During the quarter ended March 31, 2005 we concluded that we were no longer liable for $1,099 of claims to various pharmacies on behalf of a former customer who went into receivership and properly reversed those claims into income. However, during the fourth quarter of fiscal 2005, the reversal of these claims in the prior quarter was not properly processed in our general ledger, resulting in their inclusion as a liability on our June 30, 2005 and June 30, 2006 balance sheets. This error resulted in a $1,099 overstatement of our cost of claims during the fourth quarter of fiscal 2005.
During the quarter ended September 30, 2006, due to the unlikelihood of collection, we wrote off approximately $407 of receivables related to unbillable claims that were shown as a reduction to our claims payable balance. We reviewed the nature of these receivables and determined that such receivables should have been written off in the prior periods in which they originated. As such, we wrote them off during the quarter ended September 30, 2006 through an increase to our cost of claims.
We have concluded that we did not properly reverse approximately $831 of claims to various pharmacies on behalf of a former customer who went into receivership during 2001 or write-off an $831 accounts receivable from such customer. This former customer was an insurance company and certain of their
We provide comprehensive PBM services to our customers, which include managed care organizations, local governments, unions, corporations, HMOs, employers, workers’ compensation plans, third party health care plan administrators, and federal and state government programs through our network of licensed pharmacies throughout the United States. Our PBM services include electronic point-of-sale pharmacy claims management, retail pharmacy network management, mail service pharmacy claims management, specialty pharmacy claims management, Medicare Part D services, benefit design consultation, preferred drug management programs, drug review and analysis, consulting services, data access and reporting and information analysis. We own a mail service pharmacy (“Mail Service”) and a specialty service pharmacy (“Specialty Service”). In addition, we are a national provider of drug benefits to our customers under the federal government’s Medicare Part D program.
Our revenue primarily consists of sales of prescription drugs, together with any associated administrative fees, to customers and participants, either through our nationwide network of pharmacies, our Mail Service pharmacy or our Specialty Service pharmacy. Revenue related to the sales of prescription drugs by our nationwide network of pharmacies, our Mail Service or Specialty Service pharmacies is recognized when the claims are adjudicated and the prescription drugs are shipped. Claims are adjudicated at the point-of-sale using our on-line processing system. Specialty Service revenues
represent revenues from the sale of primarily biopharmaceutical drugs and are reported at the net amount billed to third party payors, patients and others.
Participant co-payments are not recorded as revenue. Under our customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. As such, we do not include participant co-payments to pharmacies in revenue or cost of claims. For the fiscal years ended June 30, 2007, 2006 and 2005, excluded from our revenue and cost of claims was $249,526, $321,055, and $280,946, respectively, of participant co-payments to pharmacies. If the above amounts were included in our revenue and cost of claims, our operating income and net income would not have been affected.
We evaluate customer contracts to determine whether we act as a principal or as an agent in the fulfillment of prescriptions through our retail pharmacy network. We act as a principal in most of our transactions with customers and revenues are recognized at the prescription price (ingredient cost plus dispensing fee) negotiated with customers, as well as our administrative fees (“Gross Reporting”). Gross reporting is appropriate because we (i) have separate contractual relationships with customers and with pharmacies, (ii) are responsible to validate and economically manage a claim through our claims adjudication process, (iii) commit to set prescription prices for the pharmacy, including instructing the pharmacy as to how that price is to be settled (co-payment requirements), (iv) manage the overall prescription drug relationship with the patients, who are participants of customers’ plans, and (v) have credit risk for the price due from the customer. In instances where we merely administer a customer’s network pharmacy contract to which we are not a party and under which we do not assume credit risk, we only record our administrative fees as revenue. For these customers, we earn an administrative fee for collecting payments from the customer and remitting the corresponding amount to the pharmacies in the customer’s network. In these transactions, we act as a conduit for the customer. As we are not the principal in these transactions, drug ingredient cost is not included in our revenues or in our cost of claims. As such, there is no impact to our gross profit. Whether revenues are recorded on either a gross or net basis, we record the gross amount billed in accounts receivable and the related claims payable to pharmacies on our consolidated balance sheet.
The rebates that we receive from pharmaceutical manufacturers are recognized when we are entitled to them in accordance with the terms of our arrangements with pharmaceutical manufacturers and our third party rebate administrator, and when the amount of the rebate is determinable. Our revenue is reduced by the amount of rebates remitted to our customers. We compute the estimated amount of rebates due from the pharmaceutical manufacturers based on the actual claims data and the criteria established in each individual contract. The pharmaceutical manufacturers are obligated to reimburse us for earned rebates within a specified period of time. We reconcile our estimates to amounts received from the pharmaceutical manufacturers on a quarterly basis. Certain of our customers are contractually entitled to all or a portion of the rebates we receive from the pharmaceutical manufacturers. The manufacturer rebates retained by us, after the customers receive their contractual amounts, have historically had a significant impact on our financial performance. For the fiscal years ended June 30, 2007, 2006 and 2005, the rebates retained by us have approximated 13%, 20% and 22%, respectively, of our total gross profit. We expect rebates to continue to account for a significant, but declining, percentage of our total gross profit.
We plan to expand our growth through increased marketing of our services and by expanding the range of services offered, including home delivery services through Mail Service, and specialty pharmacy services through our Specialty Service segment. We also intend to provide our PDP services to our customers under the federal government’s Medicare Part D program. We believe these services to be in growing demand within the healthcare industry.
Fiscal Year Ended June 30, 2007 Compared to Fiscal Year Ended June 30, 2006
Revenue decreased $183,772 or 21.3%, from $862,853 for the fiscal year ended June 30, 2006 to $679,081 for the fiscal year ended June 30, 2007. We include in revenue only those co-payments earned from Mail Service. For the fiscal year ended June 30, 2007, there was $16,592 of co-payments included in revenue as compared to $18,423 for the fiscal year ended June 30, 2006. Co-payments retained by pharmacies on prescriptions filled for our participants and not included in our revenue were $249,526 and $321,055, for the fiscal years ended June 30, 2007 and 2006, respectively. Under our customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. As such, we do not include participant co-payments to pharmacies in our revenue or our cost of claims.
Selling, general and administrative expenses increased $11,629 or 15.3%, from $75,852 for the fiscal year ended June 30, 2006 to $87,481 for the fiscal year ended June 30, 2007. This increase is primarily the result of (i) $5,781 net increase in compensation and related items, inclusive of a $2,327 increase in one-time termination benefits primarily incurred in connection with our senior management changes during the fourth quarter of fiscal 2007, (ii) $2,945 increase in professional fees primarily related to the review
Selling, general and administrative expenses as a percent of revenue increased from 8.8% for the fiscal year ended June 30, 2006 to 12.9% for the fiscal year ended June 30, 2007.
Other income, net increased $298 or 25.7%, from $1,158 for the fiscal year ended June 30, 2006 to $1,456 for the fiscal year ended June 30, 2007. The increase primarily relates to (i) $322 increase in interest income earned from higher interest rates and on higher cash balances during the fiscal year ended June 30, 2007, and (ii) $128 of late fees charged to various customers for untimely payments of their invoices during the fiscal year ended June 30, 2007. These increases were offset by $203 of additional interest expense incurred during the fiscal year ended June 30, 2007 primarily related to the financing of various capital leases.
Net income decreased $9,565 or 99.0%, from $9,657 for the fiscal year ended June 30, 2006 to $92 for the fiscal year ended June 30, 2007. The decrease is primarily the result of (i) the decrease in gross profit, (ii) the increase in selling, general and administrative expenses, offset by (i) the increase in our effective tax rate from 42.1% to 92.9%, and (ii) the increase in other income, net.
Income before the provision for income taxes decreased $3,740, or 18.3%, from $20,412 for the fiscal year ended June 30, 2005 to $16,672 for the fiscal year ended June 30, 2006. The decrease relates to the $4,657 increase in our gross profit primarily offset by the $8,066 increase in our selling, general and administrative expense as noted above.
In addition, there were two charges against net income available to common stockholders related to the New Mountain Transaction (see “Commitments and Contingencies”). The first of these charges relates to series A preferred stock cash dividends, which amounted to $5,600 for both fiscal years ended June 30, 2006 and 2005. The series A preferred stock provides for an initial cash dividend equal to 7% of the investment amount (currently $80,000), which decreases to 3.5% after the fifth anniversary of issuance, March 19, 2009. The dividend of $5,600 represents the amount accrued and paid for both fiscal years ended June 30, 2006 and 2005. The second charge is for the accretion of transaction expenses which were $475 for both fiscal years ended June 30, 2006 and 2005.
After deducting these two charges from net income, there remained net income available to common stockholders of $3,582 for the fiscal year ended June 30, 2006 as compared to $6,306 for the fiscal year ended June 30, 2005.
We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial condition or results of operations.
In July 2006, we received approval from CMS to operate as a PDP sponsor under Medicare Part D through our wholly-owned subsidiary, NMHC Group Solutions which commenced on January 1, 2007.
In order for us to maintain our risk bearing licensures and continue to apply for additional licensures in the various states, we must fulfill statutory, capital and surplus requirements. We currently maintain approximately $5.2 million in a restricted cash account to fulfill such requirements. We do not intend to continue to provide our PDP to individual enrollees in 2008 and CMS has acknowledged our intent to provide the PDP Medicare benefits solely to employer groups. In addition, as of January 1, 2008, we will only be providing non-risk bearing Medicare benefits to employer groups that will reimburse us directly for any prescription drug costs. We do not intend to offer our PDP to employer groups in instances where we could be subject to risk. This change in PDP offerings may allow us to decrease the capital and surplus amounts maintained in our restricted cash accounts.
In addition, we may not be able to realize any return on our investments in Medicare initiatives if the cost and complexity of recent changes by and requirements of CMS exceed our expectations or prevent effective program implementation; if the government alters or reduces funding of Medicare programs because of the higher-than-anticipated cost to taxpayers of the MMA or for other reasons; if we fail to become a risk bearing entity prior to the expiration of the CMS waiver for the 49 other states and territories (we are in the process of obtaining the appropriate state licenses and are currently licensed in nine states); if we fail to design and maintain programs that are attractive to our customers or individual Medicare participants; if we are not successful in retaining employer groups and their enrollees, or winning contract renewals or new contracts under the MMA’s competitive bidding process; if the government alters or reduces funding of Medicare programs because of the higher-than-anticipated cost to taxpayers of the MMA or for other reasons.
Net cash used in investing activities was $6,554 for the fiscal year ended June 30, 2007 as compared to $8,022 for the fiscal year ended June 30, 2006. The $6,554 net cash used in investing activities during the fiscal year ended June 30, 2007 was primarily the result of $5,392 used for capital expenditures, $901 used for an earnout payment to PPP and $266 used for the acquisition of MPP. See Item 8 hereof (Note 4 - Business Acquisitions) for descriptions of the various acquisitions that have been consummated in the last 3 years.
We calculate and use EBITDA and EBITDA per adjusted prescription as indicators of our ability to generate cash from our reported operating results. These measurements are used in concert with net income and cash flows from operations, which measure actual cash generated in the period. In addition, we believe that EBITDA and EBITDA per adjusted prescription are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. EBITDA does not represent funds available for our discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operations data as measured under generally accepted accounting principles. The items excluded from EBITDA but included in the calculation of our reported net income are significant components of our consolidated statements of income, and must be considered in performing a comprehensive assessment of our overall financial performance. EBITDA, and the associated year-to-year trends, should not be considered in isolation. Our calculation of EBITDA may not be consistent with calculations of EBITDA used by other companies.
Includes PCN’s operating results commencing March 7, 2005, the date of acquisition.
We lease offices and warehouse space throughout the United States under various operating leases. We also lease pill dispensing and counting devices for use in our Mail Service pharmacy, as well as computer equipment, for use in our various offices. In addition, we lease office equipment and computer software under various capital leases.
The following table summarizes scheduled maturities of our contractual obligations for which cash flows are fixed and determinable as of June 30, 2007 ($ in thousands):
Certain of our business acquisition agreements include “earn-out” provisions. These provisions generally require that we pay to the seller or sellers of the business additional amounts based on the performance of the acquired business. Since the size of each payment depends upon performance of the acquired business, we do not expect that such payments will have a material adverse impact on our future results of operations or financial condition.
Changes in prices charged by manufacturers and wholesalers for pharmaceuticals affect our revenue and cost of claims.
Participant co-payments are not recorded as revenue. Under our customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. As such, we do not include participant co-payments to pharmacies in revenue or cost of claims.
with customers and revenues are recognized at the prescription price (ingredient cost plus dispensing fee) negotiated with customers, as well as our administrative fees (“Gross Reporting”). Gross reporting is appropriate because we (i) have separate contractual relationships with customers and with pharmacies, (ii) are responsible to validate and economically manage a claim through our claims adjudication process, (iii) commit to set prescription prices for the pharmacy, including instructing the pharmacy as to how that price is to be settled (co-payment requirements), (iv) manage the overall prescription drug plan relationship with the patients, who are participants of customers’ plans, and (v) have credit risk for the price due from the customer. There are certain contracts in which we recognize revenue on a net basis. The primary factor that leads to the recognition of net revenue on these contracts is that the amount we earn is primarily fixed. Whether revenues are recorded on either a gross or net basis, we record the gross amount billed in accounts receivable and the related claims payable to pharmacies on our consolidated balance sheet.
The rebates that we receive from pharmaceutical manufacturers are recognized when we are entitled to them in accordance with the terms of our arrangements with pharmaceutical manufacturers and our third party rebate administrator, and when the amount of the rebate is determinable. Our revenue is reduced by the amount of rebates earned by our customers.
Rebates Receivable and Payable. We record the rebate receivable and the appropriate payable to the customers based on estimates, which are subject to final settlement. The estimates are based upon claims submitted and our rebate experience, and are adjusted as additional information becomes available. Upon billing the manufacturer, any differences between our estimate and the actual amount of the rebates receivable is recorded to cost of claims, net of the estimated impact to our customers. Rebates are generally paid to customers on a quarterly basis, or as agreed upon with our customers, subsequent to collections from pharmaceutical manufacturers, although there are certain instances where rebates are paid to customers on a more accelerated basis.
Intangible Assets. Our intangible assets primarily reflect the value of client relationships that arose in connection with our various business acquisitions. These intangible assets are recorded at cost and are reviewed for impairment whenever events, such as losses of significant customers or other changes in circumstances indicate that the carrying amount may not be recoverable. We continually assess the useful lives of the intangible assets, taking into account historical customer turnover experience, including recent losses of customers and expected future losses, to ensure they reflect current circumstances.
Stock-Based Compensation. With the adoption of SFAS No. 123R on July 1, 2005, we are required to record the fair value of stock-based compensation awards as an expense. In order to determine the fair value of stock options on the date of grant, we apply the lattice-binomial option-pricing model. Inherent in this model are assumptions related to expected stock-price volatility, option life, risk-free interest rate, post-vesting terminations, sub-optimal exercise factor and dividend yield. While the risk-free interest rate, post-vesting terminations, sub-optimal exercise factor and dividend yield are less subjective assumptions that are based on factual data derived from public sources, the expected stock-price volatility and option life assumptions require a greater level of judgment which makes them critical accounting estimates.
We use an expected stock-price volatility assumption that is based on the historical volatility of the underlying stock which is obtained from public data sources. This approach is used as a predictor of future realized and implied volatilities and is directly related to the stock option valuation. For stock options granted during the fiscal year ended June 30, 2007, we used a weighted-average expected stock-price volatility ranging from 49.7% to 58.2% based upon the historic volatility.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”) to provide guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. Under SAB No. 108, companies should evaluate a misstatement based on its impact on the current year income statement, as well as the cumulative effect of correcting such misstatements that existed in prior years existing in the
current year’s ending balance sheet. Our adoption of SAB No. 108 during the fiscal year ended June 30, 2007 did not have a material impact on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation Number 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 establishes a recognition threshold and measurement for income tax positions recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a two-step evaluation process for tax positions taken, or expected to be taken, in a tax return. The first step is recognition and the second is measurement. For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.
We are currently evaluating the impact FIN 48 will have on our consolidated financial statements when it becomes effective for the Company in fiscal year 2008 and are unable, at this time, to quantify the impact, if any, to retained earnings at the time of adoption.