NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING AND PRINCIPLES OF CONSOLIDATION

The Company has elected to not adopt the option available under United States generally accepted accounting principles ("GAAP") to measure any eligible financial instruments or other items at fair market value at this time. Accordingly, the Company measures all of its assets and liabilities on the historical cost basis of accounting, except as otherwise required by GAAP.

Inter-company accounts and transactions have been eliminated in consolidation. Certain minor reclassifications of prior period amounts have been made to conform to the current year presentation.

USE OF ESTIMATES

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates that affect the reported amounts. Actual results could differ from these estimates. Estimates involved in the determination of accrued claims payable, including incurred but not reported, are considered by management as particularly susceptible to material change in the next year. Other significant estimates relate to stock based compensation, valuation of warrants and beneficial conversion features.

ACCOUNTS RECEIVABLE

Accounts and notes receivable are carried net of an allowance at their estimated collectible value. Since customer credit is generally extended on a short-term basis, accounts receivable do not bear interest and are uncollateralized. We manage credit risk and determine necessary allowances by evaluating customers' credit worthiness before extending credit and periodically for collectability, based primarily on customers' past credit history and current financial conditions and general economic conditions, results of prior collection efforts, the relative strength of our relationship therewith and, in the event of a dispute, its legal position and the estimated cost of proposed collection proceedings. Management has not established a policy for when to charge off uncollectible accounts receivable or to use external collection agencies and makes such decisions on a case-by-case basis. The maximum losses that the Company would incur if a customer failed to pay would be limited to the carrying value of the receivable after any related allowances provided.

PROPERTY AND EQUIPMENT

Property and equipment (Note 3) is stated at cost less accumulated depreciation. Depreciation and amortization are computed using the straight-line method over the estimated useful lives ranging from 2 to 12 years. Leasehold improvements are amortized over the shorter of the lease term or the asset's useful life.

ACCRUED CLAIMS PAYABLE

Accrued claims payable includes losses under our managed care contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated and estimated amounts for claims incurred but not yet reported ("IBNR") to us. We perform this loss accrual analysis on a contract-by-contract basis taking into consideration such factors as future contractual revenue, estimated future healthcare and maintenance costs, and each contract's specific terms related to future revenue increases as compared to expected increases in healthcare costs. Future healthcare and maintenance costs are estimated based on historical trends and expected future cost increases.

We generally have the ability to cancel a contract with 60 to 90 days written notice or request a renegotiation of terms under certain circumstances, if a managed care contract is not meeting our financial goals. Prior to a cancellation, we typically submit a request for a rate increase accompanied by supporting utilization data. Although our clients have historically been generally receptive to such requests, no assurance can be given that such requests will be fulfilled in our favor in the future. If a rate increase is not granted, we have the ability, in some cases, to terminate the contract and limit our risk to a short-term period.

On a quarterly basis, we perform a review of our portfolio of contracts for the purpose of identifying loss contracts (as defined in Accounting Standards Codification ("ASC") 944-60, "Premium Deficiency and Loss Recognition") and developing a contract loss allowance, if applicable, for succeeding periods. Our review at December 31, 2011 identified one contract for which it is probable that a loss will be incurred during the remaining contract term. We have submitted a request for a rate increase accompanied by supporting utilization data. No assurance can be given that such rate request will be granted. Based on available information, we have estimated the loss at $450,000 and established an allowance for the loss on our consolidated balance sheet. At December 31, 2010, no contract loss allowance for future periods was necessary.

FAIR VALUE MEASUREMENTS

The carrying amounts of cash, accounts receivable and accounts payable approximate their estimated fair value due to the short-term nature of these instruments. Since our other financial liabilities are not traded in an open market, we generally use a present value technique, which is a level 3 input, as defined in GAAP, to measure the estimated fair value of these financial instruments, except for valuing stock options and warrants (see below). The rate used for discounting expected cash flows is a risk-free rate adjusted for systematic and unsystematic risk.

The carrying amounts and estimated fair values of these financial instruments (all are liabilities) at December 30, 2011 and 2010, are as follows (in thousands):


	December 31
	2011					2010
	Carrying Amount			Estimated Fair Value		Carrying Amount			Estimated Fair Value
Promissory notes	$	2,920		$	2,908	$	2,750		$	2,834
Zero-coupon promissory notes		230			225		230			225
Debentures		549			557		579			554
Senior promissory notes		1,759			1,786		1,727			1,653
Long-term promissory notes		3,600			3,649		—			—
Less Unamortized discount		(361	)		—		(719	)		—

Net liabilities	$	8,697		$	9,125	$	4,567		$	5,266

REVENUE RECOGNITION

Revenue under our agreements to provide contracted behavioral healthcare and pharmacy management services to subscribing members is earned continuously regardless of services actually provided and, therefore, recognized monthly based on the number of qualified members. The information regarding qualified members is supplied by our clients, and we review member eligibility records and other reported information to verify its accuracy and determine the amount of revenue to be recognized. In some cases, we may adjust our monthly revenue periodically as claims data becomes available to permit a comparison of actual claims costs to targeted claims costs, for example, as a result of unforeseen variations in utilization. Similar to our other at-risk arrangements, pharmacy drug management revenue is recognized monthly as it is earned at a contracted rate per eligible member. All other service revenues are on a non-risk basis and earned and recognized as services are provided.

COSTS OF REVENUES

Costs of revenues consist of three major components: claims expense, pharmacy expense and healthcare operating expense. Claims expense is recognized in the period in which an eligible member actually receives services and includes an estimate of the cost of behavioral health services that have been incurred but not yet reported.

We also incur pharmacy expense under the contracts for which we manage the psychotropic drug benefit. Pharmacy expense is recognized in the period in which an eligible member actually receives psychotropic medications. The health plan's PBM periodically reports the cost of drugs used, which is subtracted from our pharmacy management premium to yield a net payment to us or payment to the health plan, depending on actual drug usage. Healthcare operating expenses are any expenses associated with care administration, which are recognized in the period that they incur.

LEGAL DEFENSE COSTS

We accrue an estimate of incurred legal defense costs in connection with pending disputes and litigation matters as part of our estimated minimum probable losses (see Note 7c).

INCOME TAXES

We are subject to the income tax jurisdictions of the U.S., Puerto Rico and multiple state tax jurisdictions. However, our provisions for income taxes for 2011 and 2010 include only state income taxes (see Note 9).

Management has evaluated our tax positions taken or to be taken on income tax returns that remain subject to examination (i.e., tax years 2008 and thereafter federally), and has concluded that there have been no uncertain tax positions (as defined in GAAP) taken that require recognition or disclosure in the consolidated financial statements. In the event of any income tax-related interest or penalties are incurred, they would be included in general and administrative expense.

STOCK OPTIONS AND WARRANTS

We grant stock options and warrants (see Note 8) to our employees, non-employee directors, note holders and certain consultants and clients allowing them to purchase our common stock pursuant to approved terms. The estimated value of the warrants issued with debt instruments is recorded as a discount on notes payable and amortized as interest expense over the term of the notes using the effective interest method.

We use a Black-Scholes valuation model to estimate the fair value of options and warrants on the measurement date and for determining the allocation of the relative values of debt and warrants. In applying the model, we use level 3 inputs, as defined by GAAP, consisting of historical data and management judgment to estimate the expected terms of the instruments. Expected volatility is based on the historical volatility of our traded stock. We do not expect to pay dividends for the period of the expected life of the instruments, and therefore we assume no expected dividend. The assumed risk-free rates used are based on the U.S. Treasury yield curve with the same expected terms as those of the equity instruments at the time of grant.

The following table lists the assumptions utilized in applying the Black-Scholes valuation model for options and warrants.


	2011	2010

Expected volatility	160%	160%
Expected life (in years) of options	1-10	5
Expected life (in years) of warrants	3-10	3-5
Risk-free interest rate range, options	0.10-2.03%	1.49%
Risk-free interest rate range, warrants	0.62-1.97%	0.62-1.85%
Expected dividend yield	0%	0%

PER SHARE DATA

For the periods presented, since losses would produce anti-dilution, no diluted loss per common share is presented. The following table sets forth the computation of basic loss per common share (amounts in thousands, except per share data):


	December 31,
	2011			2010

Numerator:
Net loss attributable to common stockholders	$	(14,088	)	$	(10,426	)


Denominator:
Weighted average common shares		57,031			46,156

Basic loss per share attributable to common stockholders	$	(0.25	)	$	(0.23	)