PAI currently occupies approximately 7,000 square feet of office space in Little Rock, Arkansas, at an annual rent of $110,372, including monthly expenses. The landlord for these premises is Executive Park Partnership. The lease expires on April 30, 2002. PAI is currently negotiating with Executive Park Partnership the terms of a lease that would commence May 1, 2002 and would increase the space occupied by PAI.
The following table sets forth the breakdown of Health Card's charges relating to pharmaceuticals dispensed and administrative fees:
Cost of claims includes the amounts paid to network pharmacies, including mail service pharmacies, for pharmaceutical claims, and reductions resulting from the gross rebates received from drug manufacturers. Cost of claims are recognized as follows: the contractual obligation of Health Card to pay for these drugs is recorded as cost of claims at the time of dispensing of the drug by the pharmacy network. Cost of claims is reduced by the rebates that Health Card receives. Rebates are earned from drug manufacturers based on drugs utilized by plan participants at the time of dispensing. Health Card's portion of these rebates, which varies by sponsor, is recorded monthly based upon the claims adjudicated in that month.
Health Card processes its rebate claims either direct with the drug manufacturers, through its wholly-owned subsidiary, Specialty, or through a third party rebate administrator. During the fiscal year ended June 30, 2001, Health Card dealt with three different rebate administrators. Effective July 1, 2001, Health Card has entered into an agreement with the Administrator to handle all of its consolidated rebate claims which it does not otherwise submit direct to the drug manufacturers.
Years ended June 30, 1999 2000 2001 --------------------- Rebates as a: % Of cost of claims 2.1% 2.4% 3.9% % Of total gross profit 20% 27% 45% % Of income before taxes 87% 133% 508%
Due to the expected continued growth and diversification of Health Card's business, Health Card also expects rebates as a percentage of cost of claims, to increase and continue to account for a significant percentage of total gross profit and income before taxes. Certain of Health Card's sponsors are entitled to all or a portion of rebates received by Health Card, which portion varies by sponsor. If such rebate programs were to be discontinued or adversely altered by drug manufacturers, or if the terms of Health Card's rebate sharing arrangements with its sponsors were adversely altered, it would have a material adverse effect on Health Card's business, operating results and financial condition.
On August 2, 1999, Health Card completed the sale of 1,600,000 shares of its common stock in an underwritten public offering (the "Public Offering"). Pursuant to the Public Offering, Health Card received net proceeds of approximately $9,538,037. Concurrently, the Bert E. Brodsky Revocable Trust (the "Brodsky Trust") sold 400,000 shares of common stock of Health Card in an underwritten offering. Of the proceeds received by the Brodsky Trust, it used approximately $1,992,900 to partly repay certain indebtedness owed by certain affiliates of the Brodsky Trust to Health Card. See Item 13 hereof.
Cost of claims increased $96.2 million, or approximately 63%, from $153.4 million for the fiscal year ended June 30, 2000, to $249.6 million for the fiscal year ended June 30, 2001. PAI and PMP accounted for $67.8 million, or 70% of the increase. As a percentage of revenues, cost of claims increased from 91.5% to 91.7% for the fiscal years ended June 30, 2000 and June 30, 2001, respectively. The percentage for the fiscal year ended June 30, 2000 was favorably impacted by a $736,000 reduction in rebates payable, which reduced cost of claims, which arose when the Company reevaluated its liabilities to a plan sponsor. The effect of this reduction is unrelated to the reduction in revenues and cost of claims described in the preceding paragraph.
Gross profit increased from $14.3 million for the fiscal year ended June 30, 2000 to $22.5 million for the fiscal year ended June 30, 2001; an $8.2 million, or 58%, increase. PAI and PMP accounted for $7.9 million, or 96%, of the increase. Gross profit as a percentage of revenue declined from 8.5% to 8.3% for the fiscal years ended June 30, 2000 and June 30, 2001, respectively. The decline is partially attributable to the impact of the one-time adjustment, described in the explanation for the change in cost of claims above. The Company has also seen a decline in profit margins due to competitive pressures.
General and administrative expenses charged by affiliates increased approximately $1,095,000, or 37%, year-over-year from $2,986,000 to $4,081,000 for the fiscal year ended June 30, 2000 and June 30, 2001, respectively. The majority of the increase related to additional rent related to additional space taken in fiscal year 2001, increased information technology services, and additional administrative support services and supplies to support the continued expansion of the business.
Income before income taxes declined approximately $861,000, or 30%, from approximately $2,863,000, for the fiscal year ended June 30, 2000, to approximately $2,001,000 for the fiscal year ended June 30, 2001. The primary reasons for the decline were the one time adjustments noted above: (i) the $733,000 revenue reduction in the fiscal year ended June 30, 2001; (ii) the $1,353,000 payments/accrued reserve for settlements in the fiscal year ended June 30, 2001; and (iii) the $736,000 reduction in rebates payable in the fiscal year ended June 30, 2000. While income before income taxes declined year-over-year, EBITDA (earnings before interest, taxes, depreciation and amortization) for these same periods actually increased by approximately $478,000, or 15%, from $3,241,000 for the fiscal year ended June 30, 2000 to $3,719,000 for the fiscal year ended June 30, 2001. This was due to the inclusion of approximately $568,000 of goodwill amortization related to the PAI and PMP acquisitions in the period ended June 30, 2001, approximately $93,000 of depreciation of PAI's and PMP's assets during this same year, as well as approximately $635,000 of incremental depreciation and amortization of new assets procured and capitalized during the year ended June 30, 2001. These increases offset the approximate $818,000 decline in operating income year-over-year.
Fiscal Year Ended June 30, 2000 Compared to Fiscal Year Ended June 30, 1999
Revenues increased $39.4 million, or approximately 31%, from $128.3 million for the fiscal year ended June 30, 1999 to $167.7 million for the fiscal year ended June 30, 2000. The increase related to revenues from new sponsors during the fiscal year was approximately $21 million. The majority of the remaining increase of approximately $17 million was due to other existing sponsors as a result of several factors including: higher charges relating to increased cost of pharmaceuticals, new drugs, plan participant growth, and an increase in the average number of claims per plan participant. The remainder of the increase, approximately $630,000, was due to new services offered during the year around the e-pharmacy and clinical services.
Revenues grew year over year despite the loss of two key clients during the June 30, 2000 fiscal year. One, a previous significant sponsor, terminated its contract with Health Card as of January 1, 2000. The second was placed in receivership by the State of Florida as of January 1, 2000, and their members were dispersed to other plans not covered by Health Card. These two sponsors accounted for $20.5 million and $21.4 million in revenues during the fiscal years ended June 30, 1999 and 2000, respectively. The revenue from these two sponsors was replaced by the $21 million of revenue from new sponsors described above. This helped to mitigate the overall impact of their loss on an actual run rate basis. Two other factors influencing the year to year comparison were: revenues of the fiscal year ended June 30, 1999 included a one-time rate increase of $500,000 from a major sponsor, and the revenue for the fiscal year ended June 30, 2000 was net of an $821,000 reduction in revenue when Health Card settled certain fees from a major sponsor as consideration for a new two year arrangement with this sponsor.
Cost of claims increased $37.6 million, or approximately 32%, from $115.8 million for the fiscal year ended June 30, 1999 to $153.4 million for the fiscal year ended June 30, 2000. As a percentage of revenues, cost of claims increased from 90.3% for the fiscal year ended June 30, 1999 to 91.5% for the fiscal year ended June 30, 2000. The primary reason for the cost of claims increasing as a percentage of revenue has to do with a risk sharing arrangement Health Card had with a major sponsor. During the fiscal year ended June 30, 2000 the cost of drugs covered under this arrangement were greater than the agreed upon capitated rate, which led to a sharing of those costs between Health Card and the sponsor. This fact along with the $821,000 revenue reduction mentioned above led to a differential between revenue and cost under this contract of $1.6 million during fiscal 2000. This risk sharing arrangement is no longer in effect. Partially offsetting this increase in costs was a $540,000 increase in the amount of manufacturer rebates received due to the increased volume of claims in fiscal 2000 and the administrative fee to be paid to Specialty. See "Business Services - - Claims Management - - Rebate Administration". In addition, during the fiscal year ended June 30, 2000 rebates payable were reduced by $736,000 when Health Card reevaluated its liability to a plan sponsor. Cost of claims for the fiscal year was decreased by the same amount.
Net cash provided by operating activities was $6.1 million and $12.6 million for the fiscal years ended June 30, 2000 and 2001, respectively. For the fiscal year ended June 30, 2001, accounts payable increased by $9.4 million more than accounts receivable, thus providing cash. For the fiscal year ended June 30, 2000, accounts payable increased by more than accounts receivable as well, but only by $0.5 million. There was also $2.6 million of non-cash depreciation and amortization related to the acquisitions and increased fixed assets during the fiscal year ended June 30, 2001 as compared to $1.3 million for the fiscal year ended June 30, 2000.
During fiscal year 2000, the Company entered into three capital lease transactions for hardware and software. The purchase price of these capital assets was $2,537,730. One hardware lease is for a term of 57 months with monthly payments of $40,322. Another hardware lease is for a term of 60 months with monthly payments of $3,245. The software lease is for a term of 33 months with monthly payments of $13,662. The principal balance of these three capital leases as of June 30, 2001 was $1,875,443.
The Company anticipates that current cash positions, after the PAI and PMP acquisitions and the repayment of certain affiliate and shareholder debt, together with anticipated cash flow from operations, will be sufficient to satisfy the Company's contemplated cash requirements for at least 24 months. This is based upon current levels of capital expenditures and anticipated operating results for the next 24 months. However, it is one of the Company's stated goals to acquire other pharmacy benefit management companies, evidenced by the two acquired during the fiscal year ended June 30, 2001. This will require cash. Depending on the Company's evaluation of future acquisitions, additional cash may be required. Therefore, the Company has put in place a $4,000,000 revolving credit line for acquisitions with its bank. The Company has no current borrowings against this credit line. The Company is also currently negotiating a larger amount, based on anticipated future earnings and its balance sheet, to meet anticipated future needs. In the event that the Company's plans change or its assumptions prove to be inaccurate, or that the additional financing is not consummated, or the proceeds of the financing prove to be insufficient to fund operations and acquisitions, the Company could be required to seek additional financing sooner than anticipated. There can be no assurance that such financing could be obtained at rates or on terms acceptable to the Company, if at all.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS Nos. 141 and 142, Business Combinations and Goodwill and Other Intangibles, respectively. FASB 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FASB 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill is subject to at least an annual assessment for impairment by applying a fair-value based test. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented or exchanged, regardless of the acquirer's intent to do so. The Company is in the process of determining the impact of these pronouncements on its financial position and operations.