SELECTED FINANCIAL DATA - ------- ----------------------- (In thousands except per share data)
Since its inception HealthExtras has focused on the sale of supplemental health programs to individual consumers. These products are generally marketed to consumers in collaboration with nationally recognized financial institutions through means including telemarketing, direct mail and statement inserts. However, over the past year, the Company has changed its strategic emphasis through its acquisitions of International Pharmacy Management, Inc., ("IPM"), now operating as HealthExtrasRx, and Catalyst both of which provide pharmacy benefit management services to self-insured employer groups and managed care organizations. These acquisitions have positioned the Company to aggressively grow this segment of its business. The Company expects this portion of its business to be the primary source of growth and profit potential in the years ahead. The consumer segment will continue to provide revenue and gross margin contributions but the Company expects to be more selective in marketing and product development expenditures as a result of increasing direct expenses for the components of our programs, increasing customer acquisition costs and higher attrition rates.
Our primary PBM services consist of the automated online processing of prescription claims on behalf of our employer and managed care customers. When a member of one of our customer accounts presents a prescription or health plan identification card to a retail pharmacist in our network, our system provides the pharmacist with accesses to online information regarding eligibility, patient history, health plan formulary listings, and contractual reimbursement rates. The member generally pays a co-pay to the retail pharmacy and the pharmacist fills the prescription. On behalf of our customer accounts, we electronically aggregate pharmacy benefit claims, which include prescription costs plus our claims processing fees for consolidated billing and payment. We receive payments from customer accounts and remit the amounts owed to the retail pharmacies pursuant to our negotiated rates and retaining the difference, including claims processing fees.
The terms of the Catalyst acquisition agreements also require the Company to purchase the remaining 20% of the Catalyst common stock outstanding by March 14, 2003, for a price based on the future EBITDA of Catalyst. Effective March 1, 2002, this clause was amended when the Catalyst minority interest agreed to the sell the remaining 20% ownership of Catalyst to the Company for additional consideration of $5,280,000. The consideration consists of 319,033 shares of Company stock, valued at $1,056,000 on the closing date of the amendment, and $4,224,000 in cash. The stock is to be transferred to the seller on April 1, 2002, and the cash will be paid in four installments of $1,056,000, due on April 1, 2002, October 1, 2002, January 1, 2003 and March 1, 2003.
* Pursuing new marketing opportunities with a broader set of plan sponsors and pharmaceutical manufacturers. Our acquisition of Catalyst provides us with a more diverse and complete set of products and services to sell to a larger customer base. For example, Catalyst is engaged in demand management, generic substitution and other clinical programs that will significantly enhance our ability to serve larger and more sophisticated customers.
* Generating corporate overhead and information technology efficiencies. Our combination with Catalyst will allow us to better capture efficiencies in corporate overhead and information technology investments. We expect cost savings to result from the consolidation of certain corporate activities and the elimination of certain duplicated components of our corporate operations.
We have successfully completed the initial steps in integrating Catalyst that are necessary for us to operate as a single, combined company. We intend to operate with a combined financial, organizational and management structure so that all of our customers and employees and suppliers have access to consistent and reliable organizational infrastructure. Over the next several quarters we expect to complete additional integration steps around data processing platforms and other technology systems.
Revenue from program payments received, and related direct expenses, are deferred to the extent that they are applicable to future periods or to any refund guarantee we offer. As of December 31, 2001, more than 725,000 members had enrolled in our supplemental health programs. As of December 31, 2001, initial program revenue was deferred for approximately 65,000 program members. HealthExtras has committed to minimum premium volumes with respect to the insurance features of its programs supplied by others. In the event that there were insufficient members to utilize the minimum premium commitment, the differential would be expensed by HealthExtras without any related revenue. HealthExtras believes that current enrollment trends will allow the minimum future commitments at December 31, 2001 to be fully utilized by current enrollment levels.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 ---------------------------------------------------------------------
HealthExtras incurred an operating loss of $7.8 million for the year ended December 31, 2001, including a non-cash warrant charge of approximately $6.1 million relating to services provided under a marketing agreement. Total revenues of $124.4 million for 2001 included $77.5 million earned from the supplemental health segment and $46.9 million earned from pharmacy benefit management services. Total revenues increased $80.2 million in 2001 with revenue from pharmacy benefit management, program member payments and business partner revenues contributing 52.4%, 25.1% and 22.5% respectively of that growth. As the Company has increased its strategic focus on pharmacy services during the year, the majority of its revenue and revenue growth were derived from such services by the end of 2001. Much of the growth in pharmacy service revenue was attributable to the acquisitions of HealthExtras Rx (formerly IPM) and Catalyst during the fourth quarters of 2000 and 2001 respectively. HealthExtras incurred an operating loss of $19.8 million for the year ended December 31, 2000. Total revenues of $44.2 million for 2000 included $39.3 million from the supplemental health segment and $4.9 million from the pharmacy benefit management segment.
The following table details financial data by segment for the years ended December 31, 2000 and December 31, 2001. PBM services operating results include the results for HealthextrasRx and Catalyst from the dates of acquisition.
Operating expenses for the year ended December 31, 2001, totaled $132.1 million. Direct expenses of $93.7 million, consisted of $50.1 million in benefit costs, warrant charges and fees payable to our distribution partners for our supplemental health and disability products and $43.6 million in direct costs associated with pharmacy benefit services consisting largely of reimbursements to network pharmacies. These direct expenses represented 70.9% of operating expenses for the period. For the year ended December 31, 2001, HealthExtras incurred $27.2 million in product development and marketing expenses, or 20.6% of total operating expenses. The primary component of the expenditures related to direct sales activities including telemarketing, direct mail and statement inserts. The expenses for these direct sales activities were approximately $21.4 million. In addition, the Company incurred approximately $2.0 million in product endorsement costs, $2.6 million for media production, including television, radio, Internet and print advertisements and $1.2 million in other marketing-related expenses. General and administrative expenses for the year totaled $11.2 million or 8.5% of total operating expenses, $7.5 million of which was related to the Company's supplemental health and disability segment while the remaining $3.7 million was related to the management of pharmacy benefits. These expenses included $6.1 million in compensation and benefits, $1.1 million in professional fees, $843,000 in facility costs, $313,000 in telephone and software costs, $466,000 in travel expenses, and $1.8 million in depreciation and amortization. Interest income for the period was approximately $ 1.1 million.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 ---------------------------------------------------------------------
HealthExtras incurred an operating loss of $19.8 million for the year ended December 31 2000, consisting of a $19.7 million loss from the Company's supplemental health operations, and a $100,000 loss from IPM. Revenue of $44.2 million consisted of program member payments earned during the period of $39.3 million and sales revenue for 2000 generated by IPM's pharmacy benefit management services of $4.9 million from the acquisition date of November 1, 2000. HealthExtras incurred an operating loss of $11.1 million for the year ended December 31, 1999. Revenue of $5.3 million consisted of annual program member payments earned during the period. The increase in revenue and program receipts was primarily attributable to the net growth in our membership for the year ended December 31, 2000. The increase in the net loss was primarily attributable to significantly increased marketing expenses.
Operating expenses for the year ended December 31, 2000 totaled $64.0 million. Direct expenses of $24.3 million, consisted of $19.8 million in costs for benefits included in our programs and fees payable to our distribution partners and $4.5 million in direct costs associated with IPM operations. These direct expenses represented 38% of operating expenses for the period. For the year ended December 31, 2000, HealthExtras incurred $31.2 million in product development and marketing expenses, or 49% of total operating expenses, $1.2 million of which was for the continuing creative development of promotional sales materials, $4.9 million for media production, including television, radio, Internet and print advertisements, $21.2 million for media distribution, $1.1 million in product endorsement costs, and $2.8 million in market research, product development, and other marketing-related expenses. General and administrative expenses for the year totaled $8.5 million or 13% of total operating expenses, $8.0 million of which was attributable to the Company's supplemental health operations and approximately $448,000 was associated with IPM operations. These expenses included $4.2 million in compensation and benefits, $653,000 in professional fees, $467,000 in facility costs, $308,000 in telephone and software costs, $380,000 in other personnel costs, $274,000 in travel expenses, and $702,000 in depreciation and amortization. Interest income for the period was approximately $2.1 million.
Total operating expenses for the year ended December 31, 1999, totaled $16.4 million. Direct expenses of $3.1 million consisted of the cost of obtaining the benefits included in our programs, and marketing and other fees payable to our distribution partners. These direct expenses represented 19% of operating expenses for the year. For the year ended December 31, 1999, HealthExtras incurred $10.3 million in product development and marketing expenses, or 63% of total operating expense, $4.3 million of which was incurred for the continuing creative development of promotional and sales materials, including television and print advertisements, and $1.1 million of which was product endorsement costs. Media production expenses totaled $5.1 million for print and Internet advertisement production and distribution. General and administrative expenses for the year totaled $3.0 million or 18% of total operating expenses. These expenses included $1.7 million in compensation and benefits and $205,000 in professional services. Interest expense totaled $350,000. The increase in operating expenses was attributable to the net growth in our membership as well as expanded product development and marketing for the year ended December 31, 2000.
As of December 31, 2001, we had $33.0 million in cash and cash equivalents, $24.6 million in operating working capital and short-term debt of $8.9 million related to the acquisition of Catalyst. As the Company has increased its PBM operations, its accounts receivable and accounts payable balances have grown significantly. In order to remain in compliance with its contractual arrangements with network pharmacies, the Company generally must reimburse claims within approximately thirty days. The Company expects to reduce its claims payable balance by between $8 and $10 million in the first quarter of 2002. In order to meet these obligations, the Company may borrow against its accounts receivable as necessary. The Company intends to manage its cash flow cycle by reducing its days outstanding on accounts receivable to as close to thirty days as is commercially practical.
By managing accounts receivable to conform more closely to our payment obligations to suppliers, the Company should be able to generate positive operating cash flow, which when combined with available cash resources will be sufficient to meet our planned working capital, capital expenditures and business expansion requirements. However there can be no assurance that we will not require additional capital. Even if such funds are not required, we may seek additional equity or debt financing. We cannot assure you that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our stockholders.
The Company estimates reserves for doubtful PBM accounts receivable as of each balance sheet date. The Company has historically had very limited exposure to bad debts due to the nature of the employee benefits involved, the necessity of maintaining benefit continuity for its customers employees, and the general financial strength of its customer base. With respect to supplemental health benefits, almost all revenues are collected in advance via credit card and as such generate no accounts receivable exposure.
FASB Statement No. 141 (FAS 141), Business Combinations, and FASB Statement No. 142 (FAS 142), Goodwill and Other Intangible Assets were issued July 20, 2001.
FAS 141 changes the accounting principles for Business combinations. Some significant changes from the previous principles are: a) the purchase method of accounting must be used for all business combinations initiated after June 30, 2001; and b) specific criteria are provided for recognizing intangible assets apart from goodwill. FAS 141 is effective for all business combinations occurring after June 30, 2001.
FAS 142 establishes the accounting principles for goodwill and intangible assets subsequent to their initial recognition. Some significant changes from the previous principles are: a) goodwill and indefinite-lived intangible assets are no longer amortized; and b) goodwill and intangible assets deemed to have an indefinite life are tested for impairment at least annually.
The provisions of FAS 142 are not effective for the Company until January 1, 2002; however, certain provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. Those provisions have been applied to the Catalyst acquisition and other purchases of intangible assets that occurred after June 30, 2001. Upon adoption of FAS 142, the Company will be required to perform an impairment analysis on the goodwill from the IPM acquisition. The Company will perform the required analysis by June 30, 2002.
Because we have a limited operating history, our business prospects are subject to a great deal of uncertainty - ----------------------------------------------------------------------------
We have not been consistently profitable and may not be profitable in the future - ---------------------------------------------------------------------------
Our pharmacy benefit management business relies on real-time management information systems - ---------------------------------------------------------------------------
Our pharmacy operations utilizes an electronic network connecting approximately 50,000 retail pharmacies to process third-party claims. The systems we utilize are provided by a third-party. Because claims are adjudicated in real time, systems availability and reliability are key to meeting customers' service expectations. Any interruption in real time service, either through systems availability or telecommunications disruptions can significantly damage the quality of service we provide. Our pharmacy benefit management services depend on third-party proprietary software to perform automated transaction processing. While our pharmacy benefit management services have not experienced significant or detrimental service interruptions, and have significant back-up database capability, there can be no assurance that the business will not be harmed by these service interruptions.
If we lose one or more of our marketing relationships, our access to potential customers would decline and sales and revenues would suffer - -------------------------------------------------------------------------
We are dependent on the providers of benefits included in our programs. These benefits are provided pursuant to arrangements with Unum Life Insurance Company of America, The Chubb Group of Insurance Companies, Zurich American Insurance Company and others that may be terminated on relatively short notice. If we lose these relationships and are unable to replace them quickly and cost effectively, we would not be able to satisfy consumer demand for our programs.
We arrange for the provision by others of the benefits included in our member programs. If the firms with which we have contracted to provide those benefits fail to provide them as required, or are negligent or otherwise culpable in providing them, we could become involved in any resulting claim or litigation.
We may experience significant fluctuations in our quarterly results of operations, which will make it difficult for investors to make reliable period-to-period comparisons and may contribute to volatility in our stock price - --------------------------------------------------------------------------------
Our quarterly expenses have fluctuated significantly in the past, and we expect our quarterly revenues and expenses to continue to fluctuate significantly in the future. The causes for fluctuations could include, among other factors:
* levels of pharmacy claims expenditures, seasonal fluctuations in demand and enrollment levels;
Any new laws or regulations or new interpretations of existing laws or regulations relating to the Internet could hinder our ability to offer programs over the Internet.
Our pharmacy benefit management business must comply with a range of State and Federal regulatory requirements - ------------------------------------------------------------------------------
Open Network Legislation. Numerous states have adopted "any willing provider" legislation, which requires pharmacy network sponsors to admit for network participation any retail pharmacy willing to meet a healthcare plan's price and other terms.
Anti-Remuneration Legislation. "Anti-kickback" statutes at the federal and state level prohibit an entity from paying or receiving any compensation to induce the referral of healthcare plan beneficiaries or the purchase of items or services for which payment may be made under such healthcare plans. Additionally, state and federal regulations have been the basis for investigations and multi-state settlements relating to financial incentives provided by pharmaceutical manufacturers to retail pharmacies in connection with pharmaceutical switching programs. To our knowledge, these laws have not been applied to prohibit pharmacy benefit management companies from receiving amounts from pharmaceutical manufacturers in connection with pharmaceutical purchasing and formulary management programs, to prohibit therapeutic substitution programs conducted by independent pharmacy benefit management companies, or to prohibit contractual relationships such as we have regarding these types of programs.
Patient Choice. Some states have enacted legislation that prohibits the plan sponsor from implementing certain restrictive design features, and many states have introduced legislation to regulate various aspects of managed care plans, including provisions relating to the pharmacy benefit. Legislation has been introduced in some states to prohibit or restrict therapeutic substitution, or to require coverage of all FDA approved drugs. Other states mandate coverage of certain benefits or conditions. Such legislation does not generally apply to us, but it may apply to certain of our customers, such as HMOs and health insurers. If such legislation were to become widespread and broad in scope, it could have the effect of limiting the economic benefits achievable through pharmacy benefit management and consequently make our services less attractive.
Consumer Protection Legislation. Most states have consumer protection laws that have been the basis for investigations and multi-state settlements relating to financial incentives provided by drug manufacturers to retail pharmacies in connection with drug switching programs. We believe that our contractual relationships with drug manufacturers and retail pharmacies do not include the features that were viewed adversely by enforcement authorities. However, no assurance can be given that we will not be subject to scrutiny or challenge under one or more of these laws.
Confidential Information. Most of our activities involve the receipt or use by us of confidential, medical information concerning individual members, including the transfer of the confidential information to the member's health benefit plan. In addition, we use aggregated population data for research and analysis purposes. Legislation has been proposed at the federal level and in several states to restrict the use and disclosure of confidential medical information the enactment of such legislation could require significant changes to a our business operations.
We use both internally developed and third party systems to operate the Internet aspects of our business. If the number of users of our service increases substantially, we will need to significantly expand and upgrade our technology, transaction processing systems and network infrastructure. We do not know whether we will be able to accurately project the rate or timing of any increases, or expand and upgrade our systems and infrastructure to accommodate any increases in a timely manner. Our ability to facilitate transactions successfully and provide high quality customer service also depends on the efficient and uninterrupted operation of our computer and communications hardware systems. Our service has experienced periodic system interruptions, and it is likely that these interruptions will continue to occur from time to time. Additionally, our systems and operations are vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, acts of vandalism and similar events. We may not carry sufficient business interruption insurance to compensate for losses that could occur. Any system failure that causes an interruption in service or decreases the responsiveness of our service would impair our revenue-generating capabilities, and could damage our reputation and our brand name.