenue
 
% of revenue
 
$
 
%
TPAs *
28

 
$
15,591

 
57.7
%
 
27

 
$
17,379

 
49.4
%
 
$
(1,788
)
 
(10
)%
PPOs
11

 
7,565

 
28.0

 
11

 
14,845

 
42.2

 
(7,280
)
 
(49
)
Direct/Insurance Companies
2

 
3,679

 
13.6

 
3

 
2,800

 
8.0

 
879

 
31

Other
3

 
203

 
0.7

 
2

 
154

 
0.4

 
49

 
32

Gross revenue, before provision for refunds
 
 
$
27,038

 
100.0
%
 
 
 
$
35,178

 
100.0
%
 
$
(8,140
)
 
(23
)%

* This group includes a TPA controlled by our most significant client. The TPA generated revenue of approximately $602,000 and $1.3 million in 2013 and 2012, respectively.

Variable Costs

Variable costs are comprised of payments to our providers and administrative fees paid to our clients for converting claims to electronic data interchange and routing them to both the Company for processing and to their payors for payment.  Payments to providers are the most significant variable cost and it consists of our payments for ancillary care services in accordance with contracts negotiated separately with providers for specific ancillary services.


24


The following tables set forth a comparison of the variable cost components of our cost of revenues, for the periods presented ended December 31,:

 
 
 
 
 
 
 
 
 
 
Change
($ in thousands)
 
2013
 
% of net revenue
 
2012
 
% of net revenue
 
$
 
%
Provider payments
 
$
19,762

 
73.9
%
 
$
25,660

 
73.5
%
 
$
(5,898
)
 
(23
)%
Administrative fees
 
1,083

 
4.0

 
1,551

 
4.4

 
(468
)
 
(30
)
Total variable costs
 
$
20,845

 
77.9
%
 
$
27,211

 
77.9
%
 
$
(6,366
)
 
(23
)%

Provider payments  

The 23% decrease in provider payments in 2013 is consistent with the decline in revenue as discussed above. The decrease in provider payments as a percentage of net revenues compared to the same prior year period is primarily due to the combination of the mix of clients that utilized our network of ancillary service providers and the mix of ancillary service categories utilized. The mix of clients and service categories shifted to those that historically contribute higher margins relative to other clients and categories.

Administrative fees

Administrative fees paid to clients as a percent of net revenues declined to 4.0% in 2013 compared to 4.4% in 2012. The decrease is due to a change in mix from clients with higher administrative fees to clients with lower administrative fees.

Non-variable Costs

Non-variable costs are those that are not contingent on claims activity and are primarily fixed in nature, but can be adjusted. They are comprised of such expenses as salaries and benefits, professional fees, consulting costs, non-cash equity compensation costs and travel and entertainment expenses. A significant driver of these costs are headcount, as payroll, commissions and related benefits (including non-cash equity compensation) accounted for approximately 59% of our non-variable cost structure during 2013. Our average headcount of full-time employees ("FTE's") was 49 and 56 at December 31, 2013 and 2012, respectively.

Following is a discussion of the changes in non-variable costs and related drivers:

Claims administration

Our claims administration function consists of our operations and information technology groups.  Our operations group is responsible for most aspects of claims management and processing, including billing and quality assurance. In addition, our operations group is responsible for credentialing contracted ancillary service providers.  The cost of our operations group is adjusted consistent with the level of claims we process and bill. Our information technology group is responsible for maintaining and enhancing the technological capabilities and applications of the claims management process, is not solely driven by claims volume.  

During the twelve months ended December 31, 2013, the costs related to the claims administration function decreased 6% partially due to a decrease in outsourced claims processing costs of $52,000, consistent with the decline in claims volume. Additionally, headcount decreased by one FTE, through natural attrition, within the information technology group, which contributed to the reduction in costs year-over-year.

Provider Development

Our provider development function is responsible for developing our network of ancillary healthcare service providers, which includes contracting with providers to be included in the network and maintaining a relationship with existing providers, all for the purpose of enhancing our ancillary service provider network for our client payors. We customize networks for our clients, thus as new client contracts are secured, our recruiting activities will increase.

The 25% decrease in costs related to the provider development function during the year ended December 31, 2013 as compared to the year ended December 31, 2012 is primarily the result of a headcount reduction of one FTE, through natural attrition, reduced legal fees and travel expenses.


25


Sales and Marketing

Our sales and marketing function consists of our sales and client services groups, as well as the strategic development group. Our sales group is primarily responsible for securing new client contracts, while our client services group maintains our existing client relationships, as well as attempts to generate incremental growth from those relationships. The strategic development group is responsible for executing the strategic objectives as dictated by the Board of Directors and executive management.

The 16% decrease in costs related to sales and marketing during the twelve months ended December 31, 2013 as compared to the same prior year period was the result of a reduction in total consulting fees of approximately $123,000 and a headcount reduction of two FTE's, when compared to the same prior year period.

Finance and Administration
    
Our finance and administration function consists primarily of human resources, finance and accounting, and performance management as well as our former Chief Executive Officer, former President and Chief Operating Officer and Chief Financial Officer.

For the year ended December 31, 2013, costs related to the finance and administration function decreased 7%, as compared to the same prior year period. A decrease of approximately $307,000, year-over-year, is the result of a reduction in professional fees related to strategic consulting, audit fees, legal consultation regarding employment issues and legal review of various client contracts. A severance charge of approximately $216,000 was recorded in the second quarter of 2013, but was offset by the decrease in expenses discussed above.

Selling, General and Administrative Expenses

Following is a table showing the components of selling, general and administrative (“SG&A”) expenses as presented per the Statement of Operations for the periods presented ending December 31,:
 
 
 
 
 
 
Change
($ in thousands)
 
2013
 
2012
 
$
 
%
Sales and marketing
 
$
1,900

 
$
2,268

 
$
368

 
16
%
Finance and administration
 
4,266

 
4,573

 
307

 
7

Selling, general and administrative expenses
 
$
6,166

 
$
6,841

 
$
675

 
10
%
Percentage of total net revenues
 
23.0
%
 
19.6
%
 
 
 
 

SG&A expenses as a percentage of total net revenues increased during the year ended December 31, 2013 compared to the prior year, due primarily to the decline in net revenues compared to the same prior year period.

Income Tax Provision
 
For the years ended December 31, 2013 and 2012, we recorded an income tax provision of approximately $25,000 and $31,000, respectively.  The effective income tax rates for 2013 and 2012 were different from the statutory United States federal income tax rate of 34% due primarily to the establishment of a deferred income tax valuation allowance of approximately $2.8 million in 2011 and an increase in the allowance by approximately $1,009,000 and $845,000 in 2013 and 2012, respectively.


26


Liquidity and Capital Resources

     As of December 31, 2013 the Company had working capital of $5.6 million compared to $9.0 million at December 31, 2012.  Our cash and cash equivalents balance decreased to $6.2 million as of December 31, 2013 compared to $10.7 million at December 31, 2012. We continued to experience a decline in claims volume and resulting revenue, resulting in a net loss during the year ended December 31, 2013 which expended cash despite various cost containment measures. During the third quarter we invested $500,000 in a project with a strategic partner that is expected to facilitate the future implementation of new business. Additionally, the decline in our cash balance is also attributable to the timing of payments to providers during January 2013 related to cash received from payors in December 2012. The payments made totaled $1.2 million. Following are the components of our cash flows for the year ended December 31, 2013:

 
Year ended December 31, 2013
Loss before income taxes
$
(3,760
)
Depreciation and amortization
795

Non-cash stock-based compensation expense
299

Investment in joint project with strategic partner
(500
)
Capital expenditures (primarily software development costs)
(315
)
Other working capital changes
(1,017
)
Decrease in cash for the year ended December 31, 2013
$
(4,498
)

We believe our current cash balance of $6.2 million as of December 31, 2013 will be sufficient to meet our anticipated cash needs for working capital, capital expenditures, strategic initiatives and other activities through the foreseeable future. Our continuing losses will also continue to reduce our available cash. We have reduced our non-variable cost structure to preserve our existing cash balances for investments in the business model and/or other strategic initiatives. However; we will need to increase our client base significantly or identify alternative business opportunities in order to stop the reduction in our available cash. If we are unable to do so, we might be required to access additional capital either through debt or equity markets. If additional financing is required, there cannot be assurances that we would be successful in obtaining sufficient capital financing on commercially reasonable terms or at all, or, if we did obtain capital financing, that it would not be dilutive to current shareholders. We do not have any lines of credit, credit facilities or outstanding bank indebtedness as of December 31, 2013.

Inflation
 
Inflation did not have a significant impact on the Company’s costs during the years ended December 31, 2013 and December 31, 2012, respectively.  The Company continues to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions.

Off-Balance Sheet Arrangements
 
The Company did not have any off-balance sheet arrangements at December 31, 2013 or December 31, 2012 or for the periods then ended.


27


Critical Accounting Policies
 
Critical accounting policies are those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
 
The Company’s significant accounting policies are described in the Notes to the Consolidated Financial Statements located elsewhere in this Annual Report on Form 10-K. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following accounting policies are deemed to be critical by our management:

Revenue recognition.

The Company recognizes revenue on the services that it provides, which includes (i) providing payor clients with a comprehensive network of ancillary healthcare providers, (ii) providing claims management, reporting, processing and payment services, (iii) providing network/need analysis to assess the benefits to payor clients of adding additional/different service providers to the client-specific provider networks and (iv) providing credentialing of network services providers for inclusion in the client payor-specific provider networks.  Revenue is recognized when services are delivered, which occurs after processed claims are billed to the client payors and collections are reasonably assured.  The Company estimates revenues and costs of revenues using average historical collection rates and average historical margins earned on claims.  Periodically, revenues are adjusted to reflect actual cash collections so that revenues recognized accurately reflect cash collected.

The Company determines whether it is acting as a principal or agent in the fulfillment of the services rendered.  After careful evaluation of the key gross and net revenue recognition indicators, the Company acknowledges that while the determination of gross versus net reporting is highly judgmental in nature, the Company has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.

Following are the key indicators that support the Company’s conclusion that it acts as a principal when settling claims for service providers through its contracted service provider network:

The Company is the primary obligor in the arrangement. The Company has assessed its role as primary obligor as a strong indicator of gross reporting.  The Company believes that it is the primary obligor in its transactions because it is responsible for providing the services desired by its client payors.  The Company has distinct, separately negotiated contractual relationships with its client payors and with the ancillary health care providers in its networks.  The Company does not negotiate “on behalf of” its client payors and does not hold itself out as the agent of the client payors when negotiating the terms of the Company’s ancillary healthcare service provider agreements.  The Company’s agreements contractually prohibit client payors and service providers to enter into direct contractual relationships with one another.  The client payors have no control over the terms of the Company’s agreements with the service providers.  In executing transactions, the Company assumes key performance-related risks.  The client payors hold the Company responsible for fulfillment, as the provider, of all of the services the client payors are entitled to under their contracts; client payors do not look to the service providers for fulfillment.  In addition, the Company bears the pricing/margin risk as the principal in the transactions.  Because the contracts with the client payors and service providers are separately negotiated, the Company has complete discretion in negotiating both the prices it charges its client payors and the financial terms of its agreements with the service providers.  Since the Company’s profit is the spread between the amounts received from the client payors and the amount paid to the service providers, it bears significant pricing/margin risk.  There is no guaranteed mark-up payable to the Company on the amount the Company has contracted.  Thus, the Company bears the risk that amounts paid to the service provider will be greater than the amounts received from the client payors, resulting in a loss or negative claim.

The Company has latitude in establishing pricingAs stated above, the Company has complete latitude in negotiating the price to be paid to the Company by each client payor and the price to be paid to each contracted service provider.  This type of pricing latitude indicates that the Company has the risks and rewards normally attributed to a principal in the transactions.


28


The Company changes the product or performs part of the services. The Company provides the benefits associated with the relationships it builds with the client payors and the services providers.  While the parties could deal with each other directly, the client payors would not have the benefit of the Company’s experience and expertise in assembling a comprehensive network of service providers, in claims management, reporting and processing and payment services, in performing network/needs analysis to assess the benefits to client payors of adding additional/different service providers to the client payor-specific provider networks, and in credentialing network service providers.

The Company has complete discretion in supplier selection. The Company has complete discretion in supplier selection.  One of the key factors considered by client payors who engage the Company is to have the Company undertake the responsibility for identifying, qualifying, contracting with and managing the relationships with the ancillary healthcare service providers.  As part of the contractual arrangement between the Company and its client payors, the payors identify their obligations to their respective covered persons and then work with the Company to determine the types of ancillary healthcare services required in order for the payors to meet their obligations.  The Company may select the providers and contract with them to provide services at its discretion.

The Company is involved in the determination of product or service specifications. The Company works with its client payors to determine the types of ancillary healthcare services required in order for the payors to meet their obligations to their respective covered persons.  In some respects, the Company is customizing the product through its efforts and ability to assemble a comprehensive network of providers for its payors that is tailored to each payor’s specific needs.  In addition, as part of its claims processing and payment services, the Company works with the client payors, on the one hand, and the providers, on the other, to set claims review, management and payment specifications.

The supplier (and not the Company) has credit risk. The Company believes it has some level of credit risk, but that risk is mitigated because the Company does not remit payment to providers unless and until it has received payment from the relevant client payors following the Company’s processing of a claim.

The amount that the Company earns is not fixed. The Company does not earn a fixed amount per transaction nor does it realize a per-person per-month charge for its services.

The Company has evaluated the other indicators of gross and net revenue recognition, including whether or not the Company has general inventory risk.  The Company does not have any general inventory risk, as its business is not related to the manufacture, purchase or delivery of goods and it does not purchase in advance any of the services to be provided by the ancillary healthcare service providers.  While the absence of this risk would be one indicator in support of net revenue reporting, as described in detail above, the Company has carefully evaluated all of the key gross and net revenue recognition indicators and has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.

The Company records a provision for refunds based on an estimate of historical refund amounts. Refunds are paid to payors for overpayments on claims, claims paid in error, and claims paid for non-covered services. In some instances, we will recoup payments made to the ancillary service provider if the claim has been fully resolved. The evaluation is performed periodically and is based on historical data. We present revenue net of the provision for refunds on the consolidated statements of operations.

Intangible Assets.
 
Intangible assets consist of ancillary provider network and internally developed claims payment and billing software.  The software has been fully amortized using the straight-line method over its expected useful life of 5 years. The ancillary provider network is being amortized using the straight-line method over their expected useful lives of 15 years.  Experience to date is that approximately 2-8% annual turnover or attrition of provider contracts occurs each year.  The ancillary provider network is being accounted for on a pooled basis and the actual cancellation rates of provider contracts that were acquired are monitored for potential impairment or amortization adjustment, if warranted.  We have performed an impairment assessment based on projected future cash flows and determined no impairment exists as of December 31, 2013 and 2012. The cost of adding additional providers is considered an ongoing operating expense, and is captured on the Statement of Operations under "Claims administration and provider development".

    

29


Deferred Income Taxes.

Income taxes are accounted for under the asset and liability method.  Deferred taxes arise because of different treatment between financial statement accounting and tax accounting, known as “temporary differences”.  The Company records the tax effect of these temporary differences as “deferred tax assets” (generally items that can be used as a tax deduction or credit in the future periods) and “deferred tax liabilities” (generally items that we received a tax deduction for, which have not yet been recorded in the statements of operations).  The deferred tax assets and liabilities are measured using enacted tax rules and laws that are expected to be in effect when the temporary differences are expected to be recovered or settled. The realization of the deferred tax assets, including net operating loss carryforwards, is subject to our ability to generate sufficient taxable income during the periods in which the temporary differences become realizable. In evaluating whether a valuation allowance is required, we consider all available positive and negative evidence, including prior operating results, the nature and reason of any losses, our forecast of future taxable income, and the dates of which any deferred tax assets are expected to expire. These assumptions require a significant amount of judgment, including estimates of future taxable income. The estimates are based on our best judgment at the time made based on current and projected circumstances and conditions. Based on estimates impacted by such factors as revenue declines of our two most significant client accounts and the impact of operating results, we determined that a valuation allowance was appropriate. In 2011, a valuation allowance in the amount of $2.8 million was established against the net deferred tax assets with the exception of the Texas tax credit carryforward of approximately $232,000. The valuation allowance against the net deferred tax assets increased by approximately $1.0 million to $4.6 million and the Texas tax credit carryforward was approximately $228,000 as of December 31, 2013.

Pending Accounting Pronouncements

None.
 
Item 8.                    Financial Statements and Supplementary Data.

The Company’s consolidated financial statements and supplementary data required to be filed pursuant to this Item 8 are located at the end of this Annual Report on Form 10-K, beginning on page F-1.

Item 9.                    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
 
None.

Item 9A.                  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2013.  Based upon this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effective to ensure that information required to the disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosures.


30


Management’s Annual Report on Internal Control over Financial Reporting
 
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting by the Company.  “Internal control over financial reporting“ is defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act, as amended, as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the Company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the Company; and

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.
 
Internal control over financial reporting has inherent limitations and may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Management reviewed the results of its assessment with the Audit Committee of the Company’s Board of Directors.  Based on this assessment, management believes that, as of December 31, 2013, the Company has maintained effective internal control over financial reporting.
 
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
 
Changes in Internal Control over Financial Reporting
 
Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has concluded there were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company's last fiscal quarter that have materially affected the Company’s internal control over financial reporting or are reasonably likely to materially affect internal control over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses.

Item 9B.                  Other Information

Not applicable.

31


PART III

Item 10.                  Directors, Executive Officers and Corporate Governance

The information required by this Item 10 is incorporated herein by reference to the applicable information contained in the definitive proxy statement for our 2014 annual meeting of stockholders or our annual report on Form 10-K/A, which will be filed with the SEC not later than 120 days after our fiscal year ended December 31, 2013.

Item 11.                    Executive Compensation

The information required by this Item 11 is incorporated herein by reference to the applicable information contained in the definitive proxy statement for our 2014 annual meeting of stockholders or our annual report on Form 10-K/A, which will be filed with the SEC not later than 120 days after our fiscal year ended December 31, 2013.

Item 12.                 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table provides information with respect to the equity securities that are authorized for issuance under our equity compensation plans as of December 31, 2013:
 
Equity Compensation Plan Information at December 31, 2013
Plan Category
Number of securities to be issued upon
exercise of outstanding options, warrants and rights
(Column (a))
Weighted-average exercise price of outstanding options, warrants and rights

Number of securities remaining available for future issuance under equity compensation plans, excluding securities reflected in column (a)
Equity compensation plans approved by security holders
800,894

$
4.43

482,083

Equity compensation plans not approved by security holders



Total
800,894

$
4.43

482,083

 
In addition, warrants to purchase 44,444 shares of Common Stock of the Company were issued and outstanding as of December 31, 2013, as shown in the table below.  

 
Shares of Common Stock issuable under outstanding warrants
Weighted-average exercise price of outstanding warrants
Series E (1)
44,444

$
1.50

Total Warrants Outstanding
44,444

$
1.50


(1)
These warrants were granted to an employee on February 25, 2011 as incentive to achieve defined and agreed upon revenue targets generated by new clients within a five year term. Pursuant to the original agreement, the Company agreed to issue warrants to purchase 83,333 shares of common stock with an exercise price of $5.01. The agreement also obligated the Company to issue warrants to purchase up to an additional 166,666 shares of common stock (issued in 83,333 increments) upon the achievement of additional defined agreed upon revenue targets. On February 1, 2012, certain terms of the agreement were modified, including the revenue targets and the total number of shares under the initial and future warrants. The warrant issuance now allows for 44,444 shares to be purchased at an exercise price of $1.50, 22,222 of which vested immediately, and the remaining 22,222 shares vesting upon the achievement of certain revenue targets. The number of shares under the future warrant issuances was also reduced to 88,889 (issued in 44,444 increments) shares based upon the achievement of additional defined agreed upon revenue targets. In making the issuance of these warrants without registration under the Securities Act of 1933, as amended (the "Securities Act"), the Company relied upon the exemption from registration contained in Section 4(2) of the Securities Act.

Shares of common stock and common stock equivalents, along with earnings per share and other per share amounts, have been retroactively restated to reflect the 1-for-3 reverse stock split that occurred on September 4, 2012 for all periods presented.

The other information required by this Item 12 is incorporated herein by reference to the applicable information contained in the definitive proxy statement for our 2014 annual meeting of stockholders or our annual report on Form 10-K/A, which will be filed with the SEC not later than 120 days after our fiscal year ended December 31, 2013.


32


Item 13.                    Certain Relationships and Related Transactions, and Director Independence

The information required by this Item 13 is incorporated herein by reference to the applicable information contained in the definitive proxy statement for our 2014 annual meeting of stockholders or our annual report on Form 10-K/A, which will be filed with the SEC not later than 120 days after our fiscal year ended December 31, 2013.

Item 14.                    Principal Accounting Fees and Services

The information required by this Item 14 is incorporated herein by reference to the applicable information contained in the definitive proxy statement for our 2014 annual meeting of stockholders or our annual report on Form 10-K/A, which will be filed with the SEC not later than 120 days after our fiscal year ended December 31, 2013.


33


PART IV

Item 15.                  Exhibits and Financial Statement Schedules

(a)    The following documents are filed as part of this Annual Report on Form 10-K:

(1)    Financial Statements
 
The following financial statements are set forth in Item 8 hereof:
 

(2)    Financial Statement Schedules    
 
None.

(3)    Exhibits 
 
Reference is made to the Exhibit Index at the end of this Annual Report on Form 10-K.


34


Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders
 
American CareSource Holdings, Inc.
 
We have audited the accompanying consolidated balance sheets of American CareSource Holdings, Inc. and Subsidiary as of December 31, 2013 and 2012, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended.  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 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 the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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 American CareSource Holdings, Inc. and Subsidiary as of December 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
 
/s/ McGladrey LLP
 
Des Moines, Iowa
February 28, 2014


F-1


AMERICAN CARESOURCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31,
(amounts in thousands, except per share data)
 
 
2013
 
2012
Net revenues
$
26,751

 
$
34,902

Cost of revenues:
 
 
 
Provider payments
19,762

 
25,660

Administrative fees
1,083

 
1,551

Claims administration and provider development
2,705

 
3,032

Total cost of revenues
23,550

 
30,243

 
 
 
 
Contribution margin
3,201

 
4,659

 
 
 
 
Selling, general and administrative expenses
6,166

 
6,841

Depreciation and amortization
795

 
878

Total operating expenses
6,961

 
7,719

 
 
 
 
Loss before income taxes
(3,760
)
 
(3,060
)
Income tax provision
25

 
31

Net loss
$
(3,785
)
 
$
(3,091
)
 
 
 
 
Loss per basic and diluted common share
$
(0.66
)
 
$
(0.54
)
 
 
 
 
Basic and diluted weighted average common shares outstanding
5,715

 
5,707


 
See accompanying notes.


F-2


AMERICAN CARESOURCE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
(amounts in thousands except per share amounts)
 
 
2013
 
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
6,207

 
$
10,705

Accounts receivable, net
1,977

 
2,432

Prepaid expenses and other current assets
357

 
290

Deferred income taxes
6

 
6

Total current assets
8,547

 
13,433

 
 
 
 
Property and equipment, net
1,236

 
1,593

 
 
 
 
Other assets:
 

 
 

Deferred income taxes
215

 
222

Other assets
391

 
16

Intangible assets, net
640

 
768

 
$
11,029

 
$
16,032

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Due to service providers
$
1,865

 
$
3,100

Accounts payable and accrued liabilities
1,056

 
1,343

Total current liabilities
2,921

 
4,443

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Stockholders’ equity:
 

 
 

Preferred stock, $0.01 par value; 10,000 shares authorized none issued

 

Common stock, $0.01 par value; 40,000 shares authorized; 5,713 and 5,706 shares issued and outstanding in 2013 and 2012, respectively
57

 
57

Additional paid-in capital
23,149

 
22,845

Accumulated deficit
(15,098
)
 
(11,313
)
Total stockholders’ equity
8,108

 
11,589

 
$
11,029

 
$
16,032


 
See accompanying notes.


F-3


AMERICAN CARESOURCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the years ended December 31, 2013 and 2012
(amounts in thousands)
 
 
 
Common Stock
 
 

 
 

 
 

 
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Total Stockholders’ Equity
Balance at December 31, 2011
 
5,692

 
$
57

 
$
22,414

 
$
(8,222
)
 
$
14,249

Net loss
 

 

 

 
(3,091
)
 
(3,091
)
Stock-based compensation expense
 

 

 
408

 

 
408

Issuance of common stock as equity incentive awards, net of tax withholdings
 
13

 

 
23

 

 
23

Issuance of common stock upon conversion of restricted stock units, net of tax withholdings
 
1

 

 

 

 

Balance at December 31, 2012
 
5,706

 
57

 
22,845

 
(11,313
)
 
11,589

Net loss
 

 

 

 
(3,785
)
 
(3,785
)
Stock-based compensation expense
 

 

 
299

 

 
299

Issuance of common stock upon exercise of equity incentive awards
 
5

 

 
5

 

 
5

Issuance of common stock upon conversion of restricted stock units, net of tax withholdings
 
2

 

 

 

 

Balance at December 31, 2013
 
5,713

 
$
57

 
$
23,149

 
$
(15,098
)
 
$
8,108


 
See accompanying notes.



F-4


AMERICAN CARESOURCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(amounts in thousands)
 
 
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(3,785
)
 
$
(3,091
)
Adjustments to reconcile net loss to net cash used in operations:
 
 
 
 
Non-cash stock-based compensation expense
 
299

 
408

Depreciation and amortization
 
795

 
878

Amortization of long-term client agreement
 

 
250

Deferred income taxes
 
7

 
4

Loss on write-off of software development costs
 
5

 
14

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
455

 
1,885

Prepaid expenses and other assets
 
(442
)
 
27

Accounts payable and accrued liabilities
 
(287
)
 
129

Due to service providers
 
(1,235
)
 
(578
)
Net cash used in operating activities
 
(4,188
)
 
(74
)
 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Investments in software development costs
 
(303
)
 
(419
)
Additions to property and equipment
 
(12
)
 
(109
)
Net cash used in investing activities
 
(315
)
 
(528
)
 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

Proceeds from exercise of equity incentives
 
5

 

Payment of income tax withholdings on net exercise of equity incentives
 

 
(8
)
Net cash provided by (used in) financing activities
 
5

 
(8
)
 
 
 
 
 
Net decrease in cash and cash equivalents
 
(4,498
)
 
(610
)
Cash and cash equivalents at beginning of period
 
10,705

 
11,315

 
 
 
 
 
Cash and cash equivalents at end of period
 
$
6,207

 
$
10,705

 
 
 
 
 
Supplemental cash flow information:
 
 

 
 

Cash paid for taxes
 
$
117

 
$
49

 
 
 
 
 
Supplemental non-cash operating and financing activity:
 
 

 
 

Accrued bonus paid with equity incentives
 
$

 
$
23


 
See accompanying notes.


F-5


AMERICAN CARESOURCE HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013
(Tables in thousands, except per share amounts)

1. Summary of Significant Accounting Policies
 
American CareSource Holdings, Inc. ("ACS,” "the Company,” the “Registrant,” “we,” “us,” or “our”) works to help its clients control healthcare costs by offering cost containment strategies, primarily through the utilization of a comprehensive national network of ancillary healthcare service providers.  The Company markets its services to a number of healthcare companies including third party administrators (“TPAs”), insurance companies, large self-funded organizations, various employer groups and preferred provider organizations ("PPOs").  The Company offers payors this solution by:
 
lowering its payors’ ancillary care costs through its network of high quality, cost effective providers that the Company has under contract at more favorable terms than they could generally obtain on their own;

providing payors with a comprehensive network of ancillary healthcare service providers that is tailored to each payor’s specific needs and is available to each payor’s members for covered services;

providing payors with claims management, reporting, processing and payment services;

performing network/needs analysis to assess the benefits to payors of adding additional/different service providers to the payor-specific provider networks; and

credentialing network service providers for inclusion in the payor-specific provider networks.

Basis of Presentation
 
The consolidated financial statements include the accounts of the Company and its one wholly-owned subsidiary, Ancillary Care Services, Inc.  All material intercompany accounts and transactions are eliminated in consolidation.  Certain prior year amounts have been reclassified within the consolidated statement of operations, consolidated balance sheet, and consolidated statement of cash flow to conform to the current year presentation.
 
Cash and Cash Equivalents
 
The Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents include amounts in deposit accounts in excess of federally insured limits of $250,000.  The Company has not experienced any losses in such accounts.
 
Revenue Recognition
 
The Company recognizes revenue on the services that it provides, which includes (i) providing payor clients with a comprehensive network of ancillary healthcare providers, (ii) providing claims management, reporting, processing and payment services, (iii) providing network/need analysis to assess the benefits to payor clients of adding additional/different service providers to the client-specific provider networks and (iv) providing credentialing of network services providers for inclusion in the client payor-specific provider networks.  Revenue is recognized when services are delivered, which occurs after processed claims are billed to the client payors and collections are reasonably assured.  The Company estimates revenues and costs of revenues using average historical collection rates and average historical margins earned on claims.  Periodically, revenues are adjusted to reflect actual cash collections so that revenues recognized accurately reflect cash collected.

The Company determines whether it is acting as a principal or agent in the fulfillment of the services rendered.  After careful evaluation of the key gross and net revenue recognition indicators, the Company acknowledges that while the determination of gross versus net reporting is highly judgmental in nature, the Company has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.

Following are the key indicators that support the Company’s conclusion that it acts as a principal when settling claims for service providers through its contracted service provider network:

The Company is the primary obligor in the arrangement.  The Company has assessed its role as primary obligor as a strong indicator of gross reporting.  The Company believes that it is the primary obligor in its transactions because it is responsible for providing the services desired by its client payors.  The Company has distinct, separately negotiated contractual relationships with its client payors and with the ancillary health care providers in its networks.  The Company does not negotiate “on behalf of” its client payors and does not hold itself out as the agent of the client payors when negotiating the terms of the Company’s ancillary healthcare service provider agreements.  The Company’s agreements contractually prohibit client payors and service providers to enter into direct contractual relationships with one another.  The client payors have no control over the terms of the Company’s agreements with the service providers.  In executing transactions, the Company assumes key performance-related risks.  The client payors hold the Company responsible for fulfillment, as the provider, of all of the services the client payors are entitled to under their contracts; client payors do not look to the service providers for fulfillment.  In addition, the Company bears the pricing/margin risk as the principal in the transactions.  Because the contracts with the client payors and service providers are separately negotiated, the Company has complete discretion in negotiating both the prices it charges its client payors and the financial terms of its agreements with the service providers.  Since the Company’s profit is the spread between the amounts received from the client payors and the amount paid to the service providers, it bears significant pricing/margin risk.  There is no guaranteed mark-up payable to the Company on the amount the Company has contracted.  Thus, the Company bears the risk that amounts paid to the service provider will be greater than the amounts received from the client payors, resulting in a loss or negative claim.
 
The Company has latitude in establishing pricing.  As stated above, the Company has complete latitude in negotiating the price to be paid to the Company by each client payor and the price to be paid to each contracted service provider.  This type of pricing latitude indicates that the Company has the risks and rewards normally attributed to a principal in the transactions.
 
The Company changes the product or performs part of the services.  The Company provides the benefits associated with the relationships it builds with the client payors and the services providers.  While the parties could deal with each other directly, the client payors would not have the benefit of the Company’s experience and expertise in assembling a comprehensive network of service providers, in claims management, reporting and processing and payment services, in performing network/needs analysis to assess the benefits to client payors of adding additional/different service providers to the client payor-specific provider networks, and in credentialing network service providers.
 
The Company has discretion in supplier selection.  The Company has complete discretion in supplier selection.  One of the key factors considered by client payors who engage the Company is to have the Company undertake the responsibility for identifying, qualifying, contracting with and managing the relationships with the ancillary healthcare service providers.  As part of the contractual arrangement between the Company and its client payors, the payors identify their obligations to their respective covered persons and then work with the Company to determine the types of ancillary healthcare services required in order for the payors to meet their obligations.  The Company may select the providers and contract with them to provide services at its discretion.
 
The Company is involved in the determination of product or service specifications.  The Company works with its client payors to determine the types of ancillary healthcare services required in order for the payors to meet their obligations to their respective covered persons.  In some respects, the Company is customizing the product through its efforts and ability to assemble a comprehensive network of providers for its payors that is tailored to each payor’s specific needs.  In addition, as part of its claims processing and payment services, the Company works with the client payors, on the one hand, and the providers, on the other, to set claims review, management and payment specifications.

The supplier (and not the Company) has credit risk.  The Company believes it has some level of credit risk, but that risk is mitigated because the Company does not remit payment to providers unless and until it has received payment from the relevant client payors following the Company’s processing of a claim.
 
The amount that the Company earns is not fixed.  The Company does not earn a fixed amount per transaction nor does it realize a per-person per-month charge for its services.

The Company has evaluated the other indicators of gross and net revenue recognition, including whether or not the Company has general inventory risk.  The Company does not have any general inventory risk, as its business is not related to the manufacture, purchase or delivery of goods and it does not purchase in advance any of the services to be provided by the ancillary healthcare service providers.  While the absence of this risk would be one indicator in support of net revenue reporting, as described in detail above, the Company has carefully evaluated all of the key gross and net revenue recognition indicators and has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.

If the Company were to report its revenues net of provider payments rather than on a gross reporting basis, for the years ended December 31, 2013 and 2012, its net revenues would have been $7.0 million and $9.2 million, respectively.
 
The Company records a provision for refunds based on an estimate of historical refund amounts. Refunds are paid to payors for overpayments on claims, claims paid in error, and claims paid for non-covered services. In some instances, we will recoup payments made to the ancillary service provider if the claim has been fully resolved. The evaluation is performed periodically and is based on historical data. We present revenue net of the provision for refunds on the consolidated statements of operations.

Provider Payments
 
Payments to providers is the largest component of our cost of revenues and it consists of our payments for ancillary care services in accordance with contracts negotiated with providers for specific ancillary services, separately from contracts negotiated with our clients.
 
Use of Estimates
 
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States 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 financial statements and the reported amounts of revenues and expenses during the reporting period.  The company considers its most significant estimates to be the collectibility of revenue and payments due to providers (and resulting margin as a percentage of revenue). Actual amounts could differ from those estimates.
 
Property and Equipment
 
Property and equipment are recorded at original cost and increased by the cost of any significant improvements subsequent to purchase.  The Company expenses repairs and maintenance as incurred.  Depreciation and amortization is calculated using the straight-line method over the shorter of the asset’s estimated useful life or the term of the lease in the case of leasehold improvements.  The Company capitalizes costs associated with software developed for internal use.  During 2013 and 2012, we capitalized approximately $303,000 and $419,000 of internally developed software costs, respectively.  
 
Research and Development
 
Research and development costs are expensed as incurred.

Income Taxes
 
Income taxes are accounted for under the asset and liability method.  Deferred taxes arise because of different treatment between financial statement accounting and tax accounting, known as “temporary differences”.  The Company records the tax effect of these temporary differences as “deferred tax assets” (generally items that can be used as a tax deduction or credit in the future periods) and “deferred tax liabilities” (generally items that we received a tax deduction for, which have not yet been recorded in the statements of operations).  The deferred tax assets and liabilities are measured using enacted tax rules and laws that are expected to be in effect when the temporary differences are expected to be recovered or settled.  A valuation allowance is established to reduce deferred tax assets considered to be more likely than not that the deferred tax assets will not be realized.

Stock Compensation
 
The Company records all stock-based payments to employees in the consolidated financial statements over the vesting period based on their estimated fair values as of the measurement date of the respective awards.  Additional information about the Company’s stock-based payment plan is presented in Note 8.
 
Segment and Related Information
 
The Company uses the “management approach” for reporting information about segments in its annual and interim financial statements.  The management approach is based on the way the chief operating decision-maker organizes segments within a company for making operating decisions and assessing performance.  Reportable segments are based on products and services, geography, legal structure, management structure and any other manner in which management disaggregates a company.  Based on the “management approach” model, the Company determined that the business is comprised of a single operating segment.
 
Fair Value of Financial Instruments
 
The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities.  The fair value of instruments is determined by reference to various market data and other valuation techniques, as appropriate.  Unless otherwise disclosed, the fair value of short-term financial instruments approximates their recorded values due to the short-term nature of the instruments. 

2. Concentration of Credit Risk

During the years ended December 31, 2013 and 2012, five of the Company's clients comprised a significant portion of the Company’s revenues. The following is a summary of the approximate amounts of the Company’s revenue and accounts receivable contributed by each of those clients as of the dates and for the periods presented (amounts in thousands):

 
 
2013
 
2012
 
 
Accounts Receivable
 
Revenue
 
% of Total Revenue
 
Accounts Receivable
 
Revenue
 
% of Total Revenue
Material Client Relationship
 
$
532

 
$
5,905

 
22
 %
 
$
720

 
$
10,704

 
31
 %
HealthMarkets, Inc.
 
252

 
3,599

 
13

 
149

 
2,752

 
8

Benefit Administrative Systems, LLC
 
148

 
2,618

 
10

 
87

 
2,379

 
7

HealthSCOPE Benefits, Inc.
 
69

 
2,511

 
9

 
50

 
1,348

 
4

MultiPlan, Inc. (formerly Viant Holdings, Inc.)
 

 
1,008

 
4

 
22

 
2,941

 
8

All Others
 
1,312

 
11,397

 
43

 
1,711

 
15,054

 
43

Allowance for Uncollectable Receivables/Provision for refunds
 
(336
)
 
(287
)
 
(1
)
 
(307
)
 
(276
)
 
(1
)
 
 
$
1,977

 
$
26,751

 
100
 %
 
$
2,432

 
$
34,902

 
100
 %

The Material Client Relationship includes five related entities and MultiPlan, Inc. includes two related entities, which are aggregated for this presentation.  

3. Allowance for Uncollectable Receivables and Provision for Refunds
 
The Company maintains an allowance for uncollectable receivables which primarily relates to payor refunds.  Refunds are paid to payors for overpayments on claims, claims paid in error, and claims paid for non-covered services. In some instances, we will recoup payment made to the ancillary service provider if the claim has been fully resolved. Co-payments, deductibles and co-insurance payments can also impact the collectability of claims.  While the Company is able to process a claim and estimate the cash it will receive from the payor for that claim, the presence of co-pays, deductibles and co-insurance payments can affect the ultimate collectability of the claim.  The Company records an allowance against revenue to better estimate collectability.   Provisions for refunds recorded were approximately $287,000 and $276,000 for the years ended December 31, 2013 and 2012, respectively. The allowance was approximately $336,000 and $307,000 at December 31, 2013 and 2012, respectively.


F-6


4. Property and Equipment
 
Property and equipment, net consists of the following:
 
 
 
Useful Lives (years)
 
2013
 
2012
Software – internally developed
 
5
 
$
2,877

 
$
2,582

Software – purchased
 
3-5
 
596

 
614

Computer equipment
 
3-5
 
589

 
594

Furniture and fixtures
 
5
 
358

 
356

Leasehold improvements
 
7
 
205

 
205

 
 
 
 
4,625

 
4,351

Accumulated depreciation and amortization
 
 
 
(3,389
)
 
(2,758
)
Property and equipment, net
 
 
 
$
1,236

 
$
1,593


The Company recognized depreciation expense of approximately $667,000 and $750,000 during 2013 and 2012, respectively. The depreciation amounts include approximately $503,000 and $437,000 of amortization of internally developed software during 2013 and 2012, respectively.
    
The Company capitalizes costs associated with internally developed software, developed for internal use only, during the application development stage. Application development stage costs generally include costs associated with internal-use software configuration, coding, installation and testing. Costs of significant upgrades and enhancements that result in additional functionality also are capitalized, whereas costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. Capitalized costs include external direct costs of materials and services utilized in developing or obtaining internal-use software and payroll and payroll-related expenses for employees who are directly associated with and devote time to the internal-use software project. Capitalization of such costs begins when the preliminary project stage is complete and ceases no later than the point at which the project is substantially complete and ready for its intended purpose.

During the years ended December 31, 2013 and 2012, the Company capitalized costs related to enhancements to its internal information technology claims management applications. The applications were originally developed in 2005 and from time to time, the Company will enhance the functionality and reporting capabilities of the applications. The enhancements are typically developed by the Company's internal information technology group. For internal resources, the Company capitalizes salary and related benefits. Periodically, third-party consultants will be utilized to perform the development with all related costs capitalized.

5. Income Taxes
 
Income tax provision for the years ended December 31, differed from the U.S. federal income tax rate of 34% approximately in the amounts indicated as a result of the following:
 
 
2013
 
2012
Computed “expected” tax provision (benefit)
 
$
(1,278
)
 
$
(1,040
)
Increase in the valuation allowance for deferred tax assets
 
1,009

 
845

Short-fall on stock options, warrants, and RSUs
 
330

 
245

State taxes
 
19

 
25

Permanent items
 
12

 
10

Other
 
(67
)
 
(54
)
Total income tax provision
 
$
25

 
$
31


Differences between financial accounting principles and tax laws cause differences between the bases of certain assets and liabilities for financial reporting purposes and tax purposes.

    

F-7


The tax effects of these differences, to the extent they are temporary, are recorded as deferred tax assets and liabilities and consisted of the following components:
 
 
2013
 
2012
Deferred tax assets:
 
 

 
 
Operating loss carryforward
 
$
3,197

 
$
1,919

Accounts receivable allowance
 
69

 
106

Texas tax credit carryforward
 
221

 
228

Stock option compensation
 
1,070

 
1,306

Goodwill
 
602

 
723

Accrued expenses
 
120

 
121

Alternative Minimum Tax credit carryforwards
 
16

 
16

Total deferred tax assets
 
5,295

 
4,419

Deferred tax liabilities:
 
 
 
 

Property and equipment
 
(397
)
 
(514
)
Prepaid expense
 
(71
)
 
(80
)
Total deferred tax liabilities
 
(468
)
 
(594
)
Valuation allowance
 
(4,606
)
 
(3,597
)
Net deferred tax assets
 
$
221

 
$
228

 
In 2011, a valuation allowance in the amount of $2.8 million was established against the net deferred tax assets with the exception of the Texas tax credit carryforward of approximately $232,000. During the year ended December 31, 2013, the Company increased the valuation allowance by approximately $1,009,000, which was included in the income tax provision for the year ended December 31, 2013. Due to the nature and timing of the reversal of the deferred tax assets and liabilities, the valuation allowance was established against the net deferred tax assets with the exception of the Texas tax credit carryforward of approximately $221,000.

    As of December 31, 2013 and 2012, the net operating loss carryforwards were approximately $14.5 million and $10.9 million, which expire in 2025 through 2031. Included in the net operating loss carryforward is approximately $5.4 million which related to the excess tax benefits for stock options and warrants exercised which will result in a credit to additional paid in capital of approximately $1.9 million when the associated tax deduction results in a reduction in the income taxes payable.

The income tax provision shown on the statement of operations for the years ended December 31, 2013 and 2012 consisted of the following:
 
 
2013
 
2012
Current
 
$
18

 
$
27

Deferred
 
7

 
4

 
 
$
25

 
$
31


The Company has evaluated the accounting guidance for uncertainty in income taxes. Management has evaluated their material tax positions and determined there is no income tax effects with respect to the consolidated financial statements. The Company has identified the United States and Texas as major tax jurisdictions and is no longer subject to federal or state income tax examinations by tax authorities for years before 2007. During 2011 and the early part of 2012 the Company underwent an examination by tax authorities for its U.S. federal return for the year ended 2009. In August of 2012, the Company was notified that there were no changes proposed to the 2009 income tax return.

6. Intangible Assets

The ancillary provider network is being amortized using the straight-line method over their expected useful lives of 15 years.  Experience to date is that approximately 2-8% annual turnover or attrition of provider contracts occurs each year.  The ancillary provider network is being accounted for on a pooled basis and the actual cancellation rates of provider contracts that were acquired are monitored for potential impairment or amortization adjustment, if warranted.  We have performed an impairment assessment based on projected future cash flows and determined no impairment exists as of December 31, 2013 and 2012.  The cost of adding additional providers is considered an ongoing operating expense, and is captured on the Statement of Operations under "Claims administration and provider development".

F-8



The following is a summary of our intangible assets as of December 31, for the years presented: 
 
 
2013
 
2012
Ancillary provider network
 
$
1,921

 
$
1,921

Software
 
428

 
428

 
 
2,349

 
2,349

Accumulated amortization
 
(1,709
)
 
(1,581
)
Intangibles, net
 
$
640

 
$
768


The capitalized value of the ancillary provider network that was acquired in the 2003 acquisition of the assets of our predecessor, American CareSource Corporation by Patient Infosystems (now CareGuide, Inc.), our former parent corporation. Amortization expense was approximately $128,000 for each of the years ended December 31, 2013 and 2012.  Amortization expense is estimated at $128,000 per year through 2018.

7. Commitments and Contingencies
 
The Company leases office space under a non-cancelable lease agreement. In January 2013, the Company executed an extension of its existing lease agreement for a term of 24-months, expiring on March 31, 2015, which is included in the table below. Additionally the Company leases certain equipment under non-cancelable lease agreements, which expire at various dates through September 2016.
 
At December 31, 2013 minimum annual lease payments for operating leases are approximately as follows:
 
Operating Leases
 
 
2014
$
345

2015
91

2016
6

 
 
Total minimum lease payments
$
442


Expense related to operating leases was approximately $342,000 and $318,000 for the years ended December 31, 2013 and 2012, respectively.
 
8. Stock-Based Compensation
 
Stock Options
 
American CareSource Holdings, Inc. has an Employee Stock Option Plan (the “Stock Option Plan”) for the benefit of certain employees, non-employee directors, and key advisors.  On May 16, 2005, the stockholders approved the 2005 Stock Option Plan which (i) authorized options to purchase 749,776 shares and (ii) established the class of eligible participants to include employees, nominees to the Board of Directors of American CareSource Holdings and consultants engaged by American CareSource Holdings, limited to 16,667 shares of Common Stock underlying the one-time grant of a Non-Qualified Option to which non-employee directors or non-employee nominees of the Board of Directors may be entitled.  Stock options granted under the Stock Option Plan may be of two types:  (1) incentive stock options and (2) nonqualified stock options.  The option price of such grants shall be determined by a Committee of the Board of Directors (the “Committee”), but shall not be less than the estimated fair value of the common stock at the date the option is granted.  The Committee shall fix the terms of the grants with no option term lasting longer than ten years.  The ability to exercise such options shall be determined by the Committee when the options are granted.
 
Over time this plan has been amended to increase the number of shares available to a total of 1,249,776 shares.


F-9


On May 19, 2009, the stockholders of the Company approved the 2009 Equity Incentive Plan (the “2009 Plan”).  The purpose of the 2009 Plan is (a) to allow selected employees and officers of the Company to acquire and increase equity ownership in the Company, which will strengthen their commitment to the success of the Company, and to attract new employees, officers and consultants, (b) to provide annual cash incentive compensation opportunities that are competitive with other peer corporations, (c) to optimize the profitability and growth of the Company through incentives that are consistent with the Company’s goals, (d) to provide grantees an incentive for individual excellence, (e) to promote teamwork and (f) to attract and retain highly-qualified persons to serve as non-employee directors.  The 2009 Plan allows for awards of non-qualified options, stock appreciation rights, restricted shares, performance units/shares, deferred stock, dividend equivalents and other stock-based awards up to 500,000 shares.  The term of the 2009 Plan is ten years and all non-qualified options will be valued at not less than 100% of the market value of the Company’s stock on the date of grant.
 
Shares of common stock reserved for future grants under the Stock Option Plan and the 2009 Plan (the “Plans”) were 482,083 and 494,788 at December 31, 2013 and 2012, respectively.
 
Compensation expense related to all equity awards, including non-qualified stock options, restricted stock units and warrants, that has been charged against income for the years ended December 31, 2013 and 2012 was approximately $299,000 and $408,000, respectively.

The awards granted to employees and non-employee directors become exercisable over periods of up to five years.  The fair value of each award granted is estimated on the date of grant using the Black-Scholes-Merton valuation model that uses the assumptions noted in the following table.  Volatility is calculated using an analysis of historical volatility.  The Company believes that the historical volatility of the Company’s stock is the best method for estimating future volatility.  The expected lives of options are determined based on the Company’s historical share option exercise experience.  The Company believes the historical experience method is the best estimate of future exercise patterns currently available.  The risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the awards.  The expected dividend yields are based on the approved annual dividend rate in effect and current market price of the underlying common stock at the time of grant. 
 
 
2013
 
2012
Weighted average grant date fair value
 
$
1.26

 
$
1.01

Weighted average assumptions used:
 
 
 
 
Expected volatility
 
75.8
%
 
77.7
%
Expected lives (years)
 
6.2

 
6.2

Risk free interest rate
 
1.7
%
 
1.0
%
Forfeiture rate
 
20.5
%
 
20.5
%
Dividend rate
 

 


A summary of stock option activity is as follows:
 
Options
(thousands)
 
Weighted-Average Exercise Price
Outstanding at December 31, 2011
739

 
$
6.72

Granted
100

 
1.49

Forfeited
(33
)
 
5.11

Cancelled
(14
)
 
10.65

Exercised

 

Outstanding at December 31, 2012
792

 
6.06

Granted
284

 
1.88

Forfeited
(113
)
 
2.88

Cancelled
(208
)
 
6.99

Exercised
(5
)
 
0.93

Outstanding at December 31, 2013
750

 
4.74

Exercisable at December 31, 2013
400

 
$
6.66

     
As of December 31, 2013, the weighted average remaining contractual life of the options outstanding was 6.6 years and the weighted average remaining contractual life of the outstanding exercisable options was 4.5 years.


F-10