HPI and DPI lease facilities in connection with their operations at eight locations, including 24,000 square feet at its new unit-dose central-fill facility at Trenton, New Jersey. Various other sales and administrative offices, none of which are material, are also leased by the Company throughout the United States. No difficulty is anticipated in negotiating any of the Company's lease renewals.
Further information concerning the Company's obligation under lease agreements is contained in Note 13 of the Notes to Consolidated Financial Statements included in Part II of this report.
The Company has not declared or paid dividends since its inception.
Note: Operations of Perform Cost Management Services, Inc. and Chronitech Health Services, Inc. included from dates of acquisition (October 26 and 29, 1993, respectively).
During the fiscal year ended March 31, 1995, the Company actively marketed its new RxChoice(c) product and entered new product niches including the providing of services to the Federal and state pharmacy benefit management programs. Lives covered under integrated pharmacy services increased to approximately 16 million from the 13 million reported at fiscal year end 1994. The early termination of its contracts with CIGNA, partly offset these sales gains.
During fiscal 1994, the Company diversified its product lines to position itself as a full-service, integrated supplier in the pharmacy benefit management industry. During May 1993, the Company introduced its RxChoice(c) integrated retail/mail pharmacy benefit product, marking its entry into the employer/organization sponsor market, and, during October 1993, acquired Perform Cost Management Services, Inc. to provide immediate access to its retail pharmacy network and claims pricing capabilities. Through acquisition of certain assets and contracts of Chronitech (Note 3 to Notes to Consolidated Financial Statements) during October 1993, the Company entered the specialty pharmacy markets targeting certain disease-state populations, including the HIV/AIDS community.
Integrated pharmacy service operating income totaled $28.7 million for fiscal 1995, an increase of $13.6 million or 90% from fiscal 1994. Operating income increase was attributable primarily to higher product margins ($20.6 million) attributable primarily to improved formulary agreements and contract pricing from pharmaceutical suppliers (offsetting drug cost inflation), and retail and mail service claim volume increases; offset partly by higher general and administrative ($5.8 million) and selling and marketing costs ($1.2 million) attributable mainly to expansion of physical plant and client-support services, respectively.
approximately 2.0 million prescriptions filled annually under the contract and the Company used this figure to anticipate the revenues to be generated under the contract. The Company commenced providing services under the contract in November, 1994. The volume of prescriptions filled under this contract has to date grown to approximately 28,000 prescriptions per month. Because the prescription volume to date under the CHAMPUS contract is substantially lower than the assumed number provided by DOD in its request for proposal, the Company expects that the revenues under this contract will be substantially less than anticipated based on DOD's assumptions.
Managed care pharmacy service revenues totaled $153.5 million for fiscal year 1994, an increase of $20.6 million or 16% from fiscal 1993 primarily due to increases ($20.2 million) from the CIGNA contract, which was implemented during mid-fiscal 1993. Excluding this contract, revenue decrease was attributable primarily to terminated or unrenewed contracts ($6.3 million) offset by internal growth and new client contracts ($4.2 million).
The Company, has contracts with over 51,000 retail pharmacies to provide point-of-service retail prescription dispensing in support of the Company's RxChoice (c) integrated product line. These contracts generally provide for reimbursement to the contracted retail pharmacy at prices specified as a discount to published average wholesale product cost.
The Company also stocks over 4,500 brand name and generic medications at its mail pharmacy service dispensing facilities, in varying dosages and dosage forms. Prescription requests for unstocked items are obtained, as required, from wholesalers.
Diagnostek purchases pharmaceuticals directly from manufacturers and wholesalers, generally in high volume and at a discount, resulting in lower costs than available to smaller purchasers. The Company is not dependent upon any one supplier.
The Company receives a significant amount of rebates based on the purchase of pharmaceuticals from numerous suppliers. These rebates are generally contractually due the Company based on the purchase of specified volume levels of various name brand pharmaceuticals, changes in relative market share, or through the placement of certain pharmaceuticals on a drug formulary. At this time, rebate practices are being reviewed within the pharmaceutical industry as they relate to overall pricing strategies. The Company continues to aggressively negotiate rebate agreements and believes that any change in rebate practices would be part of changes in overall pharmaceutical pricing methods. Any such change could have a material adverse effect on the Company's operating margin.
The Company, in certain of its managed care pharmacy contracts, purchases pharmaceutical products on behalf of its customers utilizing its customers purchase agreements with suppliers. Under the terms of its mail service contract with the Department of Defense ("DoD") in support of CHAMPUS benefit programs in six states, the Company also purchases pharmaceutical products for mail distribution to eligible beneficiaries utilizing Government contract prices.
Cash flows from operations for fiscal year 1995 totaled ($1.6) million, a decrease of $17.7 million from 1994. The decrease was attributable primarily to payment of shareholder litigation settlement costs accrued in fiscal 1994, increased receivables associated with higher claims volumes and higher inventories, offset partly by increased net earnings. At March 31, 1995, market value of marketable securities totaled $59.2 million. The Company intends to utilize these securities to fund working capital growth (including that associated with further expansion of Diagnostek's RxChoice(c) and CapRx(c) products), expand its existing operating facilities and equipment, and potentially to fund future acquisitions, or retire debt. There are currently no acquisitions pending. Under terms of its Agreement and Plan of Merger with Value Health, Inc. dated March 27, 1995, as amended on June 4, 1995, the Company shall not make any investments in non-investment grade securities exceeding $1,000,000 or sell at a loss of greater than $50,000 any debt securities held for investment purposes.
Diagnostek's capital expenditures totaled $9.1 million for fiscal 1995, compared with $5.4 million and $2.0 million for 1994 and 1993, respectively. Expansion of the Albuquerque facility totaled $5.5 million, including $3.7 million which had been expended at March 31, 1994. The Company also utilizes leases and other third party financing to fund certain equipment acquisitions.
The Company has a $30 million term loan, with outstanding principal balance of $12.0 million at March 31, 1995, from Metropolitan Life Insurance Company ("Metropolitan"), which bears interest at a fixed annual rate of 10.02%. Principal repayments of $6.0 million per year are payable each December. During fiscal year 1995, $6.0 million principal was repaid. The Company expects to make scheduled principal payments from operating cash flows.
We have audited the accompanying Consolidated Statement of Financial Position of Diagnostek, Inc. and subsidiaries as of March 31, 1995 and 1994 and the related Consolidated Statements of Earnings, Cash Flows, and Changes in Stockholders' Equity for each of the years in the three year period ended March 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.
Notes to the consolidated financial statements are an integral part of this statement.
The Company participates in the pharmacy benefit management industry with principal business activities being the providing of prescription drugs through mail and retail pharmacy service plans, providing contract pharmacy management services to acute care hospitals and HMO's, and operating, managing, and providing medical imaging and diagnostic equipment.
Certain prior period amounts have been reclassified to conform with the 1995 basis of presentation. Amounts reclassified had no impact on consolidated or segment operating income or earnings.
Money market accounts and temporary investments with original maturities of ninety days or less are included in cash and cash equivalents.
Inventories, consisting primarily of prescription medications purchased for resale, are stated at the lower of cost, on a first-in, first-out basis, or market.
The Company accounts for marketable securities utilizing Financial Accounting Standards Board Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities". All marketable securities at March 31, 1995 and 1994 were deemed by management to be available for sale and therefore are reported at fair value with net unrealized gains(losses) reported in stockholders' equity.
Diagnostek utilizes the asset and liability method for recording deferred income taxes, which provides for establishment of deferred tax asset or liability accounts based on the difference between tax and financial reporting bases of certain assets and liabilities.
Treasury stock is carried at acquisition cost (market price at acquisition date).
Earnings per common and common equivalent share is computed on the weighted average number of common shares, less treasury stock, and, if dilutive, common equivalent shares (common shares assuming exercise of all options and warrants) outstanding during the period. For the years ended March 31, 1995, 1994 and 1993, approximately 0.9 million, 1.1 million, and 0.8 million common equivalent shares, respectively, were included in the computation of weighted average shares. Fully diluted earnings per share is not materially different than primary earnings per share and has not been presented.
On March 27, 1995, the Company entered into a definitive Agreement and Plan of Merger (the "Merger Agreement") with Value Health, Inc. ("VHI"), a New York Stock Exchange company that provides specialized managed care programs including pharmacy benefit management services, and VHI Merger-Sub. Corp., a wholly-owned subsidiary of VHI pursuant to which the Company will become a wholly-owned subsidiary of VHI (the "Merger"). It is intended that the Merger will qualify as a pooling of interests for accounting purposes and will constitute a tax-free reorganization for federal income tax purposes. In accordance with the terms and conditions of the Merger Agreement, as amended, each share of the Company's common stock (and outstanding common stock options) will be converted into common stock (and common stock options) of VHI at an exchange ratio of 0.4975. In connection with the Merger Agreement, the Company's Chairman of the Board and Chief Executive Officer has entered into a five year consulting agreement and a ten year agreement not to compete with VHI and the Company, effective only upon the consummation of the Merger. At March 31, 1995, approximately $0.5 million of costs associated with the Merger had been deferred.
Consummation of the Merger is subject to satisfaction of certain conditions, including approval by shareholders of each of the companies and treatment as a pooling of interests for accounting purposes. In the event of termination under specified conditions, VHI may be entitled to receive a fee of $15 million from the Company.
As a result of the announcement of the execution of the Merger Agreement, a number of shareholder lawsuits were filed against the Company, its directors and VHI (note 12).
On October 26, 1993, Diagnostek acquired by assignment the prescription drug and supply contracts held by Chronitech Health Services, Inc. and its subsidiaries ("Chronitech"), a provider of specialty pharmacy, home care medication and infusion services to the HIV and AIDS market, together with certain assets related thereto, including accounts receivable, inventory, equipment, leases, trade names and symbols along with approximately $350,000 of liabilities. The purchase price was $3.2 million in cash and 132,500 shares of common stock, valued at $2,037,000. The acquisition was accounted for using the purchase method of accounting with resulting goodwill of approximately $5.3 million which is being amortized over a period of 15 years.
Note 5 Property, plant, and equipment Property, plant, and equipment are summarized as follows:
Note 6 Goodwill and other intangible assets Goodwill and other intangible assets are summarized as follows:
At March 31, 1995, scheduled maturities of marketable debt securities are as follows: one to five years, $28,622,000; five to ten years, $25,709,000; ten to fifteen years, $5,597,000; and over fifteen years, $1,516,000.
Interest on the note payable is due semi-annually. The note payable to the insurance company contains various restrictive provisions and covenants including the maintenance of certain minimum financial ratios and restrictions related to the payment of dividends. The Company was in compliance with or obtained waivers on restrictive covenants at March 31, 1995.
Scheduled maturities of the Company's debt are as follows (in thousands):
The Company has stock option plans under which both incentive and non-qualified options have been granted. The terminated 1983 Plan allowed for the purchase of up to 2,000,000 shares of which substantially all options have been granted. The 1991 Plan, as amended during 1994, permits the granting of options for the purchase of up to 1,950,000 shares. Exercise prices for non-qualified options may be less than market price.
Reconciliation of the Company's actual tax rate to the U.S. Federal statutory rate is as follows:
The Securities and Exchange Commission notified the Company in 1993 that it was conducting a formal inquiry into the adequacy of the Company's financial disclosures and internal accounting controls. Diagnostek continues to cooperate fully in connection with this inquiry.
In late March 1995, eleven purported class action lawsuits were filed against the Company, its Directors and VHI seeking to enjoin the Company from consummating its previously announced merger with VHI (note 2). The lawsuits allege breach of fiduciary responsibility by the Company's Directors in approving the merger and other damages. The Company believes there is no merit to the suits and will vigorously defend the action.
In addition during fiscal 1993, thirteen lawsuits were initiated against the Company, certain current and former officers, and certain directors on behalf of a class of purchasers of the Company's common stock, asserting damages resulting from an alleged inflation of the Company's stock price. In March 1994, the Company entered into a Stipulation of Settlement, pursuant to which it agreed to settle the thirteen consolidated shareholder class action lawsuits. The settlement consisted of the payment of $8.0 million by the Company, which was funded into an escrow account in May 1994, the payment of $5.0 million by the insurance company which provides directors and officers liability insurance to the Company and its officers and directors, and the issuance of $3.0 million of the Company's common stock (137,510 shares). The settlement did not constitute an admission by the Company and its officers and directors of any fault, liability or wrongdoing. Such amounts were recorded as accrued litigation settlement in the Company's statement of financial condition at March 31, 1994.
There are extensive state and Federal regulations applicable to the practice of pharmacy and, since sanctions may be imposed for violations, compliance is a significant operational requirement for the Company. Management believes that the Company and its subsidiaries are in substantial compliance with all existing statutes and regulations materially affecting the conduct of its business. Various federal and state pharmacy associations and some boards of pharmacy have attempted to promote laws or regulations directed at restricting the activities of mail service pharmacies, to the economic benefit of retail pharmacies. In addition, a number of states have laws or regulations which, if successfully enforced, would effectively limit some of the financial incentives available to third-party payors that offer managed care prescription drug programs. To the extent such laws or regulations are found to be applicable to the
On February 1, 1995, the Company's HPI subsidiary began performing under a contract with the State of New Jersey to provide unit dose medications to the state's hospital system. The Company has estimated that it will incur losses over the three year term of the contract and, in addition to losses incurred through March 31, 1995, has accrued $9,621,000 at March 31, 1995 and included such amounts in cost of sales in its Consolidated Statement of Earnings.
Diagnostek utilizes leased facilities and equipment under non-cancelable operating leases expiring at various dates through 2002. Certain leases contain renewal and or escalation clauses. Leased medical diagnostic equipment was subleased to third parties on a fee per procedure remuneration basis. All such sublease agreements had expired at March 31, 1995.
Total rent expense for operating leases, sublease and rental income, and contingent rental income are summarized as follows:
Substantially all of the Company's employees are covered by a defined contribution plan. In addition, certain union member employees are covered under both multi-employer defined benefit and multi-employer defined contribution plans. Contributions by Diagnostek to these plans are not material.
During fiscal 1994, the Company sold 54,000 shares of CAPX Corporation, a company whose founder, principal stockholders and officers had previously included the Chairman and Chief Executive Officer and the Executive Vice President and General Counsel of the Company. The sale resulted in a net gain of approximately $252,000.
The carrying amount of cash and cash equivalents, accounts receivables, accounts payable and borrowings under line of credit approximate fair value due to the short maturity periods of these instruments, as do notes receivable from officers and directors. The fair value of marketable securities is based on quoted market prices (note 7).
The fair value of the Company's debt with an insurance company (note 9) is based on the present value of the cash flows from that debt, assuming interest rates of 8.65% and 7.75% at March 31, 1995 and 1994, respectively. Fair market value of this debt was approximately $12,176,000 and $18,620,000 at March 31, 1995 and 1994, respectively.
Financial information related to the Company's business segments and significant customers for the years ended March 31, 1995, 1994, and 1993, are summarized (in thousands) as follows.
Total revenues from contracts with two affiliated customers (contracts terminated during September 1994) represented 6%, 17%, and 16% of the Company's consolidated revenues during fiscal 1995, 1994 and 1993, respectively.