The Company occupied approximately 26,500 square feet of office space located at 26 Harbor Park Drive, Port Washington, New York 11050 up until April 30, 2004 (the “Leased Premises”). The Company subleases the Leased Premises from BFS Realty, LLC, an affiliate of the Company’s former Chairman and current director (the “Affiliate”). The Affiliate leases the Leased Premises from the Nassau County Industrial Development Agency (“NCIDA”) pursuant to a lease that was entered into by NCIDA and the Affiliate in July 1994, which expires in March 2005. The Affiliate has the right to purchase the Leased Premises upon expiration of that lease for the purchase price of one dollar. The Affiliate subleases a portion of the Leased Premises to the Company (the “Lease”). As of November 1, 2001, the Company and the Affiliate amended the Lease. The Lease provided that, effective August 1, 2001, the rent payable by the Company would be an aggregate annual rent of $308,305. While formerly the Company made estimated monthly real estate tax, utilities and maintenance-expense payments to the Affiliate, the Lease provided that the Company would pay its pro-rata share of such expenses directly, to the entities to whom payment must be made. The annual rent would increase by 5% per year during the term of the Lease.
Pursuant to a lease dated August 10, 1998 and expiring on August 31, 2005, Health Card occupies approximately 1,500 square feet at 63 Manorhaven Boulevard, Port Washington, New York, which is used currently for office storage space. The landlord for these premises is 61 Manorhaven Boulevard, LLC, of which the Company’s former Chairman and current director is the sole member. The current rent is $2,000 per month. The annual rent increases by 5% per year. Additional rent, in the form of certain expenses, is also payable.
Revenue for the PBM division is earned and recognized as follows: administrative fees are agreed upon with the sponsor on either a per claim charge or a per plan participant per month charge. Per claim fees are billed to sponsors for the claims adjudicated during the period. Per plan participant per month fees are generally billed to sponsors at the beginning of the month. The amount of revenue related to the drugs dispensed by pharmacies participating in Health Card’s pharmacy network is recognized at the time of dispensing the drug as the cost is incurred. The amount of revenue recognized is reduced by the amount of rebates that Health Card shares with its sponsors. The specific terms of the contracts that Health Card enters into with its sponsors will determine whether Health Card recognizes the gross revenue related to the cost of the prescriptions filled. In certain cases, the Company has not recognized the gross revenue or cost related to prescriptions filled for a specific sponsor. This has no impact on the Company’s gross profit since neither the prescription revenue nor the related cost of the prescriptions is recorded.
Health Card utilizes its comprehensive pharmacy benefit database to perform outcome studies and to develop disease information programs which are used to reduce overall healthcare costs. The Company’s Integrail division uses its software tools to analyze and predict outcomes for both medical and pharmacy data. These programs currently produce a small amount of revenue, but are starting to attract interest in the marketplace. Health Card believes that these value added information based services are becoming a more important component of managed care as well as management of the overall healthcare dollar, and therefore these services may provide an increasing source of revenue for Health Card in the future.
Mail Order recognizes revenue at the point of shipment for both the co-pay collected from the individual member, as well as for the “sale” of the prescription to the PBM at specified prices. Revenue from this intercompany sale is elimiated in consolidation. To date, Mail Order only fills prescriptions for NMHC plan sponsors. Revenue is recognized by Ascend at the point of shipment to the member. Ascend invoices individual members, sponsors, and insurance companies as well as Medicare and Medicaid.
The third party administrator provides estimates to Health Card based on its analysis of the amount of rebates that Health Card’s claims should generate. These estimates are prepared based on estimates of how Health Card’s claims might influence the market share of a particular drug covered under an agreement with a drug manufacturer. Market share is generally defined as the percentage of utilization of a certain drug or drugs within its therapeutic class. Under Health Card’s contract with the Administrator, Health Card receives a specified minimum amount per claim 150 days after the end of a quarter. Amounts above the minimum are shared between the Administrator and Health Card with final settlement twelve months after a quarter end. Health Card accrues rebates based upon an estimate provided by the Administrator.
Certain of Health Card’s sponsors are entitled to all or a portion of rebates received by Health Card, which portion varies contractually by sponsor. The manufacturer rebates retained by Health Card, after the sponsors receive their contractual amounts, have historically had a significant impact on Health Card’s financial performance. For the fiscal years ended June 30, 2004, 2003 and 2002 the rebates retained by Health Card has equaled 16%, 11% and 19%, respectively, of the Company’s total gross profit. Due to the expected continued growth and diversification of Health Card’s business, Health Card expects rebates to continue to account for a significant, but declining, percentage of its total gross profit.
If such rebate programs were to be discontinued or adversely altered by drug manufacturers, or government action, or if the terms of Health Card’s rebate sharing arrangements with its sponsors were adversely altered when these arrangements expire, there could be a material adverse effect on Health Card’s business, operating results and financial condition.
The pharmacy benefit management industry is intensely competitive, generally resulting in continuous pressure on Health Card’s gross profit as a percentage of total revenue. In recent years, industry consolidation and dramatic growth in managed healthcare have led to increasingly aggressive pricing of pharmacy benefit management services. Given the pressure on all parties to reduce healthcare costs, Health Card expects this competitive environment to continue for the foreseeable future.
Health Card plans to continue its organic growth through increased marketing of its services and by expanding the range of services offered, including value added consulting and information-based services through its Integrail division, mail order services through its facility in Florida, and specialty pharmacy services through its Ascend division. Health Card believes these services to be in growing demand within the healthcare industry. In addition, Health Card intends to continue to pursue an acquisition program to supplement its organic growth by making acquisitions of other pharmacy benefit management service providers, as well as related services providers.
Of the $77.8 million increase in revenue in fiscal 2004, $33.3 million was due to the inclusion of revenues from Ascend and Inteq, which were included in the revenue for the twelve months ended June 30, 2004, but not in the twelve months ended June 30, 2003. Another approximate $77.3 million of the overall gross revenue increase was due to revenue related to new sponsors or new services offered during fiscal 2004 excluding contracts recorded on a net revenue basis. An additional increase of approximately $77.5 million was attributable 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. These increases were partially offset by revenue decreases related to three factors: 1) the termination of existing customer contracts throughout the fiscal year including one major sponsor which terminated their contract effective December 31, 2002, leading to a reduction in revenue of approximately $93.3 million, and 2) there was one contract during the twelve months ended June 30, 2004 that the Company recognized on a net revenue basis that was recognized on a gross revenue basis for four months during the twelve months ended June 30, 2003. Due to a change in the contract terms effective November 1, 2002, this customer’s revenue was recognized on a net basis from that point. The revenue impact of this change was a year over year reduction of gross revenue of approximately $9.0 million. The third decrease occurred when rebates payable to the Company’s sponsors increased by $8.0 million for the twelve months ended June 30, 2004 as compared to the twelve months ended June 30, 2003. Since these rebates are treated as a reduction in revenue, this led to a reduction in the overall year-over-year revenue increase.
Included in selling, general and administrative expenses for the twelve months ended June 30, 2004 were approximately $2,569,500 of non-recurring expenses related to the New Mountain Transaction including: 1) transaction bonuses and a severance payment totaling $1,542,500, 2) a non-cash compensation charge of approximately $339,000 related to the acceleration of stock options for two directors who resigned upon the closing of the New Mountain Transaction and 3) a non-cash compensation charge and related expenses of approximately $688,000 related to stock options issued in lieu of a transaction bonus.
Selling, general, and administrative expenses as a percent of revenue increased from 6.3% for the fiscal year ended June 30, 2003 to 7.8% for the fiscal year ended June 30, 2004. The main reasons for the increase are the impact of recognizing more contracts on a net revenue basis, as that has the effect of dividing these same expenses over a smaller gross revenue base, the $2.6 million of non-recurring expenses related to New Mountain which added 40 basis points, and the start-up of NMHCmail.
Income before the provision for income taxes increased approximately $2.5 million, or 22%, from approximately $11.0 million, for the fiscal year ended June 30, 2003, to approximately $13.5 million for the fiscal year ended June 30, 2004. The primary reason for the increase was the improving efficiencies that come with scale arising from the integration of the acquisitions the Company has completed. The start-up of the mail order facility had the impact of reducing overall profitability in the year ended June 30, 2004.
Net income for the fiscal year ended June 30, 2004 was approximately $8.0 million as compared to approximately $6.4 million for the fiscal year ended June 30, 2003; a 24% increase. Net income for the twelve months ended June 30, 2004 includes the $1.5 million after tax impact of the New Mountain transaction items.
While net income and net income available to common stockholders excluding non-recurring New Mountain Transaction items are not measures of financial performance under U.S. generally accepted accounting principles, they are provided as information for investors for analysis purposes in evaluating the effect of the New Mountain Transaction on net income and net income available to common stockholders. Net income and net income available to common stockholders excluding non-recurring New Mountain Transaction items are not meant to be considered a substitute or replacement for net income or net income (loss) available to common stockholders as prepared in accordance with U.S. generally accepted accounting principles. The reconciliation from net income to net income available to common stockholders excluding non-recurring New Mountain transaction items, is as follows (all amounts are in thousands, except per share amounts):
Selling, general, and administrative expenses also increased in the twelve months ended June 30, 2003 due to the start-up of two new activities in the quarter ended December 31, 2002. The Company acquired Integrail as of November 1, 2002 (See Note 3 to the Consolidated Financial Statements comprising Item 8 hereof). In the months since the Company acquired Integrail, approximately $1.3 million of expenses were incurred primarily related to salary and benefits and depreciation and amortization. The other activity was the start-up of the build out of a mail order facility in Miramar, Florida. Prior to July 1, 2003, the Company out-sourced the total actual fulfillment of prescriptions that are ordered by mail. By bringing these services in-house the Company will be better able to control service and cost for its customers. For the twelve months ended June 30, 2003, approximately $450,000 of expenses were incurred on this endeavor. The division started dispensing pharmaceuticals as of July 1, 2003.
Due to the additions of Integrail and the mail order facility along with Centrus for the full twelve months in the fiscal year ended June 30, 2003, the Company’s expenses increased $4.4 million for expenditures related to increases in compensation and benefits, primarily associated with new employees including senior management. Some of this increase was also related to the replacement of resources from related parties with full time employees (see below). In addition, the Company incurred the following additional expenses in the twelve months ended June 30, 2003: 1) approximately $400,000 of expenses incurred related to two acquisitions which the Company did not complete, 2) approximately $127,000 related to a settlement of a New York State sales tax audit, and 3) the payment of $100,000 related to a terminated consulting agreement.
Net cash provided by operating activities was $23.9 million and $15.7 million for the fiscal years ended June 30, 2004 and 2003, respectively. One factor leading to the $8.2 million increase in cash provided by operations was the $1.5 million of incremental net income generated during the fiscal year ended June 30, 2004 as compared to the fiscal year ended June 30, 2003. Another factor in the increase in cash was the growth in income tax payables and other current and long-term liabilities which increased approximately $3.2 million.
During the year ended June 30, 2004 the Company repaid a net of approximately $15.6 million under its revolving credit facility. The Company also paid $0.5 million towards its outstanding capital lease and other debt obligations during the fiscal year ended June 30, 2004. As stated previously, the Company received a net of $24 million from the New Mountain transaction (See Item 1, “Description of Business-Recent Acquisitions”, and Note 3 to the Consolidated Financial Statements comprising Item 8 hereof), plus $7.0 million from the exercise of stock options. The Company used some of these funds to pay $1.6 million of preferred dividends for the twelve months ended June 30, 2004.
On January 29, 2002, the Company entered into a $40 million revolving credit facility, details of which are set forth in Item 1 above and in Note 7 to the Consolidated Financial Statements comprising Item 8 hereof. Borrowings of $28.7 million under the Facility were used to finance part of the purchase price of the Company’s acquisition of Centrus. The Facility contains various covenants that, among other things, require the Company to maintain certain financial ratios, as defined in the agreements governing the Facility. As of September 17, 2004, approximately $5.1 million was outstanding under the Facility, and the Company was in compliance with its financial-ratios covenants.
The total future payments under these contractual obligations as of June 30, 2004 is as follows:
Total Less than 1 year 1-3 years 4-5 years After 5 years
The shareholders of Centrus were eligible to receive additional consideration of up to $4,000,000, payable over three years, if certain financial targets were met over the first two years. The financial performance targets were achieved and $4 million has been earned. Of this amount, $1 million was paid in May 2003, $2 million was paid in May 2004, and another $1 million will be paid in May 2005.
The Company entered into an amended and restated preferred stock purchase agreement, dated as of November 26, 2003, with New Mountain Partners, L.P. (the “purchase agreement”). Pursuant to the purchase agreement, the Company agreed, subject to various conditions, to issue to New Mountain Partners a total of 6,956,522 shares of series A preferred stock at a purchase price of $11.50 per share, for aggregate proceeds of approximately $80 million. On March 19, 2004, the Company completed the sale of the series A preferred stock to New Mountain Partners and used approximately $49 million of the proceeds of the sale of the series A preferred stock to purchase, pursuant to a tender offer, 4,448,900 shares of the Company’s outstanding common stock at $11.00 per share. Prior to the closing of the New Mountain Transaction, Bert E. Brodsky, the former chairman of the board of directors and a current director, and certain stockholders related to him, held (assuming the exercise of 330,000 options and warrants held by Mr. Brodsky, which occurred in April 2004), in the aggregate, approximately 59% of the Company’s outstanding common stock and had agreed to tender 4,448,900 shares, or approximately 54% of the Company’s outstanding common stock, held by them, into the tender offer. No other shareholders tendered shares in the offer.
The Company anticipates that current cash positions, after its six acquisitions together with anticipated cash flow from operations, will be sufficient to satisfy the Company’s contemplated cash requirements for at least 24 months. This is based upon current levels of capital expenditures and anticipated operating results for the next 24 months. However, it is one of the Company’s stated goals to acquire other pharmacy benefit management companies and companies providing related services. Depending on the Company’s evaluation of future acquisitions, additional cash may be required to complete these acquisitions. In addition, the Company will require cash to acquire inventory for its mail order and specialty distribution operations. In the event that the Company’s plans change or its assumptions prove to be inaccurate, or the proceeds from the Facility and the New Mountain Transaction prove to be insufficient to fund operations and acquisitions, the Company could be required to seek additional financing sooner than anticipated. There can be no assurance that such financing could be obtained at rates or on terms acceptable to the Company, if at all.
Unaudited quarterly financial data ($ in thousands, except per share amounts) for the fiscal years 2004 and 2003 are summarized as follows:
Health Card’s discussion and analysis of its financial condition and results of operations are based upon Health Card’s Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires Health Card to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses; these estimates and judgments also affect related disclosures of contingent assets and liabilities. On an on-going basis, Health Card evaluates its estimates and judgments, including those related to revenue recognition, bad debt, intangible assets, income taxes, and financing operations. Health Card bases its estimates on experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The specific terms of the contracts that Health Card enters into with its sponsors will determine whether Health Card recognizes the gross revenue related to the cost of the prescriptions filled. There are several factors from EITF 99-19 that led the Company to recognize the majority of its revenue on a gross basis. These include: the Company acts as a principal and not an agent and is the primary obligor in the relationship among the pharmacies, the sponsors and the Company, the Company has credit risk, the Company has certain latitude in establishing price, and the Company has discretion in supplier selection. In certain cases, primarily because the amount the Company earns is fixed, the Company has not recognized the gross revenue or cost related to prescriptions filled for a specific sponsor. This has no impact on the Company’s gross profit since neither the prescription revenue nor the related cost of the prescriptions is recorded.
Rebates are recognized when the Company is entitled to them in accordance with the terms of its arrangements with drug manufacturers, third party rebate administrators, and sponsors, and when the amount of the rebates is determinable. The Company records the gross rebate receivable and the appropriate payable to the sponsors based on estimates, which are subject to final settlement. The estimates are based upon the claims submitted and the Company’s rebate experience, and are adjusted as additional information becomes available.