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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
 For the fiscal year ended on June 30, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 For the transition period from  to
 Commission file number 000-26749
 NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC.
  Delaware
    
    11-2581812(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employee Identification No.)26 Harbor Park Drive, 
Port Washington, NY
(Address of principal executive offices)
    
    11050
(Zip Code)
 Registrants telephone number, including area code: (516) 605-6625
 Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock, $.001 par value per share
 Securities registered pursuant to Section 12(g) of the Exchange Act:
None
 o þ
 o þ
 þ o
 o
 o þ o
 o þ




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DOCUMENTS INCORPORATED BY REFERENCE:
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##### 



INDEX
 Page No.Forward Looking Statements
    
    
    4PART IItem 1. Business
    
    
    4Item 1A. Risk Factors
    
    
    27Item 1B. Unresolved Staff Comments
    
    
    36Item 2. Properties
    
    
    36Item 3. Legal Proceedings
    
    
    37Item 4. Submission of Matters to a Vote of Security Holders
    
    
    37PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
    
    
    38Item 6. Selected Financial Data
    
    
    40Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    41Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    56Item 8. Financial Statements and Supplementary Data
    
    
    56Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
    
    
    56Item 9A. Controls and Procedures
    
    
    56Item 9B. Other Information
    
    
    59PART IIIItem 10. Directors, Executive Officers and Corporate Governance
    
    
    60Item 11. Executive Compensation
    
    
    60Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
    
    
    60Item 13. Certain Relationships and Related Transactions, and Director Independence
    
    
    60Item 14. Principal Accountant Fees and Services
    
    
    60PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    61Signatures
    
    
    66Ex-4.1 Specimen of Common Stock CertificateEx-4.2 Specimen of Series A 7% Convertible Preferred Stock CertificateEx-4.5 Registration Rights Agreement dated March 19, 2004Ex-10.2 Amendment No.1 to Credit AgreementEx-10.3 Amendment No.2 to Credit AgreementEx-10.9 Health Card Sublease AgreementEx-10.25 Consulting Agreement and Departure AgreementEx-10.26 Departure Agreement and General Release between NMHC and Mr. Tery BaskinEx-10.29 Departure Agreement and General Release between NMHC and Mr. James F. SmithEx-10.30 National Medical Health Card Corporate Incentive PlanEx-10.31 Form of Severance Agreement with executive officersEx-10.33 Management Rights Letter dated March 19, 2004Ex-10.35 General Release dated June 28, 2007Ex-10.36 Stock Option Agreement dated October 27, 2003Ex-10.37 Stock Option Agreement dated May 6, 2005Ex-10.39 Stock Option Agreement dated September 17, 2004Ex-21.1 List of SubsidiariesEx-23.1 Consent of Ernst & Young LLPEx-31.1 Section 302 Certification of the CEOEx-31.2 Section 302 Certification of the CFOEx-32.1 Section 906 Certification of the CEOEx-32.2 Section 906 Certification of the CFO
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Forward Looking Statements
  
 PART I
 
 Item 1. BUSINESS.
 The following description of our business should be read in conjunction with the information
contained elsewhere in this Form 10-K . References in this Form 10-K to we, our, us, the
Company, or NMHC refer to National Medical Health Card Systems, Inc.
 General
   4




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OVERVIEW
 Recent Developments
      Industry Background
  Company Overview
  5




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
    
    PBM Services: Management of prescription drug programs for customers.
    
    Mail Service: Mail Service pharmacy for chronic therapy medications.
    
    Specialty Service: Management of specialty pharmacy programs include
infertility, transplant, growth hormone, Respiratory Syncytial Virus (RSV),
hepatitis C, rheumatoid arthritis, Gauchers disease, multiple sclerosis and
oncology.
    
    Medicare Part D Program: Medicare Part D benefits delivered to our customers.
 THE COMPANY
 PBM Services
  
    
    Claims Management;
    
    Pharmacy Network Management;
    
    Benefit Design Consultation;
    
    Drug Review and Analysis;
    
    Formulary Design;
    
    Data Access, Reporting and Information Analysis; and
    
    Medicare Part D infrastructure and support services.
  Claims Management
 Claims Processing.
  Invoicing and Payments
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Rebate Administration
  Pharmacy Network
  Benefit Design Consultation
  
    
    Participant cost  sharing levels (i.e., deductibles and co-pays);
    
    Covered and excluded drugs;
    
    Generic drug usage;
    
    Clinical and utilization management strategies;
    
    Alternate programs and services;
    
    Maintenance medication programs; and
    
    Medicare Part D services.
 
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Drug Review and Analysis
  
    
    drug interactions;
    
    premature refills of prescriptions;
    
    duration and duplication of therapy;
    
    pregnancy and breast feeding precautions;
    
    geriatric or pediatric precautions;
    
    compliance with prescriptions; and
    
    other contraindications.
  Formulary Design
  
    
    provides information to customers to ensure that the covered drugs of each plan
reflect the current standard of medical practice and pharmacology;
    
    evaluates drugs for clinical efficacy prior to cost considerations for inclusion in
a plan as a preferred drug;
    
    analyzes current literature for safety, efficacy and cost-effectiveness of covered
drugs;
    
    provides recommendations on drug therapy and utilization;
    
    evaluates drug review and analysis programs and criteria;
    
    recommends those drugs which require prior authorization from the customer; and
    
    reviews the associated guidelines for those drugs proper use.
  Data Access, Reporting and Information Analysis
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
    
    On-line system access whereby the customer is able to update and maintain certain
plan components such as participant eligibility;
    
    Periodic utilization and financial reports, which our representatives utilize to
assist customers regarding benefit design, cost containment initiatives, disease
information initiatives, generic equivalents programs and formulary management; and
    
    Plan performance indicators and ad-hoc reporting through our proprietary decision
support tools.
 Mail Service
   Specialty Service
    
    
    Delivery to a location of the patients choice (home delivery or delivery to the
patients primary care physician or specialist);
    
    Educational materials about therapies and disease states;
    
    Refill management and compliance monitoring;
    
    Pharmacist hotline;
    
    Assignment of benefits; and
    
    Study protocols and financial assistance program information.
 
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Medicare Part D Program
     Customers
   Our Business Strategy
  10




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Target Markets
  State and Local Governments:
 Unions/Taft-Hartley Trust Funds:
 Employer Groups:
 Third Party Administrators (TPAs):
 Managed Care Organizations (MCOs):
 Company Operations
 Sales and Marketing
  www.nmhc.com
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Information Systems
    Competition
   
    
    a successful record of delivering services at lower annual costs for our customers
than national trends;
    
    a broad base of experience in the information technology and PBM industries;
    
    flexible and sophisticated on-line information systems, which integrate all of the
data input, reporting, analysis, and access functions provided by NMHC;
    
    wholly-owned and operated mail service and specialty pharmacies;
    
    an integrated Medicare Part D prescription drug program;
    
    effective and measurable clinical management programs;
    
    a focus on customer service; and
    
    transparency to customers.
 
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Employees
  Government Regulation
    Anti-Kickback Statutes
   13




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Medicare Part D Prescription Drug Program Reforms
   14




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Stark Law
  State Self-Referral Laws
  15




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Statutes Prohibiting False Claims and Fraudulent Billing Activities
 qui tam
  Regulations Regarding Privacy and Confidentiality
    16




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ERISA
  17




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FDA Regulation
  Consumer Protection Laws
  Regulations Applicable to Health Care Professionals
  Third Party Administrator, Utilization Review Laws and Preferred Provider Organizations
  State Insurance Laws
  19




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Mail Service Pharmacy Regulation
  20




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Deficit Reduction Act of 2005
    21




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Antitrust
  Regulation of PBMs
  22




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Legislation and Regulation Affecting Drug Prices
    23




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24




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Legislation Affecting Plan Design
   Network Access Limitations
  25




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Formulary Restrictions
  Industry Standards for PBMs
  Future Legislation
  Company Information
 Address and Availability of Information
 http://www.nmhc.com www.sec.gov
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Code of Ethics
  
 Item 1A. RISK FACTORS.
 We face intense competition in the PBM industry.
  Recent changes in our senior management may affect our ability to retain customers, to win new
business, to maintain employees and attract new personnel.
   If we do not successfully integrate our past acquisitions, our business and results of
operations will suffer.
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
    
    Integrating the operations, services and products of the acquired company;
    
    Managing the inconsistencies in standards, controls, procedures and
policies among the companies being combined or assimilated which has made
it more difficult to implement and harmonize company-wide financial,
accounting, billing, information technology and other systems;
    
    Difficulties maintaining the quality of products and services that
acquired companies have historically provided;
    
    Diversion of managements attention from other business concerns; and
    
    Losing key employees and customers of the acquired business.
  We rely on a limited number of key customers for a significant portion of our revenues. The loss
of any of these key customers as a result of competitive bidding for contracts, consolidation of
customers or otherwise, could adversely affect our business, profitability and growth prospects.
   Due to complex calculations within our customer contracts, we may be required to issue significant
credit memos to our customers that could adversely affect our business, profitability and growth
prospects.
  Due to the complex laws and regulations governing the Medicare program in which we participate, our
recorded estimates may materially change in the future, and our failure to fully comply with such
laws and regulations may adversely impact our business and financial results.
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Changes in industry pricing benchmarks could adversely affect our financial performance.
     We rely on third parties for our point of sale information system and transaction processing
system, and any disruption in these services would materially disrupt our business and results of
operations
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We are in the process of consolidating all customers to a single third party adjudication vendor,
one of two that we are currently operating. Any severe interruption during this consolidation
process could materially disrupt our business and results of operations.
  Uncertainty regarding the impact of Medicare Part D may adversely impact our business and financial
results.
   We have invested substantial amounts of time and resources to our Medicare drug benefit program.
It is uncertain if we will achieve an acceptable return on these investments.
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We may be liable for damages and other expenses that are not covered by our insurance policies.
   Demands by our customers for enhanced service levels or possible loss or unfavorable modification
of contracts with our customers could negatively affect our profitability.
  Due to the term of our contracts with customers, if we are unable to renew those contracts or
replace any lost customers, our future business and results of operation would be adversely
affected.
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Our results of operations could suffer if we lose our pharmacy network affiliations or if our
Specialty Service pharmacy is excluded from third party pharmacy networks.
   We may be adversely affected by the loss of our relationships with one or more key pharmaceutical
manufacturers or with our rebate administrator, or if rebate payments we receive from
pharmaceutical manufacturers or our rebate administrator decline.
  
    
    we lose relationships with one or more key pharmaceutical
manufacturers or with our rebate administrator;
    
    rebates decline due to the failure of our health plan customers to
meet market share or other thresholds;
    
    legal restrictions are imposed on the ability of pharmaceutical
manufacturers to offer rebates or purchase our programs or services;
or
    
    pharmaceutical manufacturers or our rebate administrator choose not to
offer rebates or purchase our programs or services.
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Failure of our health plan customers to pay for prescription claims or a delay in payment of those
claims could have a material adverse effect on our profitability.
  We could suffer civil and/or criminal penalties, lose customers, be required to pay substantial
damages or make significant changes to our operations if we fail to comply with complex and rapidly
evolving laws and regulations.
  
    
    health care fraud and abuse laws and regulations, which prohibit certain types of
payments and referrals as well as false claims made in connection with health
benefit programs;
    
    privacy and confidentiality laws and regulations, including those under HIPAA;
    
    ERISA and related regulations, which regulate many health care plans;
    
    potential regulation of the PBM industry by the FDA;
    
    the Medicare prescription drug coverage law and CMS regulations;
    
    consumer protection and unfair trade practice laws and regulations;
    
    various licensure laws, such as state insurance, managed care and third party
administrator licensure laws;
    
    pharmacy laws and regulations;
    
    antitrust lawsuits challenging PBM pricing practices;
    
    state legislation regulating PBMs or imposing fiduciary status on PBMs;
    
    drug pricing legislation, including most favored nation pricing and unitary
pricing legislation;
    
    other Medicare and Medicaid reimbursement regulations;
    
    pending legislation regarding importation of drug products into the United States;
    
    legislation imposing benefit plan design restrictions, which limit how our
customers can design their drug benefit plans;
    
    network pharmacy access laws, including any willing provider and due process
legislation, that affect aspects of our pharmacy network contracts; and
    
    formulary development and disclosure laws.
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Government efforts to reduce health care costs and alter health care financing practices could lead
to a decreased demand for our services or to reduced rebates from manufacturers.
   Failure to develop new products, services and delivery channels may adversely affect our business.
   Our leverage and debt service obligations could impede our operations and flexibility.
   
    
    we will have to use a portion of our cash flow from operations for debt service
rather than for our operations;
    
    we may from time to time incur indebtedness under our JPMorgan credit facility,
which is subject to a variable interest rate, making us vulnerable to increases in
interest rates;
    
    we could be less able to take advantage of significant business opportunities, such
as acquisition opportunities, and react to changes in market or industry conditions;
    
    we could be more vulnerable to general adverse economic and industry conditions; and
    
    we may be disadvantaged compared to competitors with less leverage.
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Risks related to bioterrorism and mail tampering, and mail irradiation and other procedures the
government may implement to manage these risks, could adversely affect and limit the growth of our
mail and specialty service business.
   Any disruption of or failure in our automated Mail Service pharmacy or our data center could
significantly reduce our ability to process and dispense prescriptions and provide products and
services to our customers.
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Product withdrawal from the market and utilization decreases based off of increased safety risk
profiles of specific drugs may cause prescription volumes to decline and our net revenues and
profitability may be negatively impacted.
  The launch of generic pharmaceuticals into the marketplace may impact our financial results.
  
 Item 1B. UNRESOLVED STAFF COMMENTS.
  
 Item 2. PROPERTIES.
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Item 3 . LEGAL PROCEEDINGS .
  
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
  37




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PART II
 
 Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
 Market Information
  Fiscal Years ended June 30,2007
    
    2006High
    
    Low
    
    High
    
    LowFirst Quarter (July - Sept.)
    
    $
    15.66
    
    
    $
    12.73
    
    
    $
    28.57
    
    
    $
    23.75Second Quarter (Oct. - Dec.)
    
    $
    15.75
    
    
    $
    8.80
    
    
    $
    28.69
    
    
    $
    25.25Third Quarter (Jan. - March)
    
    $
    15.48
    
    
    $
    11.29
    
    
    $
    32.29
    
    
    $
    27.02Fourth Quarter (April - June)
    
    $
    17.76
    
    
    $
    14.16
    
    
    $
    28.24
    
    
    $
    10.77
 Holders
  Dividend Policy
  38




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Securities Authorized for Issuance Under Equity Compensation Plans
  Number of securities remainingNumber of
    
    Weighted-average
    
    available for future issuancesecurities to be issued
    
    price of
    
    underupon exercise of
    
    outstanding
    
    equity compensation plansoutstanding options,
    
    options, warrants
    
    (excluding securities reflected inwarrants, and rights
    
    and rights
    
    column (a))(a)
    
    (b)
    
    (c)Equity Compensation
Plans approved by
security holders
(1)
    
    
    1,144,136
    
    
    $
    22.22
    
    
    
    1,115,107Equity Compensation
Plans approved by
security holders
(2)
    
    
    42,540
    
    
    
    
    
    
    
    657,460Equity Compensation
Plans not approved
by security holders
    
    
    
    
    
    
    
    
    
    
    
 
 (1)
    
    Reflects information about outstanding and issuable options under the 1999 Stock Option Plan,
as amended.(2)
    
    Reflects information about outstanding and issuable restricted stock awards under the 2000
Restricted Stock Grant Plan. Recent Sales of Unregistered Securities
  Issuer Purchases of Equity Securities
  39




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Item 6. SELECTED FINANCIAL DATA .
  Year Ended June 30,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Income Statement Data:(1)Revenue
    
    $
    679,081
    
    
    $
    862,853
    
    
    $
    800,592
    
    
    $
    651,098
    
    
    $
    573,266Cost of claims
    
    
    591,766
    
    
    
    771,487
    
    
    
    713,883
    
    
    
    587,055
    
    
    
    525,472Gross profit
    
    
    87,315
    
    
    
    91,366
    
    
    
    86,709
    
    
    
    64,043
    
    
    
    47,794Selling, general and administrative
expenses
    
    
    87,481
    
    
    
    75,852
    
    
    
    67,786
    
    
    
    50,606
    
    
    
    35,974Operating (loss) income
    
    
    (166
    )
    
    
    15,514
    
    
    
    18,923
    
    
    
    13,437
    
    
    
    11,820Other income (expense)
    
    
    1,456
    
    
    
    1,158
    
    
    
    1,489
    
    
    
    40
    
    
    
    (804
    )Income before provision for income
taxes
    
    
    1,290
    
    
    
    16,672
    
    
    
    20,412
    
    
    
    13,477
    
    
    
    11,016Provision for income taxes
    
    
    1,198
    
    
    
    7,015
    
    
    
    8,031
    
    
    
    5,524
    
    
    
    4,602Net income
    
    
    92
    
    
    
    9,657
    
    
    
    12,381
    
    
    
    7,953
    
    
    
    6,414Beneficial conversion feature
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80,000
    
    
    
    Redeemable convertible preferred stock
cash dividends
    
    
    5,600
    
    
    
    5,600
    
    
    
    5,600
    
    
    
    1,596
    
    
    
    Accretion of transaction expenses
    
    
    475
    
    
    
    475
    
    
    
    475
    
    
    
    135
    
    
    
    Net (loss) income available to common stockholders
    
    $
    (5,983
    )
    
    $
    3,582
    
    
    $
    6,306
    
    
    $
    (73,778
    )
    
    $
    6,414Earnings (loss) per common share:Basic
    
    $
    (1.10
    )
    
    $
    0.70
    
    
    $
    1.39
    
    
    $
    (11.14
    )
    
    $
    0.85Diluted
    
    $
    (1.10
    )
    
    $
    0.67
    
    
    $
    1.03
    
    
    $
    (11.14
    )
    
    $
    0.80Weighted average number of shares
outstanding:Basic
    
    
    5,454
    
    
    
    5,143
    
    
    
    4,542
    
    
    
    6,622
    
    
    
    7,590Diluted
    
    
    5,454
    
    
    
    5,311
    
    
    
    11,984
    
    
    
    6,622
    
    
    
    8,036Balance Sheet Data:Cash and cash equivalents
    
    $
    705
    
    
    $
    8,410
    
    
    $
    7,272
    
    
    $
    3,388
    
    
    $
    5,222Restricted cash
    
    $
    19,276
    
    
    $
    4,845
    
    
    $
    3,994
    
    
    $
    1,695
    
    
    $
    2,383Working capital (deficit) (2)
    
    $
    (3,383
    )
    
    $
    (7,098
    )
    
    $
    (24,437
    )
    
    $
    (27,706
    )
    
    $
    (32,567
    )Total assets
    
    $
    253,089
    
    
    $
    272,153
    
    
    $
    283,931
    
    
    $
    226,149
    
    
    $
    156,740Long-term debt, including current portion
    
    $
    2,475
    
    
    $
    16
    
    
    $
    1,905
    
    
    $
    2,272
    
    
    $
    16,491Redeemable convertible preferred stock
    
    $
    76,813
    
    
    $
    76,338
    
    
    $
    75,864
    
    
    $
    75,389
    
    
    $
    Total common stockholders equity
(deficit)
    
    $
    25,513
    
    
    $
    25,006
    
    
    $
    9,854
    
    
    $
    (6,623
    )
    
    $
    28,426Prescriptions Paid
    
    
    23,421
    
    
    
    31,842
    
    
    
    25,828
    
    
    
    18,028
    
    
    
    16,041Retail
    
    
    22,803
    
    
    
    31,199
    
    
    
    25,251
    
    
    
    17,888
    
    
    
    16,041Mail (3)
    
    
    618
    
    
    
    644
    
    
    
    577
    
    
    
    140
    
    
    
    N/AAdjusted prescriptions (4)
    
    
    24,657
    
    
    
    33,130
    
    
    
    26,982
    
    
    
    18,308
    
    
    
    16,041
 
 (1)
    
    Reference is made to Item 1 hereof, (Business), Item 7 hereof (Managements Discussion
& Analysis of Financial Condition and Results of Operations) and Item 8 hereof (Note 4 
Business Acquisitions) for descriptions of the various acquisitions that have been consummated
in the last 3 years, and the financing arrangements that have been set in place; such
acquisitions and financings affect the comparability of the information provided in the
foregoing tables for fiscal years 2003 through 2007.(2)
    
    Calculated as current assets less current liabilities. 40




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(3)
    
    We began filling prescriptions out of our Mail Service facility on July 1, 2003.(4)
    
    Adjusted prescription volume equals the Mail Service prescriptions multiplied by 3,
plus retail prescriptions. These Mail Service prescriptions are multiplied by 3 to adjust for
the fact that they typically include approximately 3 times the amount of product days supplied
compared with retail prescriptions. 
 Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
  Rebate Error .
 Claims Payable to Pharmacies.
     41




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Accounting for Leases.
  Overview
  
  42




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OPERATING INCOME
 Increase/
    
    
    
    
    
    
    Increase/2007
    
    
    (Decrease)
    
    
    2006
    
    
    (Decrease)
    
    
    2005Revenue
    
    $
    679,081
    
    
    
    (21.3
    )%
    
    $
    862,853
    
    
    
    7.8
    %
    
    $
    800,592Cost of claims
    
    
    591,766
    
    
    
    (23.3
    )%
    
    
    771,487
    
    
    
    8.1
    %
    
    
    713,883Gross profit
    
    
    87,315
    
    
    
    (4.4
    )%
    
    
    91,366
    
    
    
    5.4
    %
    
    
    86,709Selling, general and
administrative
expenses
    
    
    87,481
    
    
    
    15.3
    %
    
    
    75,852
    
    
    
    11.9
    %
    
    
    67,786Operating (loss)
income
    
    $
    (166
    )
    
    
    (101.1
    )%
    
    $
    15,514
    
    
    
    (18.0
    )%
    
    $
    18,923
 Results of Operations ($ in thousands)
 Fiscal Year Ended June 30, 2007 Compared to Fiscal Year Ended June 30, 2006
      44




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45




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Fiscal Year Ended June 30, 2006 Compared to Fiscal Year Ended June 30, 2005
        46




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Off-Balance Sheet Arrangements
  Liquidity and Capital Resources
   47




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48




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Line of Credit
  EBITDA
   49




---



##### Table of Contents



Year Ended June 30,2007
    
    2006
    
    2005 (1)Net cash provided by operating
activities
    
    $
    3,172
    
    
    $
    7,658
    
    
    $
    10,322Provision for income taxes
    
    
    1,198
    
    
    
    7,015
    
    
    
    8,031Interest (income) expense, net
    
    
    (1,396
    )
    
    
    (1,149
    )
    
    
    299Net change in assets and
liabilities
    
    
    14,308
    
    
    
    12,342
    
    
    
    11,989Non-cash items to reconcile
net cash from operations to
net income
    
    
    (7,611
    )
    
    
    (2,873
    )
    
    
    (3,630
    )EBITDA
    
    $
    9,671
    
    
    $
    22,993
    
    
    $
    27,011Adjusted
prescriptions (2)
    
    
    24,658
    
    
    
    33,130
    
    
    
    26,982EBITDA per adjusted
prescription
    
    $
    0.39
    
    
    $
    0.69
    
    
    $
    1.00
 
 (1)
    
    Includes PCNs operating results commencing March 7, 2005, the date of acquisition.(2)
    
    Adjusted prescription volume equals the Mail Service prescriptions
multiplied by 3, plus retail prescriptions. These Mail Service prescriptions are multiplied
by 3 to adjust for the fact that they include approximately 3 times the amount of product days
supplied compared with retail prescriptions. Contractual Obligations
   Payments Due by Period
 Total
    
    
    2008
    
    
    2009-2010
    
    
    2011-2012
    
    
    ThereafterCapital lease obligations
    
    $
    2,475
    
    
    $
    989
    
    
    $
    1,362
    
    
    $
    124
    
    
    $
    Operating leases
    
    
    9,825
    
    
    
    3,295
    
    
    
    3,653
    
    
    
    1,563
    
    
    
    1,314Total contractual cash
obligations
    
    $
    12,300
    
    
    $
    4,284
    
    
    $
    5,015
    
    
    $
    1,687
    
    
    $
    1,314
 Commitments and Contingencies
  50




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51




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Condensed Interim Financial Data (Unaudited)  ($ in thousands, except per share amounts)
 Fiscal Year 2007Quarters ended
    
    June 30
    
    
    March 31
    
    
    December 31
    
    
    September 30Revenue
    
    $
    146,038
    
    
    $
    145,026
    
    
    $
    199,304
    
    
    $
    188,713Cost of claims
    
    
    124,947
    
    
    
    123,700
    
    
    
    176,607
    
    
    
    166,512Gross profit
    
    $
    21,091
    
    
    $
    21,326
    
    
    $
    22,697
    
    
    $
    22,201One-time termination benefits
    
    $
    1,938
    
    
    
    
    
    
    
    
    
    
    
    (Loss) income before (benefit)
provision for income taxes
    
    $
    (4,404
    )
    
    $
    258
    
    
    $
    2,776
    
    
    $
    2,660Net (loss) income
    
    $
    (3,263
    )
    
    $
    430
    
    
    $
    1,514
    
    
    $
    1,411Net loss available to common
Stockholders
    
    $
    (4,778
    )
    
    $
    (1,068
    )
    
    $
    (16
    )
    
    $
    (121
    )Earnings (loss) per common share:Basic
    
    $
    (0.87
    )
    
    $
    (0.20
    )
    
    $
    (0.00
    )
    
    $
    (0.02
    )Diluted
    
    $
    (0.87
    )
    
    $
    (0.20
    )
    
    $
    (0.00
    )
    
    $
    (0.02
    )Weighted-average number of
common shares outstanding:Basic
    
    
    5,489
    
    
    
    5,471
    
    
    
    5,469
    
    
    
    5,375Diluted
    
    
    5,489
    
    
    
    5,471
    
    
    
    5,469
    
    
    
    5,375
 Fiscal Year 2006December 31
    
    
    September 30Quarters ended
    
    June 30
    
    
    March 31
    
    
    (restated)
    
    
    (restated)Revenue
    
    $
    211,451
    
    
    $
    216,801
    
    
    $
    219,909
    
    
    $
    214,692Cost of claims
    
    
    189,744
    
    
    
    194,381
    
    
    
    196,232
    
    
    
    191,130Gross profit
    
    $
    21,707
    
    
    $
    22,420
    
    
    $
    23,677
    
    
    $
    23,562Income before provision for income taxes
    
    $
    3,122
    
    
    $
    3,501
    
    
    $
    5,043
    
    
    $
    5,006
 52




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##### Table of Contents



Fiscal Year 2006December 31
    
    
    September 30Quarters ended
    
    June 30
    
    
    March 31
    
    
    (restated)
    
    
    (restated)Net income
    
    $
    1,884
    
    
    $
    2,008
    
    
    $
    2,898
    
    
    $
    2,867Net income available to common
stockholders
    
    $
    369
    
    
    $
    510
    
    
    $
    1,368
    
    
    $
    1,335Earnings per common share:Basic
    
    $
    0.07
    
    
    $
    0.10
    
    
    $
    0.27
    
    
    $
    0.27Diluted
    
    $
    0.07
    
    
    $
    0.10
    
    
    $
    0.24
    
    
    $
    0.24Weighted-average number of common
shares outstanding:Basic
    
    
    5,291
    
    
    
    5,200
    
    
    
    5,025
    
    
    
    4,862Diluted
    
    
    5,413
    
    
    
    5,302
    
    
    
    12,146
    
    
    
    12,102
 Other Matters
 Inflation
  Use of Estimates and Critical Accounting Policies
 Use of Estimates
  Critical Accounting Policies and Estimates
  Revenue Recognition.
   53




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Rebates Receivable and Payable.
 Allowance for Doubtful Accounts.
 Property and Equipment.
 Internal Use Software.
 Intangible Assets.
 54




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##### Table of Contents



Goodwill.
 Income Taxes.
 Stock-Based Compensation.
   Recently Adopted Accounting Standards
  55




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##### Table of Contents



Recent Accounting Pronouncements
    
 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
  
 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
  
 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
  
 Item 9A. CONTROLS AND PROCEDURES.
 Disclosure Controls and Procedures
  56




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Changes to Internal Control Over Financial Reporting
  
    
    The Company implemented a process whereby our Legal Department and our Account
Management Department, along with our Finance Department and Rebate and Formulary Group,
evaluates the terms and conditions for rebate payments to clients which will serve as the
basis for current and subsequent rebate payments to our customers.
    
    The Company has implemented procedures for reviewing outstanding claims payable to
pharmacies to verify, on a timely basis, that the liabilities to the pharmacies are
properly recorded.
    
    The Company has implemented procedures for reviewing all new leases to determine the
proper accounting treatment in accordance with generally accepted accounting principles.
   Managements Report on Internal Control Over Financial Reporting
    57




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Internal Control-Integrated Framework
  Report of Independent Registered Public Accounting Firm
 
    58




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##### Table of Contents



.
  /s/ Ernst & Young LLP
 
 
 Item 9B . OTHER INFORMATION.
  59




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PART III
 
 Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
  
 Item 11. EXECUTIVE COMPENSATION.
  
 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
  
 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
  
 Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
  60




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##### Table of Contents



PART IV
 
 Item 15 . EXHIBITS AND FINANCIAL STATEMENT SCHEDULES .
 Page No.1.
    
    
    Financial StatementsThe following Consolidated Financial Statements of NMHC are included herein:Report of Independent Registered Public Accounting Firm
    
    F-2Consolidated Balance Sheets as of June 30, 2007 and 2006
    
    F-3Consolidated Statements of Income for each of the years ended
June 30, 2007, 2006 and 2005
    
    F-4Consolidated Statements of Stockholders Equity for each
of the years ended June 30, 2007, 2006 and 2005
    
    F-5Consolidated Statements of Cash Flows for each of the years ended
June 30, 2007, 2006 and 2005
    
    F-6Notes to Consolidated Financial Statements
    
    F-7  F-272.
    
    
    Financial Statement ScheduleSchedule II: Valuation and Qualifying Accounts
    
    S-1
  3.
    
    Exhibits
 ExhibitNumber
    
    Description of Exhibit2.1+
    
    Stock Purchase Agreement dated as of July 31, 2003 by and among NMHC and Portland
Professional Pharmacy, Portland Professional Pharmacy Associates and the individuals
listed on Schedule I thereto (4)2.2+
    
    Amended and Restated Preferred Stock Purchase Agreement dated November 26, 2003 by
and between NMHC and New Mountain Partners, L.P. (6)2.3+
    
    Asset Purchase Agreement dated as of April 1, 2004 among NMHC, Inteq PBM, LP,
Inteq-RX Group, LLP, and the other persons named therein (9)2.4+
    
    Stock Purchase Agreement dated March 7, 2005 by and among NMHC, PCN Acquisition
Corp., Pharmaceutical Care Network, and California Pharmacists Association (15)3.1
    
    Certificate of Incorporation of NMHC (2)3.2
    
    Certificate of Amendment of the Certificate of Incorporation of NMHC (8)3.3
    
    Amended and Restated By-Laws of NMHC (16)4.1
    
    Specimen of Common Stock Certificate4.2
    
    Specimen of Series A 7% Convertible Preferred Stock Certificate4.3
    
    Form of Representatives Warrant Agreement by and among NMHC, Ryan, Beck & Co.,
 61




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##### Table of Contents



ExhibitNumber
    
    Description of ExhibitInc. and Pennsylvania Merchant Group, including form of Warrant Certificate (1)4.4
    
    Certificate of Designations, Preferences and Rights of Series A 7% Convertible
Preferred Stock of NMHC (8)4.5
    
    Registration Rights Agreement dated March 19, 2004 by and among NMHC, New Mountain
Partners, L.P. , and New Mountain Affiliated Investors, L.P.10.1+
    
    Credit Agreement dated as of January 28, 2005 among NMHC, the Lenders party thereto,
JPMorgan Chase Bank, N.A., as Administrative Agent, and J.P. Morgan Securities Inc.,
as Sole Bookrunner and Sole Lead Arranger (14)10.2
    
    Amendment No. 1 to Credit Agreement, dated as of March 7, 2005 to the Credit
Agreement dated as of January 28, 2005 by and among NMHC, JPMorgan Chase Bank, N.A.,
as Administrative Agent, and the Lenders party thereto10.3
    
    Amendment No. 2 to Credit Agreement, dated as of September 28, 2005 to the Credit
Agreement dated as of January 28, 2005 by and among NMHC, JPMorgan Chase Bank, N.A.,
as Administrative Agent, and the Lenders party thereto10.4
    
    Amendment No. 3 and Waiver to Credit Agreement, dated as of December 8, 2006 to the
Credit Agreement dated as of January 28, 2005 by and among NMHC, JPMorgan Chase
Bank, N.A., as Administrative Agent, and the Lenders party thereto (22)10.5
    
    Waiver to Credit Agreement, dated as of February 16, 2007 to the Credit Agreement
dated as of January 28, 2005 by and among NMHC, JPMorgan Chase Bank, N.A., as
Administrative Agent and the Lenders party thereto (23)10.6
    
    Lease Agreement dated November 18, 2002 between Sunbeam Development Corporation and
NMHCRx Mail Order, Inc. (4)10.7
    
    Lease Expansion and Modification Agreement dated July 31, 2003 between Sunbeam
Development Corporation and NMHCRx Mail Order, Inc. (4)10.8*
    
    Prime Vendor Agreement dated May 1, 2006, by AmerisourceBergen Drug Corporation, and
NMHCRx Mail Order, Inc. d/b/a NMHC Mail (20)*10.9
    
    Health Card Sublease Agreement dated as of December 1, 2004, between BFS Realty,
LLC, as Sublessor and NMHC, as Sublessee10.10#
    
    NMHC Amended and Restated 2000 Restricted Stock Grant Plan (12)10.11#
    
    NMHC 1999 Stock Option Plan, as amended on March 18, 2004 (8)10.12#
    
    Form of Restricted Stock Grant Agreement (19)10.13#
    
    Form of Stock Option Agreement between NMHC and Non-Employee Directors dated May 4,
2004 for a grant of 15,000 shares of common stock (10)10.14#
    
    Form of Stock Option Agreement between NMHC and Non-Employee Directors dated May 4,
2004 for a grant of 20,000 shares of common stock (10)10.15#
    
    Form of Stock Option Agreement between NMHC and Senior Management dated December 20,
2004 (13)10.16#
    
    Form of Stock Option Agreement between NMHC and Non-Employee Directors dated
December 21, 2004 (13)10.17#
    
    Form of Stock Option Agreement between NMHC and Non-Employee Directors (17)10.18#
    
    Form of Stock Option Agreement between NMHC and Senior Executive Officers (17)10.19#
    
    Form of Severance Agreement and General Release for Senior Executive Officers (17)10.20#
    
    Form of Excise Tax Gross-Up Agreement between NMHC and Executive Officers(21)10.21#
    
    Form of Indemnification Agreement (19)10.22#
    
    Employment Agreement by and between NMHC and Mr. Stuart Diamond, dated December 16,
2005 (18)10.23#
    
    Agreement by and between NMHC and Mr. Thomas W. Erickson, dated February 23, 2007
(24)10.24#
    
    Stock Option Agreement by and between NMHC and Mr. Thomas W. Erickson, dated March
12, 2007 (25)10.25#
    
    Consulting Agreement and Departure Agreement and General Release Agreement between
NMHC and Mr. Bill Masters, dated June 4, 2007
 62




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.26#
    
    Departure Agreement and General Release between NMHC and Mr. Tery Baskin, dated
August 1, 200710.27#
    
    Stock Option Agreement dated August 30, 2004 between NMHC and Mr. James F. Smith (11)10.28#
    
    Employment Agreement dated August 30, 2004 by and between NMHC and Mr. James F.
Smith (11)10.29#
    
    Departure Agreement and General Release between NMHC and Mr. James F. Smith, dated
August 17, 200710.30#
    
    National Medical Health Card Fiscal Year 2007 Corporate Incentive Plan10.31#
    
    Form of Severance Agreement with executive officers10.32
    
    Support Agreement dated October 30, 2003, by and among NMHC, the Persons listed as
stockholders on Schedule A attached thereto, and New Mountain Partners L.P. (7)10.33
    
    Management Rights Letter dated March 19, 2004, by and between New Mountain Partners,
L.P., a Delaware limited partnership and NMHC10.34#
    
    Employment Agreement dated June 4, 2001, between NMHC and Mr. Tery Baskin (3)10.35#
    
    General Release dated June 28, 2007, between NMHC and Mr. Bill Masters10.36#
    
    Stock Option Agreement dated October 27, 2003 between NMHC and Mr. Mark Adkison10.37#
    
    Stock Option Agreement dated May 6, 2005 between NMHC and Mr. Robert Kordella10.38#
    
    Stock Option Agreement dated
October 4, 2004 between NMHC and Mr. Bill Masters (11)10.39#
    
    Stock Option Agreement dated September 17, 2004 between NMHC and Mr. Tery Baskin21.1
    
    List of Subsidiaries23.1
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act32.1
    
    Section 1350 Certification of CEO as adopted by Section 906 of the Sarbanes-Oxley Act32.2
    
    Section 1350 Certification of CFO as adopted by Section 906 of the Sarbanes-Oxley Act
 
 *
    
    Certain information has been omitted and filed separately with the Securities and Exchange
Commission. Confidential treatment has been requested with respect to the omitted portion.#
    
    Management contract or compensatory plan or arrangement.+
    
    As directed by Item 601(b)(2) of Regulation S-K, certain schedules and exhibits to this
exhibit are omitted from this filing. The Company agrees to furnish supplementally a copy of
any omitted schedule or exhibit to the SEC upon request.(1)
    
    Denotes document filed as an Exhibit to NMHCs Registration Statement on Form S-1
(Registration Number: 333-72209) and incorporated herein by reference.(2)
    
    Denotes document filed as Exhibit C to NMHCs Definitive Proxy Statement on Schedule 14-A
filed on December 21, 2001 and incorporated herein by reference.(3)
    
    Denotes document filed as an Exhibit to NMHCs Report on Form 10-K for the fiscal year ended
June 30, 2001 and incorporated herein by reference.(4)
    
    Denotes document filed as an Exhibit to NMHCs Report on Form 10-K for the fiscal year ended
June 30, 2003 and incorporated herein by reference. 63




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##### Table of Contents



(5)
    
    Denotes document filed as an Exhibit to NMHCs Report on Form 10-K/A Amendment Number 2 for
the fiscal year ended June 30, 2003 and incorporated herein by reference.(6)
    
    Denotes document filed as Annex B to NMHCs Definitive Proxy Statement on Schedule 14-A filed
on February 19, 2004 and incorporated herein by reference.(7)
    
    Denotes document filed as Annex E to NMHCs Definitive Proxy Statement on Schedule 14-A filed
on February 19, 2004 and incorporated herein by reference.(8)
    
    Denotes document filed as an Exhibit to NMHCs Form 10-Q for the fiscal quarter ended March
31, 2004 and incorporated herein by reference.(9)
    
    Denotes document filed as an Exhibit to NMHCs Form 8-K filed on April 14, 2004 and
incorporated herein by reference.(10)
    
    Denotes document filed as an exhibit to NMHCs Form 10-K for the fiscal year ended June 30,
2004 and incorporated herein by reference.(11)
    
    Denotes document filed as an exhibit to NMHCs Form 10-Q for the fiscal quarter ended
September 30, 2004 and incorporated herein by reference.(12)
    
    Denotes document filed as Appendix D to NMHCs Definitive Proxy Statement on Schedule 14-A
filed on October 28, 2004 and incorporated herein by reference.(13)
    
    Denotes document filed as an exhibit to NMHCs Form 10-Q for the fiscal quarter ended
December 31, 2004 and incorporated herein by reference.(14)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on February 3, 2005 and
incorporated herein by reference.(15)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on March 11, 2005 and
incorporated herein by reference.(16)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on November 14, 2005 and
incorporated herein by reference.(17)
    
    Denotes document filed as an exhibit to NMHCs Form 10-Q for the fiscal quarter ended
December 31, 2005 and incorporated herein by reference.(18)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on January 26, 2006 and
incorporated herein by reference.(19)
    
    Denotes document filed as an exhibit to NMHCs Form S-8 filed on February 3, 2006 and
incorporated herein by reference.(20)
    
    Denotes document filed as an exhibit to NMHCs Form 10-K for the fiscal year ended June 30,
2006 and incorporated herein by reference.(21)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on September 22, 2006 and
incorporated herein by reference.(22)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on December 13, 2006 and
incorporated herein by reference.(23)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on February 20, 2007 and
incorporated herein by reference.(24)
    
    Denotes document filed as an exhibit to NMHCs Form 8-K filed on February 28, 2007 and
incorporated herein by reference. 64




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##### Table of Contents



(25)
    
    Denotes document filed as an exhibit to NMHCs Form 10-Q for the fiscal quarter ended March
31, 2007 and incorporated herein by reference. 65




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##### Table of Contents



SIGNATURES
  NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC.(Registrant)By
    
    /s/ Thomas W. Erickson

Thomas W. Erickson, Chairman of the Board, Chief Executive OfficerDate: September 12, 2007Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.By
    
    /s/ Thomas W. Erickson

Thomas W. Erickson, Chairman of the Board, Chief Executive OfficerDate: September 12, 2007By
    
    /s/ Harry Durity

G. Harry Durity,DirectorDate: September 12, 2007By
    
    /s/ Gerald Angowitz

Gerald Angowitz, DirectorDate: September 12, 2007By
    
    /s/ Paul J. Konigsberg

Paul J. Konigsberg, DirectorDate: September 12, 2007By
    
    /s/ Steven B. Klinsky

Steven B. Klinsky, DirectorDate: September 12, 2007By
    
    /s/ Michael Ajouz

Michael Ajouz, DirectorDate: September 12, 2007By
    
    /s/ Robert R. Grusky

Robert R. Grusky, DirectorDate: September 12, 2007By
    
    Daniel B. Hébert, DirectorDate: September 12, 2007By
    
    Michael T. Flaherman, DirectorDate: September 12, 2007By
    
    /s/ Stuart Diamond

Stuart Diamond, Chief Financial Officer, Principal Accounting OfficerDate: September 12, 2007
 66




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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 Page No.Report of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Financial Statements:Balance Sheets
    
    
    F-3Statements of Income
    
    
    F-4Statements of Stockholders Equity
    
    
    F-5Statements of Cash Flows
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7 - F-27
 F-1




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
      
 F-2




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 (In thousands, except share data)
 June 30,
    
    June 30,2007
    
    2006AssetsCurrent Assets:Cash and cash equivalents
    
    $
    705
    
    
    $
    8,410Restricted cash
    
    
    19,276
    
    
    
    4,845Accounts receivable, net
    
    
    62,465
    
    
    
    82,365Rebates receivable
    
    
    42,417
    
    
    
    48,911Inventory
    
    
    6,250
    
    
    
    5,666Deferred tax assets
    
    
    1,913
    
    
    
    2,278Prepaid expenses and other current assets
    
    
    2,758
    
    
    
    2,623Total current assets
    
    
    135,784
    
    
    
    155,098Property and equipment, net
    
    
    14,541
    
    
    
    13,653Intangible assets, net
    
    
    2,551
    
    
    
    3,013Goodwill
    
    
    99,414
    
    
    
    99,319Other non-current assets
    
    
    799
    
    
    
    1,070Total Assets
    
    $
    253,089
    
    
    $
    272,153Liabilities, Redeemable Preferred Equity and Common Stockholders EquityCurrent Liabilities:Claims payable to pharmacies
    
    $
    59,508
    
    
    $
    88,979Rebates payable to customers
    
    
    45,668
    
    
    
    60,953Trade and other payables and accrued expenses
    
    
    19,804
    
    
    
    10,707Current portion of capital lease obligations
    
    
    989
    
    
    
    16Customer deposits payable
    
    
    12,244
    
    
    
    1,541Other current liabilities
    
    
    954
    
    
    
    Total current liabilities
    
    
    139,167
    
    
    
    162,196Capital lease obligations, less current portion
    
    
    1,486
    
    
    
    Other non-current liabilities
    
    
    1,330
    
    
    
    829Deferred tax liabilities
    
    
    8,780
    
    
    
    7,784Total liabilities
    
    
    150,763
    
    
    
    170,809Commitments and ContingenciesRedeemable Preferred Equity:Series A redeemable convertible preferred stock $.10 par value;
15,000,000 shares authorized, 6,956,522 issued and outstanding,
aggregate liquidation preference of $111,304,352
    
    
    76,813
    
    
    
    76,338Common Stockholders Equity:Common Stock, $.001 par value, 35,000,000 shares authorized, 10,158,221
and 9,933,697 shares issued, 5,518,321 and 5,293,797 outstanding, respectively
    
    
    10
    
    
    
    10Additional paid-in capital
    
    
    133,120
    
    
    
    126,630Accumulated deficit
    
    
    (55,738
    )
    
    
    (49,755
    )Treasury stock at cost, 4,639,900 shares
    
    
    (51,879
    )
    
    
    (51,879
    )Total common stockholders equity
    
    
    25,513
    
    
    
    25,006Total Liabilities, Redeemable Preferred Equity and Common Stockholders
Equity
    
    $
    253,089
    
    
    $
    272,153
 The accompanying notes are an integral part of these consolidated financial statements.
 F-3




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF INCOME
 (In thousands, except for share data)
 Years ended June 30,2007
    
    2006
    
    2005Revenue (excludes participant co-payments retained by the
pharmacies of $249,526, $321,055 and $280,946, respectively)
    
    $
    679,081
    
    
    $
    862,853
    
    
    $
    800,592Cost of claims (excludes participant co-payments retained by the
pharmacies of $249,526, $321,055 and $280,946, respectively)
    
    
    591,766
    
    
    
    771,487
    
    
    
    713,883Gross profit
    
    
    87,315
    
    
    
    91,366
    
    
    
    86,709Selling, general and administrative expenses
    
    
    87,481
    
    
    
    75,852
    
    
    
    67,786Operating (loss) income
    
    
    (166
    )
    
    
    15,514
    
    
    
    18,923Other income (expense):Interest expense
    
    
    (516
    )
    
    
    (313
    )
    
    
    (610
    )Interest income
    
    
    1,912
    
    
    
    1,462
    
    
    
    311Other income, net (includes insurance gain of $1,702 in 2005)
    
    
    60
    
    
    
    9
    
    
    
    1,7881,456
    
    
    
    1,158
    
    
    
    1,489Income before provision for income taxes
    
    
    1,290
    
    
    
    16,672
    
    
    
    20,412Provision for income taxes
    
    
    1,198
    
    
    
    7,015
    
    
    
    8,031Net income
    
    $
    92
    
    
    $
    9,657
    
    
    $
    12,381Redeemable convertible preferred stock cash dividends
    
    
    5,600
    
    
    
    5,600
    
    
    
    5,600Accretion of transaction expenses
    
    
    475
    
    
    
    475
    
    
    
    475Net (loss) income available to common stockholders
    
    $
    (5,983
    )
    
    $
    3,582
    
    
    $
    6,306Earnings (loss) per common share:Basic
    
    $
    (1.10
    )
    
    $
    0.70
    
    
    $
    1.39Diluted
    
    $
    (1.10
    )
    
    $
    0.67
    
    
    $
    1.03Weighted-average number of common shares outstanding:Basic
    
    
    5,454
    
    
    
    5,143
    
    
    
    4,542Diluted
    
    
    5,454
    
    
    
    5,311
    
    
    
    11,984
 The accompanying notes are an integral part of these consolidated financial statements.
 F-4




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 (In thousands)
 AdditionalCommon Stock
    
    Paid-In
    
    Accumulated
    
    Treasury StockShares
    
    Amount
    
    Capital
    
    Deficit
    
    Shares
    
    Amount
    
    TotalBalances at June 30, 2004
    
    
    8,970
    
    
    $
    9
    
    
    $
    104,890
    
    
    $
    (59,643
    )
    
    
    4,640
    
    
    $
    (51,879
    )
    
    $
    (6,623
    )Accretion of transaction expenses
related to
preferred stock offering
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (475
    )
    
    
    
    
    
    
    
    
    
    
    (475
    )Exercise of stock options
    
    
    418
    
    
    
    
    
    
    
    4,188
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,188Shares issued related to outstanding
warrants
    
    
    61
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Shares issued related to PPP earnout
    
    
    13
    
    
    
    
    
    
    
    358
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    358Payments of redeemable convertible
preferred stock cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,600
    )
    
    
    
    
    
    
    
    
    
    
    (5,600
    )Stock option income tax benefit
    
    
    
    
    
    
    
    
    
    
    5,625
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,625Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,381
    
    
    
    
    
    
    
    
    
    
    
    12,381Balances at June 30, 2005
    
    
    9,462
    
    
    
    9
    
    
    
    115,061
    
    
    
    (53,337
    )
    
    
    4,640
    
    
    
    (51,879
    )
    
    
    9,854Accretion of transaction expenses
related to
preferred stock offering
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (475
    )
    
    
    
    
    
    
    
    
    
    
    (475
    )Exercise of stock options
    
    
    454
    
    
    
    1
    
    
    
    4,875
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,876Shares issued related to PPP earnout
    
    
    18
    
    
    
    
    
    
    
    425
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    425Payments of redeemable convertible
preferred stock cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,600
    )
    
    
    
    
    
    
    
    
    
    
    (5,600
    )Stock option income tax benefit
    
    
    
    
    
    
    
    
    
    
    3,029
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,029Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    3,240
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,240Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,657
    
    
    
    
    
    
    
    
    
    
    
    9,657Balances at June 30, 2006
    
    
    9,934
    
    
    
    10
    
    
    
    126,630
    
    
    
    (49,755
    )
    
    
    4,640
    
    
    
    (51,879
    )
    
    
    25,006Accretion of transaction expenses
related to
preferred stock offering
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (475
    )
    
    
    
    
    
    
    
    
    
    
    (475
    )Exercise of stock options
    
    
    224
    
    
    
    
    
    
    
    2,319
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,319Accrual of redeemable convertible
preferred stock cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,600
    )
    
    
    
    
    
    
    
    
    
    
    (5,600
    )Stock option income tax benefit
    
    
    
    
    
    
    
    
    
    
    372
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    372Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    3,799
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,799Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92
    
    
    
    
    
    
    
    
    
    
    
    92Balances at June 30, 2007
    
    
    10,158
    
    
    $
    10
    
    
    $
    133,120
    
    
    $
    (55,738
    )
    
    
    4,640
    
    
    $
    (51,879
    )
    
    $
    25,513
 The accompanying notes are an integral part of these consolidated financial statements.
 F-5




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 Years Ended June 30,2007
    
    
    2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    92
    
    
    $
    9,657
    
    
    $
    12,381Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    9,777
    
    
    
    7,470
    
    
    
    6,300Stock-based compensation expense
    
    
    3,799
    
    
    
    3,240
    
    
    
    Amortization of deferred gain
    
    
    (21
    )
    
    
    (49
    )
    
    
    (100
    )Amortization of deferred financing costs
    
    
    113
    
    
    
    112
    
    
    
    167Loss on disposal of capital assets
    
    
    
    
    
    
    38
    
    
    
    Loss on impairment of capital assets
    
    
    657
    
    
    
    
    
    
    
    Provision for doubtful accounts
    
    
    2,080
    
    
    
    200
    
    
    
    651Deferred income taxes
    
    
    1,204
    
    
    
    1,587
    
    
    
    2,912Excess tax benefit from exercise of stock options
    
    
    (221
    )
    
    
    (2,255
    )
    
    
    Changes in assets and liabilities:Restricted cash
    
    
    (14,431
    )
    
    
    (851
    )
    
    
    435Accounts receivable
    
    
    17,820
    
    
    
    20,564
    
    
    
    (27,425
    )Rebates receivable
    
    
    6,494
    
    
    
    (8,534
    )
    
    
    488Inventory
    
    
    (584
    )
    
    
    (1,547
    )
    
    
    (867
    )Due from affiliates
    
    
    
    
    
    
    31
    
    
    
    (13
    )Prepaid expenses and other current assets
    
    
    (135
    )
    
    
    1,160
    
    
    
    (3,867
    )Other non-current assets
    
    
    158
    
    
    
    113
    
    
    
    2,694Claims payable to pharmacies
    
    
    (29,471
    )
    
    
    (27,159
    )
    
    
    16,401Rebates payable to customers
    
    
    (15,285
    )
    
    
    12,995
    
    
    
    11,985Trade and other payables and accrued expenses
    
    
    8,418
    
    
    
    (10,889
    )
    
    
    (19,108
    )Customer deposits payable
    
    
    10,703
    
    
    
    (1,389
    )
    
    
    2,918Income taxes payable and other current liabilities
    
    
    1,483
    
    
    
    3,284
    
    
    
    5,289Other non-current liabilities
    
    
    522
    
    
    
    (120
    )
    
    
    (919
    )Net cash provided by operating activities
    
    
    3,172
    
    
    
    7,658
    
    
    
    10,322Cash flows from investing activities:Capital expenditures
    
    
    (5,392
    )
    
    
    (7,898
    )
    
    
    (5,795
    )Acquisition of PCN, net of cash required
    
    
    
    
    
    
    
    
    
    
    3,150Acquisition of Centrus, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (1,000
    )Acquisition of Inteq, net of cash acquired
    
    
    
    
    
    
    116
    
    
    
    (139
    )Acquisition of PPP, net of cash acquired
    
    
    (901
    )
    
    
    (425
    )
    
    
    (358
    )Acquisition of MPP
    
    
    (266
    )
    
    
    
    
    
    
    Proceeds from sale of capital assets
    
    
    5
    
    
    
    185
    
    
    
    Net cash used in investing activities
    
    
    (6,554
    )
    
    
    (8,022
    )
    
    
    (4,142
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    2,319
    
    
    
    4,876
    
    
    
    4,188Proceeds from revolving credit facility
    
    
    
    
    
    
    82,625
    
    
    
    724,758Repayments of revolving credit facility
    
    
    
    
    
    
    (82,625
    )
    
    
    (724,811
    )Payments of redeemable convertible preferred stock
cash dividends
    
    
    (4,204
    )
    
    
    (5,600
    )
    
    
    (5,600
    )Excess tax benefit from exercise of stock options
    
    
    221
    
    
    
    2,255
    
    
    
    Deferred financing costs
    
    
    
    
    
    
    
    
    
    
    (459
    )Repayments of debt and capital lease obligations
    
    
    (2,659
    )
    
    
    (29
    )
    
    
    (372
    )Net cash (used in) provided by financing activities
    
    
    (4,323
    )
    
    
    1,502
    
    
    
    (2,296
    )Net (decrease) increase in cash and cash equivalents
    
    
    (7,705
    )
    
    
    1,138
    
    
    
    3,884Cash and cash equivalents at beginning of year
    
    
    8,410
    
    
    
    7,272
    
    
    
    3,388Cash and cash equivalents at end of year
    
    $
    705
    
    
    $
    8,410
    
    
    $
    7,272
 The accompanying notes are an integral part of these consolidated financial statements.
 F-6




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (All in thousands, except share amounts)
 1. BUSINESS AND BASIS OF PRESENTATION
   2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Cash and Cash Equivalents.
 Restricted Cash.
    F-7




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
   Accounts Receivable.
  Rebates.
  Inventory.
 Property and Equipment.
 Internal Use Software.
 F-8




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
   Intangible Assets.
 Goodwill.
  Impairment of Long-Lived Assets.
  Customer Deposits Payable.
 Financial Instruments.
 F-9




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 Concentrations of Risks.
    
   Revenue Recognition.
  F-10




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
   Cost of Claims.
 Earnings per Share.
  F-11




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NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 Year ended June 30,
    
    2007
    
    2006
    
    2005Basic
    
    
    5,454
    
    
    
    5,143
    
    
    
    4,542Effect of assumed exercise
of employee stock options
    
    
    
    
    
    
    168
    
    
    
    485Series A preferred stock as if converted
    
    
    
    
    
    
    
    
    
    
    6,957Diluted
    
    
    5,454
    
    
    
    5,311
    
    
    
    11,984
 Stock-Based Compensation.
       F-12




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
   Net income available to common
stockholders, as reported
    
    $
    6,306Total stock-based compensation expense
determined under fair value based method
for all awards, net of related tax effect
applied using the provisions of SFAS 123
    
    
    (2,436
    )Pro forma net income available to
common stockholders
    
    $
    3,870Pro forma earnings per share:Basic  as reported
    
    $
    1.39Basic  pro forma
    
    $
    0.85Diluted  as reported
    
    $
    1.03Diluted  pro forma
    
    $
    0.32
  Income Taxes.
 Use of Estimates.
 Recent Accounting Pronouncements.
 F-13




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
     Operating Segments.
 Reclassifications.
 3. NEW MOUNTAIN TRANSACTION
   F-14




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
       4. BUSINESS ACQUISITIONS
 Maintenance Prescriptions Programs, Inc.
 Pharmaceutical Care Network.
 F-15




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
    Year ended June 30, 2005Revenue
    
    $
    855,624Net income
    
    $
    10,901Net income available to common stockholders
    
    $
    4,826Net earnings per common share:Basic
    
    $
    1.06Diluted
    
    $
    0.91Pro forma weighted-average number of common
shares outstanding:Basic
    
    
    4,542Diluted
    
    
    11,983
  Inteq.
 F-16




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
    Ascend.
  F-17




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
  5. PROPERTY AND EQUIPMENT
  EstimatedJune 30,
    
    2007
    
    2006
    
    Useful LifeEquipment
    
    $
    9,830
    
    
    $
    9,687
    
    
    
    3 to 5 yearsSoftware
    
    
    30,305
    
    
    
    25,906
    
    
    
    3 to 5 yearsLeasehold improvements
    
    
    5,352
    
    
    
    5,269
    
    
    
    Term of leaseEquipment acquired under capital leases
    
    
    4,002
    
    
    
    122
    
    
    
    Term of leaseSoftware acquired under capital leases
    
    
    521
    
    
    
    
    
    
    
    Term of lease50,010
    
    
    
    40,984Accumulated depreciation and amortization
    
    
    35,469
    
    
    
    27,331$
    14,541
    
    
    $
    13,653
   6. COMMITMENTS AND CONTINGENCIES
  Year ending June 30,2008
    
    $
    3,2952009
    
    
    2,2572010
    
    
    1,3962011
    
    
    8702012
    
    
    693Thereafter
    
    
    1,314$
    9,825
   F-18




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
   7. GOODWILL AND INTANGIBLE ASSETS
  PBM(1)
    
    
    Specialty(2)
    
    
    TotalGoodwill:Balance as of June 30, 2006
    
    $
    94,526
    
    
    $
    4,793
    
    
    $
    99,319Specialty additional
consideration earned
    
    
    
    
    
    
    95
    
    
    
    95Balance as of June 30, 2007
    
    $
    94,526
    
    
    $
    4,888
    
    
    $
    99,414
 June 30, 2007
    
    
    June 30, 2006Gross
    
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    
    Accumulated
    
    
    Net Book
    
    
    Carrying
    
    
    Accumulated
    
    
    Net BookAmount
    
    
    Amortization
    
    
    Value
    
    
    Amount
    
    
    Amortization
    
    
    ValueIntangible assets:PBM (1)
    
    $
    7,034
    
    
    $
    4,619
    
    
    $
    2,415
    
    
    $
    6,679
    
    
    $
    3,919
    
    
    $
    2,760Specialty (2)
    
    
    595
    
    
    
    459
    
    
    
    136
    
    
    
    595
    
    
    
    342
    
    
    
    253Total
    
    $
    7,629
    
    
    $
    5,078
    
    
    $
    2,551
    
    
    $
    7,274
    
    
    $
    4,261
    
    
    $
    3,013
 
 (1)
    
    Primarily comprised of the excess
acquisition costs over the fair value of the net tangible and
identifiable assets acquired by the Company, which has been
allocated to goodwill and intangible assets. The goodwill
also includes any earnouts earned in conjunction with the
acquisitions. The intangible assets consist primarily of
customer relationships. See Note 4, Business Acquisitions
for more information.(2)
    
    Represents the Specialty Service segment
primarily reflecting the excess of the Ascend purchase price
over the net tangible and identifiable assets acquired, which
has been allocated to goodwill and intangible assets. The
goodwill also includes any earnouts earned in conjunction
with the acquisition. The change in goodwill from June 30,
2006 to June 30, 2007 is the result of final adjustments to
the earnout in connection with the Ascend acquisition. The
intangible assets consist primarily of customer relationships
and employment agreements. See Note 4, Business
Acquisitions for more information.   F-19




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
  8. LINE OF CREDIT
      9. CAPITAL LEASE OBLIGATIONS
  Year ending June 30,2008
    
    $
    1,0752009
    
    
    8232010
    
    
    6132011
    
    
    912012
    
    
    34Total minimum lease payments
    
    
    2,636Amount representing interest
    
    
    (161
    )Present value of net minimum lease payments
    
    
    2,475Current portion
    
    
    (989
    )Total long-term portion
    
    $
    1,486
 F-20




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NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 10. SEGMENT REPORTING
    Specialty
    
    
    IntersegmentYear ended June 30, 2007
    
    PBM
    
    
    Pharmacy
    
    
    Elimination
    
    
    Corporate
    
    
    TotalRevenue
    
    $
    653,485
    
    
    $
    56,027
    
    
    $
    (30,431
    )
    
    $
    
    
    
    $
    679,081Cost of claims
    
    
    569,390
    
    
    
    48,987
    
    
    
    (26,611
    )
    
    
    
    
    
    
    591,766Gross profit
    
    
    84,095
    
    
    
    7,040
    
    
    
    (3,820
    )
    
    
    
    
    
    
    87,315Selling, general and
administrative expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    87,481
    
    
    
    87,481Interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,972
    
    
    
    1,972Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (516
    )
    
    
    (516
    )Income before provision for
income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,290Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,198Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    92Total identifiable assets
    
    $
    243,657
    
    
    $
    97,530
    
    
    $
    (88,098
    )
    
    
    
    
    
    $
    253,089
 Specialty
    
    
    IntersegmentYear ended June 30, 2006
    
    PBM
    
    
    Pharmacy
    
    
    Elimination
    
    
    Corporate
    
    
    TotalRevenue
    
    $
    839,991
    
    
    $
    44,180
    
    
    $
    (21,318
    )
    
    $
    
    
    
    $
    862,853Cost of claims
    
    
    751,677
    
    
    
    38,505
    
    
    
    (18,695
    )
    
    
    
    
    
    
    771,487Gross profit
    
    
    88,314
    
    
    
    5,675
    
    
    
    (2,623
    )
    
    
    
    
    
    
    91,366Selling, general and
administrative expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75,852
    
    
    
    75,852Interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,471
    
    
    
    1,471Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (313
    )
    
    
    (313
    )Income before provision for
income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,672Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,015Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    9,657Total identifiable assets
    
    $
    263,274
    
    
    $
    40,717
    
    
    $
    (31,838
    )
    
    
    
    
    
    $
    272,153
 F-21




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 Specialty
    
    
    IntersegmentYear ended June 30, 2005
    
    PBM
    
    
    Pharmacy
    
    
    Elimination
    
    
    Corporate
    
    
    TotalRevenue
    
    $
    781,360
    
    
    $
    28,898
    
    
    $
    (9,666
    )
    
    $
    
    
    
    $
    800,592Cost of claims
    
    
    697,528
    
    
    
    24,647
    
    
    
    (8,292
    )
    
    
    
    
    
    
    713,883Gross profit
    
    
    83,832
    
    
    
    4,251
    
    
    
    (1,374
    )
    
    
    
    
    
    
    86,709Selling, general and
administrative expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67,786
    
    
    
    67,786Interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,099
    
    
    
    2,099Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (610
    )
    
    
    (610
    )Income before provision for
income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,412Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,031Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    12,381Total identifiable assets
    
    $
    276,235
    
    
    $
    8,721
    
    
    $
    (1,025
    )
    
    
    
    
    
    $
    283,931
 11. STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFIT PLAN
 Employee Stock Option Plan
     F-22




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 Year ended June 30,
    
    2007
    
    2006
    
    2005Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Risk-free interest rate
    
    
    4.9
    %
    
    
    5.1
    %
    
    
    3.4%-4.4
    %Expected volatility
    
    
    49.7%-58.2
    %
    
    
    54.0%-69.5
    %
    
    
    70.8%-74.4
    %Expected life (years)
    
    
    5.5
    
    
    
    5.5 - 7.0
    
    
    
    6.9Post-vesting terminations
    
    
    1.0
    %
    
    
    1.0
    %
    
    
    Sub-optimal exercise factor
    
    
    3.8
    
    
    
    4.0
    
    
    
    
  Weighted-AverageRemaining
    
    AggregateNumber of
    
    Weighted-Average
    
    Contractual
    
    IntrinsicOptions
    
    Exercise Price
    
    Term (in years)
    
    ValueOutstanding at June 30, 2006
    
    
    1,510,556
    
    
    $
    22.60Cancelled/forfeited
    
    
    (522,436
    )
    
    
    22.64Granted
    
    
    380,540
    
    
    
    14.27Exercised
    
    
    (224,524
    )
    
    
    10.33Outstanding at June 30, 2007
    
    
    1,144,136
    
    
    $
    22.22
    
    
    
    6.22
    
    
    $
    1,204Exercisable at June 30, 2007
    
    
    484,477
    
    
    $
    23.34
    
    
    
    4.41
    
    
    $
    648
   Weighted-AverageNumber of
    
    Grant Date FairOptions
    
    ValueNonvested at June 30, 2006
    
    
    1,036,724
    
    
    $
    16.27Granted
    
    
    380,540
    
    
    
    8.00Vested
    
    
    (285,192
    )
    
    
    15.19Cancelled/forfeited
    
    
    (472,413
    )
    
    
    14.33Nonvested at June 30, 2007
    
    
    659,659
    
    
    $
    11.60
   F-23




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
  Restricted Stock Grant Plan
    Weighted Average
    
    AggregateGrant Date
    
    IntrinsicShares
    
    Fair Value
    
    ValueOutstanding at June 30, 2006
    
    
    20,400
    
    
    $
    26.99Granted
    
    
    61,330
    
    
    
    15.02Vested
    
    
    
    
    
    
    Cancelled/forfeited
    
    
    (39,190
    )
    
    
    21.62Outstanding at June 30, 2007
    
    
    42,540
    
    
    $
    19.75
    
    
    $
    840
   Employee 401(k) Plan
   F-24




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
  12. RELATED PARTY TRANSACTIONS
      Year ended June 30,
    
    2007
    
    2006
    
    2005Management and consulting fees (a)
    
    $
    21
    
    
    $
    125
    
    
    $
    171Administrative, accounting
services and supplies (b)
    
    
    5
    
    
    
    
    
    
    
    198Rent and utilities (c)
    
    
    128
    
    
    
    147
    
    
    
    961$
    154
    
    
    $
    272
    
    
    $
    1,330
 (a)
    
    The Company incurred fees to certain other affiliated companies for various management and
consulting services.(b)
    
    A company affiliated by common ownership provided the Company with various administrative,
legal and accounting services.(c)
    
    See Note 6, Commitments and Contingencies, for additional information regarding leases with
related parties. For fiscal 2007, 2006 and 2005, the Company leased its corporate
headquarters from an affiliate of Bert E. Brodsky, the Companys former Chairman of the Board. 13. SUPPLEMENTAL CASH FLOW INFORMATION
 Year ended June 30,
    
    2007
    
    2006
    
    2005Cash paid:Interest
    
    $
    270
    
    
    $
    403
    
    
    $
    567Income taxes
    
    $
    450
    
    
    $
    1,099
    
    
    $
    2,825
 F-25




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##### Table of Contents



NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
  14. INCOME TAXES
  Year ended June 30,
    
    2007
    
    2006
    
    2005Current:Federal
    
    $
    104
    
    
    $
    4,474
    
    
    $
    4,237State
    
    
    (110
    )
    
    
    954
    
    
    
    882(6
    )
    
    
    5,428
    
    
    
    5,119Deferred:Federal
    
    
    1,140
    
    
    
    1,272
    
    
    
    1,704State
    
    
    64
    
    
    
    315
    
    
    
    1,2081,204
    
    
    
    1,587
    
    
    
    2,912Total
    
    $
    1,198
    
    
    $
    7,015
    
    
    $
    8,031
   Year ended June 30,
    
    2007
    
    2006
    
    2005Federal statutory rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %Stock-based compensation
    
    
    45.9
    
    
    
    3.5
    
    
    
    State taxes  net of federal tax benefit
    
    
    (8.2
    )
    
    
    5.8
    
    
    
    5.3Permanent differences
    
    
    7.6
    
    
    
    0.5
    
    
    
    0.6Adjustment for prior year taxes
    
    
    13.6
    
    
    
    
    
    
    
    Other, net
    
    
    
    
    
    
    (1.7
    )
    
    
    (0.6
    )Effective tax rate
    
    
    92.9
    %
    
    
    42.1
    %
    
    
    39.3
    %
   F-26




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NATIONAL MEDICAL HEALTH CARD SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All in thousands, except share amounts)
 June 30,
    
    2007
    
    2006Allowance for doubtful accounts
    
    $
    898
    
    
    $
    833Management severance accrual
    
    
    482
    
    
    
    Vacation expense accrual
    
    
    193
    
    
    
    134Acquisition related severance and restructuring
    
    
    109
    
    
    
    448Accrued liabilities
    
    
    231
    
    
    
    863Net deferred tax assets
    
    $
    1,913
    
    
    $
    2,278
 June 30,
    
    2007
    
    2006Stock-based compensation
    
    $
    1,318
    
    
    $
    518NOL carryforwards
    
    
    362
    
    
    
    612Excess tax depreciation
    
    
    (2,310
    )
    
    
    (2,430
    )Excess tax amortization
    
    
    (8,624
    )
    
    
    (6,612
    )Accrued liabilities
    
    
    474
    
    
    
    128Net deferred tax liabilities
    
    $
    8,780
    
    
    $
    7,784
   15. MANAGEMENT CHANGES
  F-27




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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
 ($ in thousands)
 Allowance for Doubtful Accounts Receivable:
 AdditionsBalance at
    
    Charged to
    
    
    
    
    
    
    
    
    
    BalanceBeginning
    
    Costs and
    
    
    
    
    
    Other
    
    at EndDescription
    
    of Year
    
    Expense (a)
    
    Write-offs
    
    Changes
    
    of YearYear ended June 30, 2005
    
    $
    2,312
    
    
    $
    651
    
    
    $
    (1,016
    )
    
    $
    260
    (b)
    
    $
    2,207Year ended June 30, 2006
    
    $
    2,207
    
    
    $
    200
    
    
    $
    (42
    )
    
    $
    (104
    ) (c)
    
    $
    2,261Year ended June 30, 2007
    
    $
    2,261
    
    
    $
    2,080
    
    
    $
    (2,004
    )
    
    
    
    
    
    $
    2,337
 
 (a)
    
    Charged to bad debts(b)
    
    Includes a $6 opening reserve balance of acquisition, a reclassification to increase Specialty
Services accounts receivable balance by $254, and the allowance for doubtful accounts by $254.
The reclassification was made to adjust the presentation of a valuation reserve that had previously
been netted against the gross accounts receivable. There was no impact to net accounts receivable
due to this reclassification.(c)
    
    Primarily includes a reclassification to increase Specialty Services accounts receivable
balance by $150 and the allowance for doubtful accounts by $150. The reclassification was made to
adjust the presentation of a valuation reserve that had previously been netted against the gross
accounts receivable. There was no impact to net accounts receivable due to this reclassification.