The Company currently occupies approximately 26,500 square feet of office space located at 26 Harbor Park Drive, Port Washington, New York 11050 (the "Leased Premises"). The Company subleases the Leased Premises from BFS Realty, LLC, an affiliate of the Company's Chairman (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 become the owner of the Leased Premises upon expiration of that lease. 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 provides that, effective August 1, 2001, the rent payable to the Company shall 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 now provides that the Company will pay its pro-rata share of such expenses directly, to the entities to whom payment must be made. The Company estimates that such monthly expenses will approximate an aggregate of $336,000 per year. The annual rent will increase by 5% per year during the term of the Lease. The annual expenses are also expected to increase, although the Company cannot estimate by how much. The Lease expires in July, 2010. The Company believes that the Leased Premises are adequate for current purposes. Leasehold improvements made to this space during the fiscal year ended June 30, 2002, were approximately $60,000.
Additionally, the Company leases office space through its subsidiaries in Little Rock, Arkansas, Tulsa, Oklahoma and Latham, New York. The aggregate annual rental payments for leased space in Little Rock are approximately $169,000; for leased space in Tulsa are approximately $48,000; and for Latham, approximately $700,000. In Latham, the subsidiary currently occupies two floors; the Company anticipates that the amount of space leased by the Company (and, concomitantly, the amount of rent paid) will be significantly reduced in the near future.
The following tables summarize certain selected financial information for each of the years in the five year period ended June 30, 2002 and provide certain supplemental data. The selected consolidated income statement data for the years ended June 30, 2000, 2001, and 2002 and the selected consolidated balance sheet data as of June 30, 2001 and 2002 have been derived from the audited consolidated financial statements of Health Card included in Item 8 hereof. The selected consolidated income statement data for the years ended June 30, 1998 and 1999 and the selected consolidated balance sheet data as of June 30, 1998, 1999 and 2000 have been derived from audited consolidated financial statements of Health Card that are not included in this Form 10-K. The information contained in this table should be read in conjunction with Health Card's consolidated financial statements and notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in
Revenue 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 limited 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 revenue nor the related cost of the prescriptions is recorded.
Years Ended June 30, 2000 2001 2002 Revenues relating to Pharmaceuticals $165,171 $266,959 $447,862 Administrative fees and other 2,505 5,160 11,970 ---------- -------- ---------
Health Card processes its rebate claims either direct with the drug manufacturers, through its wholly-owned subsidiary, Specialty, for which it receives administrative fees, or through a third party rebate administrator. 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.
Health Card computes the amount of rebates due direct from the drug manufacturers based on the actual claims data, the criteria established in each individual contract, and the specified payment schedules. The drug manufacturers are obligated to reimburse Health Card for earned rebates within a specified period of time.
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, 2000, 2001 and 2002 the rebates retained by Health Card has equaled 27%, 19% 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 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.
Revenues increased $187.7 million, or approximately 69%, from $272.1 million for the fiscal year ended June 30, 2001, to $459.8 million for the fiscal year ended June 30, 2002. Of the increase, $127.1 million, or 68% was due to the inclusion of revenues from Centrus, subsequent to January 29, 2002. PMP accounted for another $19.2 million, or 10.2%, of the increase since it was acquired on March 5, 2001 and included a full fiscal year in 2002 compared to less than four months in the fiscal year ended June 30, 2001. Another $39.6 million of the increase was due to revenues related to new sponsors or new services offered during fiscal 2002. The majority of the balance of the year-over-year increase was due primarily to increased revenues from 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. Two other factors affecting the year-over-year increase were: rebates payable to the Company's sponsors increased by $10.2 for the twelve months ended June 30, 2002 as compared to the twelve months ended June 30, 2001. Since these rebates are treated as a reduction in revenues this led to reduction in the overall year-over-year revenue increase. Secondly, there were certain contracts during fiscal year 2002 that the Company recognized on a net revenue basis. There were no contracts during the twelve months ended June 30, 2001 that the Company recognized on the net revenue basis. 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 limited 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 revenue nor the related cost of the prescriptions is recorded. Finally, revenues for the twelve months ended June 30, 2001 were negatively impacted by a reduction in revenues of $733,000 that arose when the Company settled certain fees due from a major sponsor related to a capitation arrangement for calendar year 1999.
For the fiscal year ended June 30, 2001, the Company recognized other income, net, of approximately $877,000. For the fiscal year ended June 30, 2002, the Company incurred other expense, net, of approximately $502,000. The components of the approximate $1,379,000 increase in net expense were an approximate $889,000 increase in interest expense, an approximate $591,000 decrease in interest income, and an approximate $101,000 gain on sold assets during the fiscal year ended June 30, 2002. The primary reasons for the net increase in expense were the interest expense incurred on the Company's revolving credit facility and on the Note Offering during the fiscal year ended June 30, 2002 to finance the acquisition of Centrus (see Item 1, "Description of Business-Recent Acquisitions", and Note 2 to the Consolidated Financial Statements comprising Item 8 hereof). Partially offsetting the increase in interest expense was the approximate $101,000 deferred gain during the fiscal year ended June 30, 2002 on the sale of assets related to a sale-leaseback transaction. (See Note 9 to the Consolidated Financial Statements comprising Item 8 hereof.)
Selling, general, and administrative expenses, which include amounts charged by affiliates, increased $9.0 million, or approximately 73%, from $12.4 million for the fiscal year ended June 30, 2000 to $21.4 million for the fiscal year ended June 30, 2001. Approximately 46% of the increase, or $4.2 million, was related to the inclusion of PAI and PMP in the consolidated numbers. The balance of the growth in these expenses was principally related to five areas: (i) an approximate $1,533,000 increase in expenditures related to increases in compensation and benefits, primarily associated with new employees including senior management; (ii) an approximate $635,000 increase in depreciation and amortization expenses related to increased hardware procurement and software development; (iii) an approximate $430,000 increase in data processing charges related to increased information technology services; (iv) an aggregate of approximately $1,353,000 related to actual payments made and/or reserves accrued related to the following matters: (A) the settlement of the West Contra Costa lawsuit (see Note 9 to the Consolidated Financial Statements comprising Item 8 hereof); (B) the reconciliation and settlement of amounts due to a former major sponsor (See Note 7 to the Consolidated Financial Statements), and (C) the settlement of a certain patent infringement litigation involving the use by the Company of certain PBM information technology systems and (v) an approximate $283,000 increase in legal fees related primarily to the defense of the items discussed in (iv) above.
The effective tax rate decreased from 43.6% for the fiscal year ended June 30, 2000 to 42.1% for the fiscal year ended June 30, 2001. The decrease stemmed primarily from a lower effective state tax rate net of federal taxes.
The Company's primary cash requirements are for capital expenditures and operating expenses, including cost of pharmaceuticals, software and hardware upgrades and the funding of accounts receivable. The Company also requires cash for potential acquisitions of other pharmacy benefit management companies or of companies providing related services. As of June 30, 2002, the Company had a working capital deficit of $42.7 million as compared to a working capital deficit of $7.1 million as of June 30, 2001. The primary reason for the decline in working capital was the acquisition of Centrus for $40 million in cash. This decline was partially offset by the increased profitability generated by the Company during the fiscal year ended June 30, 2002. The Company has now acquired three companies since July 2000 utilizing primarily cash. This has had the effect of increasing the Company's working capital deficits until sufficient profitability is generated to pay back the cost of the acquisitions.
Historically, the timing of the Company's accounts receivable and accounts payable has generally been a net source of cash from operating activities. This is the result of the terms of trade in place with plan sponsors on the one hand, and the Company's pharmacy network on the other hand. These terms generally lead to the Company's payments to participating pharmacies being slower than its corresponding collections from plan sponsors. The Company believes that this situation is not unusual in the pharmacy benefit management industry and expects to operate on similar terms for the foreseeable future. However, there can be no assurance that such terms of trade will continue in the future and, if they were to change materially, the Company could require additional working capital financing. The Company has put in place a $40 million revolving credit facility for acquisitions and working capital financing. However, if such terms of trade were to change materially, and/or if the Company were unable to obtain additional working capital financing, there could be a material adverse effect on the Company's business, financial condition, or results of operations.
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. With the acquisition of Centrus, the Company assumed five capital leases for computer and telephone equipment. The principal balance of these assets at the time of the acquisition was $139,447. The leases have various terms and payments. Three of those leases have subsequently been paid off in full. The principal balance of all remaining capital leases as of June 30, 2002 was approximately $1,365,000.
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 9 to the Consolidated Financial Statements. 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 13, 2002, approximately $24.5 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, 2002 is as follows:
PAI stockholders were eligible to receive up to $2,000,000 in additional consideration payable in combination of cash and common stock if certain financial targets of PAI were met for the fiscal years ended June 30, 2001 and 2002. These targets have been achieved and the $2 million has been earned. At the end of August 2001, $750,000 in cash was paid, and 62,500 shares of the Company's Common Stock valued at $4.00 per share were issued to the PAI stockholders. At the end of August 2002, $750,000 in cash was paid, and 41,668 shares of the Company's Common Stock valued at $6.00 per share were issued to the PAI stockholders.
The members of PMP are eligible to receive additional consideration of up to $1,000,000 if certain PMP clients are retained over the next three years. These targets were not met in the first year so no additional consideration was due and payable. It is the Company's expectations that these amounts will not be earned in the second and third years either as the identified clients were not generally retained directly, although they were replaced.
The shareholders of Centrus are eligible to receive additional consideration of up to $4,000,000, payable over three years, if certain financial targets are met over the next two years.
The Company anticipates that current cash positions, after its three 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 three acquired since July 2000. This will require cash and depending on the Company's evaluation of future acquisitions, additional cash may be required. In the event that the Company's plans change or its assumptions prove to be inaccurate, or the proceeds from the Facility 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.
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 limited 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 revenue nor the related cost of the prescriptions is recorded.
Health Card maintains allowances for doubtful accounts for estimated losses resulting from the liability of its sponsors to make required payments. If the financial condition of Health Card's sponsors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Health Card periodically considers whether or not it should record a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While Health Card has considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance, in the event Health Card were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should Health Card determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.
In assessing the recoverability of the Company's goodwill and other intangibles, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets not previously recorded. On July 1, 2001 the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," and will be required to analyze its goodwill for impairment issues on a periodic basis thereafter. During the year ended June 30, 2002, the Company did not record any impairment losses related to goodwill and other intangible assets.
The audited financial statements of Health Card as of June 30, 2002, 2001 and 2000, and the related Schedules, are included in this Form 10-K following Item 14 hereof.