Our corporate headquarters are located in leased office space in Elmsford, New York. We also lease commercial office space for our above-described operations in South Kingstown and Wakefield, Rhode Island; Columbus, Ohio; Livingston, New Jersey; Roslyn Heights and the Bronx, New York; and Nashville, Tennessee.
Net income (loss) includes legal expenses advanced for the defense of two former officers for the years 2000 and 1999, in the amounts of $2,700 and $1,400, respectively.
In the fourth quarter of 2000, the Company recorded a provision for loss of $2,300 on its investment in Wang Healthcare Information Systems.
Revenue includes TennCare® revenue of $67.8 million, $140.2 million, $141.9 million, $130.4 million, and $174.8 million respectively for the years ended 2003, 2002, 2001, 2000, and 1999. Revenue also includes Synagis revenue of $13.7 million, $14.6 million, $3.7 million and $0.6 million for the years ended December 31, 2003, 2002, 2001, and 2000, respectively. Both of these revenue sources have ended in 2003.
Effective tax rate (see management's discussion for why the effective tax rate has changed):
We offer Plan Sponsors a broad range of PBM Services designed to promote the cost-effective delivery of clinically appropriate PBM Services through our network of retail pharmacies and our own dedicated mail service distribution facility.
On February 2, 2004, we announced our acquisition of Natural Living, Inc. d/b/a Fair Pharmacy, a specialty pharmaceutical provider located in New York, New York for $15 million. The addition of Natural Living's foundation of long-term local physician relationships and loyal customer base to our position in the New York metropolitan region is an important enhancement of our HIV, Oncology and Hepatitis-C disease categories, as well as a complement to our overall disease state profile.
Fee-for-service agreements include: (i) specialty and mail service agreements, where we dispense prescription medications through our pharmacy facilities and (ii) PBM agreements, where prescription medications are dispensed through pharmacies participating in our retail pharmacy network as well as through our traditional mail service facility. Under fee-for-service agreements, revenue is recognized either: (a) when the pharmacy services are reported to us through the point of sale ("POS") claims processing system and the drug is dispensed to the Member, in the case of a prescription filled through a pharmacy participating in our retail pharmacy network, or (b) at the time the drug is dispensed, in the case of a prescription filled through a pharmacy owned by us.
Allowances for doubtful accounts are based on estimates of losses related to customer receivable balances. The procedure for estimating the allowance for doubtful accounts requires significant judgment and assumptions. Our primary collection risks are for patient co-payments and deductibles. The risk of collection varies based upon the product, the payor and the patient's ability to pay the amounts not reimbursed by the payor. We estimate the allowance for doubtful accounts based upon a variety of factors including the age of the outstanding receivables and our historical experience of collections, adjusting for current economic conditions and, in some cases, evaluating specific customer accounts for risk of loss. We continually review the estimation process and make changes to the estimates as necessary.
We account for acquisitions under the purchase method of accounting. Accordingly, any assets acquired and liabilities assumed are recorded at their respective fair values. The recorded values of assets and liabilities are based on third party estimates and independent valuations. The remaining values are based on management's judgments and estimates. Accordingly, our financial position or results of operations may be affected by changes in estimates and judgments.
As part of the process of preparing our consolidated financial statements, we estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax expense as well as assessing temporary differences resulting from differing treatment of items for book and tax purposes. These timing differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. A valuation allowance is recorded against deferred tax assets when, in the opinion of management, it is uncertain whether we will be able to realize the benefit from its deferred tax assets. Net deferred income tax assets increased $4.7 million in 2003. The valuation allowance for the deferred income tax asset decreased $7.5 million in 2003. Management concluded that the valuation allowance was no longer needed and the tax asset will more likely than not be realized based on our strong earnings history for the past three years and other positive factors. Hence, the total valuation allowance related to our net operating loss carryforwards generated from stock exercises was reversed. The reversal did not affect net income or the effective tax rate.
Effective on January 1, 2002, we adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. This statement addresses the accounting and reporting of goodwill and other intangible assets subsequent to their acquisition. Since adoption of SFAS No. 142 in July 2001, amortization of goodwill has discontinued, and goodwill is reviewed at least annually for impairment.
Under the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", we are required to perform an annual impairment test for its indefinite-lived intangible (i.e., Tradename) which is recorded at $4.7 million at December 31, 2003. The impairment step is a one step process where the fair value is compared to the carrying value at least annually. If the estimated fair value is lower than the carrying value, an impairment charge is recorded for the difference.
The determination of fair value of this intangible asset requires management to use estimate and assumption of the future cash flows and discount rates. Changes to these assumptions could affect the estimated fair value.
We recognize stock-based compensation using the intrinsic value method as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation expense is recorded for employee stock-based awards issued at market value at the date such awards are granted. Stock-based compensation granted to non-employees is accounted for using the fair value method in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation."
The following table provides consolidated details of our results for the years ended December 31, 2003, 2002 and 2001:
Total cost of revenue increased 3% to $520.2 million from $506.0 million from December 31, 2002. Excluding the results of TennCare® and Synagis® cost of revenue for the year 2003 was $445.2 million, compared to $363.9 million for 2002.
Gross profit for the year ended December 31, 2003 was $68.5 million representing a gross profit percentage of 11.6% compared to $70.6 million or 12.2%, respectively, for the prior year. Excluding the results of TennCare® and Synagis®, gross profit for 2003 was $62.0 million compared to $57.9 million for 2002.
Cost of revenue increased 25% to $506.0 million in 2002 from $403.2 million in 2001. These costs followed the same trend as the revenue.
Gross profit for 2002 was $70.6 million compared to $53.4 million in 2001, primarily due to growth in the Specialty Management and Delivery Services business. The gross profit percentage increased to 12.2% for 2002 compared to 11.7% for 2001.
The following table provides details for the segment for the years ended December 31, 2003, 2002 and 2001.
Year ended December 31, 2002 vs. year ended December 31, 2001
Cost of revenue increased $102.6 million to $131.0 million in 2002 compared to $28.4 million in 2001. This increase is commensurate with the business generated from the Long Island, NY distribution center business purchased on January 31, 2002 and the growth in our BioScrip® injectable and infusion therapy programs.
PBM Services cost of revenue decreased $9.7 million to $365.3 million in 2003. Gross profit decreased $1.8 million to $30.2 million compared to $32.1 million in 2002. The gross profit percentage decreased slightly from 7.9% to 7.6% compared to 2002. The decrease is primarily due to renewing a previously capitated contract on a fee for service basis, which generally has a lower margin, and lower rebates due to a change in the mix of certain drugs dispensed.
PBM Services revenues decreased $8.0 million to $407.1 million in 2002 compared to $415.1 million in 2001. In the second quarter of 2002 we changed the terms of some of our PBM contracts so that we no longer accepted financial or credit risk for these customers. As a result, we began recording revenue from these customers on a net basis where previously it was recorded on a gross basis. This change reduced revenue and cost of revenue by $53.5 million for the twelve months ended December 31, 2002, with no resulting effect on gross profit. Revenue was also reduced in 2002 as a result of the termination of certain less profitable PBM clients and the liquidation of Access MedPLUS in the fourth quarter of 2001. These decreases were partially offset by increases in our retail network and mail service contracts.
The gross profit percentage decreased to 7.9% in 2002 from 9.7% in 2001 as result of the liquidation of a former TennCare® customer, the change in the mix of PBM clients from 2001, as well as growth in our retail network and mail services for 2002 which generated lower gross profit percentages.
For the year ended December 31, 2003, selling, general and administrative (S,G&A) expenses increased to $50.6 million or 8.6% of revenue from $45.9 million or 8.0% for 2002. The increase in SG&A was a result of increased investment in sales resources and expanded management to support the growth in the Specialty Management and Delivery Services business, a severance related charge of $1.5 million associated with the termination of 55 employees in the PBM Services segment, acquisition related expenses of $0.7 million and a $0.9 million charge for a tentative settlement with the founder and former officer of the Company (see 'Other Matters'). We did not pay bonus compensation for 2003 as certain internal financial metrics were not met. Bonus compensation for 2002 was $0.9 million.
In 2002, selling, general and administrative expenses increased $7.4 million, or 19.2%, to $45.9 million compared to $38.5 million in 2001. This increase is principally the result of the inclusion of the Long Island, NY distribution center business since February 2002, additional expenses incurred to support the growth of our businesses and higher insurance premiums. Selling, general and administrative expenses as a percentage of revenue decreased to 8.0% in 2002 from 8.4% in 2001.
In 1999, we recorded $6.0 million of TennCare® reserve adjustments for estimated losses on contract receivables relating to Tennessee Health Partnership ("THP"), Preferred Health Plans and Xantus Health Plans of Tennessee, Inc. ("Xantus"). In 2001, we recorded a reserve adjustment credit of $1.0 million to reflect a favorable settlement with THP relative to the amount initially reserved in 1999. There were no reserve adjustments in 2000. In addition, in 2001 and 2002, we recorded reserve adjustment credits of $1.5 million and $0.9 million, respectively, as a result of the collection of receivables from Xantus previously reserved for in 1999.
For 2003, net cash provided from operating activities totaled $14.3 million compared to $20.8 million for 2002. This decrease is primarily due to the loss of TennCare®, which resulted in decreases in claims payable and payables to plan sponsors. Final rebate payments related to the TennCare® PBM business will be made in the first and second quarters of 2004.
Net cash used by financing activities in 2003 was $9.7 million compared to net cash provided in 2002 of $5.7 million. There were no outstanding bank borrowings under our $45 million revolving credit facility (the "Facility") with HFG Healthco-4 LLC, an affiliate of Healthcare Finance Group, Inc. ("HFG"), at December 31, 2003, a $4.6 million decrease from the same period in 2002. Outstanding bank borrowings decreased as a result of operating cash generated by our business and operations. The reduction in outstanding debt was achieved after the use of approximately $5.1 million for the repurchase of common stock under our stock repurchase program.
The Facility is an asset-based loan, has a three-year term expiring on November 1, 2006 and is secured by our receivables with interest paid monthly. Borrowings are repaid by the cash flow from customer payments. It provides for borrowing of up to $45 million at the London Inter-Bank Offered Rate (LIBOR) plus 2.4%. The Facility contains various covenants that, among other things, require us to maintain certain financial ratios, as defined in the agreements governing the Facility. As of December 31, 2003, there were no outstanding borrowings under the Facility. After the initial three year term, the Facility automatically renews for additional one-year terms unless either party gives notice not less than 90 days prior to the expiration of the initial term or any renewal term of their intention not to renew the Facility. The Facility allows us to request an increase in the amount available for borrowing up to $100 million, as well as converting a portion of any outstanding borrowings from a Revolving Loan into a Term Loan. The borrowing base utilizes receivables balances, among other things, as collateral.
The borrowing and repayment processes under the Facility are outlined below:
On February 28, 2003, we announced a stock repurchase program pursuant to which we are authorized to purchase up to $10 million of our common stock from time to time by various means. As of December 31, 2003, we used, in the aggregate, approximately $5.1 million of that authorization. The Board's current authorization superseded the repurchase program authorized in 2001.
As we continue to grow, we anticipate that our working capital needs will also continue to increase. We believe that we have sufficient cash on hand, together with funds available under the Facility and cash expected to be generated from operating activities, to fund our anticipated working capital needs, the current stock repurchase program and other cash needs.
We may also pursue joint venture arrangements, business acquisitions and other transactions designed to expand our Specialty Management and Delivery Services and PBM Services businesses, which we would expect to fund from cash on hand or debt, borrowings under the Facility, other future indebtedness or, if appropriate, the private and/or public sale or exchange of equity securities (see discussion of the Facility above).
On February 2, 2004, we acquired Natural Living, Inc. for $15 million cash. This purchase was financed using the Facility.
On March 23, 2002, Mr. Richard Friedman, our Chairman and Chief Executive Officer, repaid in full a $1.7 million loan from the Company. This loan, together with accrued and unpaid interest, totaled approximately $2.1 million.
Natural Living's 2003 annual revenues were approximately $40 million and the acquisition is expected to be slightly accretive to our earnings per share in 2004. Natural Living will be consolidated starting in February, 2004 and the purchase price allocation is not yet complete.
On April 18, 2003, the U.S. Department of Health and Human Services, Office of Inspector General ("OIG") released Compliance Program Guidance for Pharmaceutical Manufacturers (the "Guidance") designed to provide voluntary, nonbinding guidance to assist companies that develop, manufacture, market and sell pharmaceutical products or biological products, including PBM's in devising effective compliance programs. The Guidance provides the OIG's view of the fundamental elements of pharmaceutical manufacturer's compliance programs and principles that should be considered when creating and implementing an effective compliance program, or as a benchmark for companies with existing compliance programs. We currently maintain a compliance program that includes the key compliance program elements described in the Guidance. We believe that the fundamental elements of our compliance program are consistent with the principles, policies and intent of the Guidance.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue No. 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of the provisions of SFAS No. 146 in fiscal year 2003 did not have a material effect on our financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, by requiring that contracts with comparable characteristics be accounted for similarly and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and must be applied prospectively. The adoption of the provisions of SFAS No. 149 in fiscal year 2003 did not have a material impact on our financial position or results of operations.
We have audited the accompanying consolidated balance sheets of MIM Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. The financial statements and schedule of MIM Corporation as of December 31, 2001 and for the year then ended, were audited by other auditors who have ceased operations and whose report dated February 16, 2002, expressed an unqualified opinion on those statements, prior to restatement.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of MIM Corporation at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We have audited the accompanying consolidated balance sheets of MIM Corporation (a Delaware corporation) and Subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MIM Corporation and Subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
This is a copy of an Accountant's Report previously issued by Arthur Andersen LLP, and has not been reissued by Andersen. See Exhibit 23.2 for further information.
The Company paid $421, $853 and $465 in cash for interest for each of the years ended December 31, 2003, 2002, and 2001, respectively.
In 2001, the Company reclassified stockholder notes receivable of $771 to other assets. During 2001, the stockholder repaid $504 of the notes outstanding, with the balance of $267 being repaid in 2002.
(In thousands, except where otherwise noted and for share and per share amounts)
In 2003, the Company derived revenues from agreements to provide PBM services, which includes prescription Mail Service to the Members of Plan Sponsors in the United States. The Company also provided Specialty Management and Delivery Services to patients who are chronically ill, genetically impaired, or afflicted with potentially life threatening diseases that require injection and infusion therapies, as well as infusion therapies and home healthcare services to patients recently discharged from hospitals.
Historically, a significant portion of the Company's revenues were derived from providing PBM services in the State of Tennessee to managed care organizations participating in the State of Tennessee's TennCare® program. On May 27, 2003 the Company was notified that commencing July 1, 2003, we would no longer be providing PBM Services to Plan Sponsors participating in the TennCare® program. PBM agreements with Plan Sponsors participating in the TennCare® program were expected to generate $85 million in revenue and approximately $5.5 million in gross profit for the second half of 2003. For the years ended December 31, 2003, 2002 and 2001, TennCare® revenue was $67.8 million, $140.2 million and $141.9 million, respectively. Gross Profit for the same periods was $5.6 million, $11.6 million and $24.2 million, respectively. The Company is still providing Specialty Management and Delivery Services to customers in Tennessee and continues to work for increased penetration in this market.
Cash and cash equivalents include demand deposits, overnight investments and money market accounts, with maturities of ninety days or less.
Allowances for doubtful accounts are based on estimates of losses related to customer receivable balances. Our primary collection risks are for patient co-payments and deductibles. We estimate the allowance for doubtful accounts based upon a variety of factors including the age of the outstanding receivables and our historical experience of collections. We continually review the estimation process and makes changes to estimates as necessary.
The Company is responsible for all covered prescriptions provided to plan members during the contract period. Claims are continuously adjudicated through the Company's on-line adjudication system. These claims are paid to the individual pharmacies on a weekly basis.
Payables to plan sponsors represents the sharing of pharmaceutical rebates with the plan sponsors and, on a limited basis, profit sharing plans with certain contracts.
The Company generates revenue principally through the sale of prescription drugs, which are dispensed either through a pharmacy participating in the Company's pharmacy network or a pharmacy owned by the Company. Revenue is derived under two types of agreements: (i) fee-for-service agreements, which accounted for 97.0%, or $571.3 million, 90.9%, or $524.0 million, and 78.8% or $360.0 million of the Company's revenue for the years ended December 31, 2003, 2002 and 2001, respectively, and (ii) capitated agreements, which accounted for 3.0%, or $17.5 million, 9.1%, or $52.6 million, and 21.2% or $96.6 million of the Company's revenues for the years ended December 31, 2003, 2002, and 2001, respectively.
Fee-for-service agreements include: (i) specialty and mail service agreements, where the Company dispenses prescription medications through its own pharmacy facilities and (ii) PBM agreements, where prescription medications are dispensed through pharmacies participating in the Company's retail pharmacy network as well as the Company's mail service facility. Under fee-for-service agreements, revenue is recognized either: (a) when the pharmacy services are reported to the Company through the point of sale ("POS") claims processing system and the drug is dispensed to the Member, in the case of a prescription filled through a pharmacy participating in the Company's retail pharmacy network, or (b) at the time the drug is dispensed, in the case of a prescription filled through a pharmacy owned by the Company.
Revenue generated under PBM agreements is classified as gross or net by the Company based on whether it is acting as a principal or an agent in the fulfillment of prescriptions through its retail pharmacy network. When the Company independently has a contractual obligation to pay a network pharmacy provider for benefits provided to its plan sponsors' members, and has other indicators of risk and reward, the Company includes payments from these plan sponsors as revenue and payments to the network pharmacy providers as cost of revenue, as these transactions require the Company to assume credit risk and act as a principal. If the Company merely acts as an agent, and consequently administers plan sponsors' network pharmacy contracts, the Company does not assume credit risk and records only the administrative fees as revenue.
Co-payments. When prescriptions are filled and the Company is the participating pharmacy, the Company is entitled to collect and retain co-payments from plan sponsors' members and the Company records these co-payments as revenue when the amounts are deemed collectible and reasonably estimable. When prescriptions are filled through its retail pharmacy networks, the Company is not entitled to retain these amounts and accordingly does not account for co-payments in its financial statements. These amounts are never billed or collected by the Company and it has no legal right or obligation to receive any co-payments collected by the pharmacies in its retail network.
Cost of revenue includes pharmacy claims, fees paid to pharmacists and other direct costs associated with pharmacy management, claims processing operations and mail order services, offset by volume rebates received from pharmaceutical manufacturers. The Company does not maintain cost of revenue information with regards to product sales.
As part of the process of preparing the Company's consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which it operates. This process involves estimating actual current tax expense as well as assessing temporary differences resulting from differing treatment of items for book and tax purposes. These timing differences result in deferred tax assets and liabilities, which are included in the Company's consolidated balance sheet. A valuation allowance is recorded against deferred tax assets when, in the opinion of the Company's management, it is more likely than not that the Company will not be able to realize the benefit from its deferred tax assets.
On January 31, 2002, the Company acquired all of the issued and outstanding capital stock of Vitality Home Infusion Services, Inc. ("Vitality"), a New York-based provider of specialty pharmaceutical services (the Long Island, NY Distribution Center). The Long Island, NY Distribution Center provides such services to the chronically ill and genetically impaired, focusing particularly on oncology, infectious disease, immunology and rheumatory disease.
The following unaudited consolidated pro forma financial information for the whole Company for the years ended December 31, 2002 and 2001, respectively, has been prepared assuming the Long Island, NY Distribution Center was acquired as of January 1, 2001, utilizing the purchase method of accounting, with pro forma adjustments for non-amortizing goodwill, amortizing intangibles, interest expense, rent expense and income tax benefit. The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results that would have been realized had the acquisition occurred on January 1, 2001. This pro forma financial information is not intended to be a projection of future operating results.
The following table details the acquired intangible assets and their accumulated amortization as of December 31, 2003.
The amortization expense for the year ended December 31, 2003 was $1,863. The estimated amortization expense for the next five years is as follows:
The Company leases one of its facilities from Alchemie Properties, LLC ("Alchemie") pursuant to a ten-year agreement. Alchemie is controlled by Mr. E. David Corvese, a stockholder and former officer and director of the Company (the "Founder"). Rent expense was approximately $56 for each of the years ended December 31, 2003, 2002, and 2001.
The Company had a $267 note receivable from Alchemie outstanding as of December 31, 2001. The note bears interest at a rate of 10% per annum with principal due and payable on December 1, 2004. Interest income was $2 and $29 for the years ended December 31, 2002 and 2001. This note was paid in full on January 31, 2002.
Property and equipment, at cost, consists of the following at December 31:
On November 1, 2000 the Company entered into the facility. The Facility had a three-year term and is secured by the Company's receivables with interest paid monthly. It provided for borrowing up to $45 million at the London Inter-Bank Offered Rate (LIBOR) plus 2.1%. The facility contained various covenants that, among other things, required the Company to maintain certain financial ratios, as defined in the agreements governing the Facility.
As of December 31, 2003, there were no outstanding borrowings under the Facility. The Facility was scheduled to terminate on October 31, 2003. The Company extended the Facility with HFG through November 1, 2006 at LIBOR plus 2.4%. The contract governing the Facility provides for automatic one year extensions unless either party gives notice not less than 90 days prior to the expiration of the initial term or any renewal term of its intention not to renew the Facility. The extension was effective as of June 30, 2003. The Facility, as extended, permits the Company to request an increase in the amount available for borrowing to up to $100 million, as well as converting a portion of any outstanding borrowings from a Revolving Loan into a Term Loan. The borrowing base utilizes receivables balances, among other things, as collateral. In connection with the 2003 extension, the Company paid HFG a renewal fee of $315.
On February 27, 2003, the Executive Committee of the Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to an aggregate of $10,000 of its Common Stock in open market or private transactions. As of December 31, 2003, the Company has repurchased 799,893 shares of its Common Stock in the open market at an aggregate purchase price of $5,068.
Until settled on April 2, 2001, the Company had been engaged in commercial arbitration with Tennessee Health Partnership ("THP") over a number of commercial disputes surrounding the parties' relationship. In 1999, the Company recorded a TennCare® reserve adjustment of $3,300 for estimated future losses related to this dispute and another TennCare® provider. In connection with the above settlement, which was favorable to the Company, $1,300 was paid to THP in satisfaction of all claims between the parties and a $980 TennCare® reserve adjustment credit was recorded in the first quarter of 2001.
On March 31, 1999, the State of Tennessee (the "State") placed Xantus Health Plans of Tennessee, Inc. ("Xantus") in receivership. The State proposed a plan of rehabilitation (the "Plan"), as opposed to a liquidation of Xantus, that would allow Xantus to remain operating as a TennCare® MCO. Under the Plan, the State loaned Xantus $30,000 to repay pre-petition claims of providers, which claims aggregate approximately $80,000. Under the Plan, during December 1999, the Company received $4,200, including $600 of unpaid rebates to Xantus, which the Company was allowed to offset in full against its pre-petition claims. Because a plan for the payment of the remaining amounts had not been finalized in time for completion of the annual audit, and the recovery of any additional amounts was uncertain, the Company recorded a special charge in 1999 of $2,700 as a TennCare® reserve adjustment for the estimated loss on the remaining amounts owed. In the third quarter of 2001, the Company recorded $1,496 as a credit to the TennCare® reserve, resulting from the collection of receivables from Xantus for amounts previously reserved in 1999. In the first quarter of 2002, the Company recorded $851 as a credit against that reserve based on management's determination that amount was free from claims to third parties.
In 1998, the Company recorded a $2,200 charge against earnings in connection with an agreement in principle with respect to a civil settlement of the Federal and State of Tennessee investigation in connection with the conduct of two former officers of the Company, prior to the Company's initial public offering. This settlement was paid in full on July 1, 2002.
Various Federal and state laws and regulations affecting the healthcare industry do or may impact the Company's current and planned operations, including, without limitation, Federal and state laws prohibiting kickbacks in government health programs (including TennCare®), Federal and state antitrust and drug distribution laws, and a wide variety of consumer protection, insurance and other state laws and regulations. While management believes that the Company is in substantial compliance with all existing laws and regulations material to the operation of its business, such laws and regulations are subject to rapid change and often are uncertain in their application. As controversies continue to arise in the healthcare industry (for example, regarding the efforts of Plan Sponsors and pharmacy benefit managers to limit formularies, alter drug choice and establish limited networks of participating pharmacies), Federal and state regulation and enforcement priorities in this area can be expected to increase, the impact of which on the Company cannot be predicted. There can be no assurance that the Company will not be subject to scrutiny or challenge under one or more of these laws or that any such challenge would not be successful. Any such challenge, whether or not successful, could have a material adverse effect upon the Company's financial position and results of operations. Violation of the Federal anti-kickback statute, for example, may result in substantial criminal penalties, as well as exclusion from the Medicare and Medicaid (including TennCare®) programs. Further, there can be no assurance that the Company will be able to obtain or maintain any of the regulatory approvals that may be required to operate its business, and the failure to do so could have a material adverse effect on the Company's financial position and results of operations.
The Company entered into a corporate integrity agreement with the Office of Inspector General (the "OIG") within the Department of Health and Human Services ("HHS") in connection with the Global Settlement Agreement entered into with the OIG and the State of Tennessee in June 2000. In order to assist the Company in maintaining compliance with laws and regulations and the corporate integrity agreement the Company implemented its corporate compliance program in August of 2000. This program includes educational training for all employees on compliance with laws and regulations relevant to the Company's business and operations and a formal program of reporting and resolution of possible violations of laws or regulations, as well as increased oversight by the OIG. Should the oversight procedures reveal credible evidence of any violation of federal law, the Company is required to report such potential violations to the OIG and the Department of Justice ("DOJ"). The Company is therefore subject to increased regulatory scrutiny and, if the Company commits legal or regulatory violations, they may be subject to an increased risk of sanctions or penalties, including exclusion from participation in the Medicare or Medicaid programs.
The Company's reconciliation of the expected provision rate to the effective income tax rate is as follows:
As of December 31, 2003, certain of the NOLs described above are subject to limitation and may be utilized in a future year upon release of the limitation. If the NOLs are not utilized in the year they are available they may be utilized in a future year to the extent they have not expired.
As of December 31, 2003 and 2002, the exercisable portion of outstanding options was 1,628,002 shares and 1,096,071 shares, respectively. Stock option activity under the Plans through December 31, 2003 is as follows:
The 1996 Directors Stock Incentive Plan, (the ''Directors Plan'') was adopted to attract and retain qualified individuals to serve as non-employee directors of the Company (''Outside Directors''), to provide incentives and rewards to such directors and to associate more closely the interests of such directors with those of the Company's stockholders. The Directors Plan provides for the automatic granting of 20,000 non-qualified stock options to Outside Directors upon his or her initial appointment or election to the Board. The exercise price of such options is equal to the fair market value of the Common Stock on the date of grant. Options granted under the Directors Plan vest over three years. In 2002, an amendment and restatement of the Directors Plan was approved at the annual stockholders meeting to add 200,000 shares to the 300,000 shares previously authorized and provide automatic annual grants of 5,000 options to each non-employee director of the Company. Following the approval, 5,000 options at an exercise price of $9.94 were granted to each of the six Directors. In addition, in 2003, 20,000 shares at an exercise price of $8.77 were granted to a newly appointed director of the Company. As of December 31, 2003, options to purchase 225,000 shares are outstanding at an average exercise price of $6.89. At December 31, 2003, 130,002 shares under the Directors Plan were exercisable.
In association with a cost structure review related to the loss of the TennCare® PBM business the Company notified 55 employees employed in the PBM Services segment that their employment with the Company would be involuntarily terminated. As a result the Company recorded $1,590 of selling, general and administrative expenses for employee separation costs, primarily severance and contract related termination payments in the second and third quarters of 2003. All the employees left active payroll by October 31, 2003. In the fourth quarter of 2003, $84 of these charges were reversed as certain severance benefits were overestimated. There are no further TennCare® related severance charges planned or expected.
A summary of quarterly financial information for fiscal 2003 and 2002 is as follows:
On February 2, 2004, the Company announced that it has acquired Natural Living, Inc., a specialty pharmaceutical provider, based in New York City for $15 million. Natural Living's 2003 annual revenues were approximately $40 million and the acquisition is expected to be slightly accretive in 2004. The acquisition will be accounted for under the purchase method of accounting and will be consolidated starting in February, 2004. The Company has not yet completed the evaluation and allocation of the purchase price as the appraisals associated with the valuation of certain tangible assets are not yet complete. The Company may be required to pay up to $3,000 of additional cash consideration subject to specific performance targets by the end of the first year following the acquisition.