Diagnostek owns and occupies a 110,000 square foot building, erected during August 1989 and expanded during fiscal 1995, at 4500 Alexander Blvd. NE, Albuquerque, New Mexico. The Albuquerque facility houses the Company's executive offices, a 65,000 square foot HCS dispensing facility, and discount retail store counter. HCS also operates a mail pharmacy service facility of about 37,500 square feet from a leased facility located in Bensalem, Pennsylvania. The lease agreement, which expires during June 1999, gives HCS the option to renew the lease for five years. HCS also leases the former Perform headquarters; a 23,000 square feet of office space in Scottsdale, Arizona, which was sublet to an unrelated party during fiscal year 1995. The lease and sublease agreements expire during 1997.
The following information should be read in conjunction with the consolidated financial statements, and the accompanying notes thereto, included elsewhere herein.
Note: Operations of EPIC Health Group, Inc. included from date of acquisition (July 30, 1990)
Note: Operation of a subsidiary of Rite Aid Corporation included from date of acquisition (September 18, 1990)
Diagnostek's industry segments are described in Part I, Item 1 of this report. Financial highlights and industry segment data are displayed in the following table:
Results of Operations Financial Highlights (dollars in millions, except per share amounts)
Volume increases were coupled with expansion of physical capabilities and operational reorganizations. Perform's Scottsdale, Arizona operations were consolidated at the Company's Albuquerque headquarters facility. Plant expansion of the Albuquerque headquarters was completed and Diagnostek's new "A-frame" robotic dispensing technology successfully installed. In addition, Diagnostek significantly expanded its clinical and customer service departments to ensure the Company's ability to provide the highest quality of service to its clients.
Consolidated revenues totaled $670.8 million for fiscal year 1995, an increase of $185.1 million or 38% from fiscal 1994. The increase was attributable primarily to the expansion of the Company's integrated pharmacy service business ($213.7 million) due partly to the full year operations of the Company's retail operations (Note 3 to the Notes to the Consolidated Financial Statements related to the Perform acquisition in October 1993) and higher volume; offset partly by decreases ($27.9 million) in the Company's managed care pharmacy service business attributable mainly to the early termination of the Company's contracts with CIGNA Health Plan of Arizona, Inc. ("CIGNA").
Consolidated operating income totaled $15.8 million for fiscal 1995, an increase of $0.3 million or 2% from fiscal 1994. The increase in operating income was attributable primarily to higher product margins ($20.6 million) in the Company's integrated pharmacy service operations due mainly to lower pharmaceutical acquisition costs; offset by losses associated with the managed care business' New Jersey contract ($12.6 million, including estimated future losses over the three year contract term of $9.6 million, note 13 to Notes to Consolidated Financial Statements), and higher general and administrative expenses ($7.5 million) and selling/marketing expenses ($1.3 million) attributable mainly to the Company's expanded service capabilities and selling programs.
Consolidated revenues totaled $485.7 million for fiscal year 1994, an increase of $104.7 million or 27% from fiscal 1993. The increase was attributable primarily to the expansion of the Company's integrated pharmacy service business ($85.9 million) related mainly to the acquisition of Perform and internal growth ($20.6 million) in the Company's managed care pharmacy service business.
Consolidated operating income totaled $15.5 million for fiscal 1994, an increase of $9.4 million or 154% from fiscal 1993. The increase in operating income was attributable primarily to higher product margins ($10.1 million) in the Company's integrated pharmacy service operations due mainly to lower pharmaceutical acquisition costs and volume increases in the managed care business ($3.5 million) and lack of counterpart to higher than customary 1993 provisions for bad debts ($4.8 million); offset partly by increases in general and administrative expenses ($4.2 million) attributable to higher costs associated in part with the Company's 1993 acquisitions and higher selling and marketing expenses ($2.6 million) relating primarily to the introduction of the Company's RxChoice(c) and CapRx(c) products.
Integrated pharmacy service revenues totaled $540.1 million for fiscal year 1995, an increase of $213.7 million or 65% from fiscal 1994. The increase was attributable primarily to the Company's entry into the retail pharmacy market with the acquisition of Perform during October 1993 and the growth of the number of benefit plan participants ("covered lives") under management. Approximately 12.9 million retail prescription claims were adjudicated during fiscal 1995, an increase of 8.9 million from fiscal 1994. Fiscal 1995 mail order prescription volume increased by 12% to 3,546,000 prescriptions due primarily to increases in number of eligible plan participants (12.0 million mail service covered lives at March 31, 1995 compared with 11.0 million at March 31, 1994).
In November 1994, the Company entered into a one year agreement (with two one year options) with the U.S. Department of Defense ("DOD") to provide mail pharmacy services to CHAMPUS beneficiaries. The DOD request for proposal stated that the respondent should assume that there would be
Integrated pharmacy service revenues totaled $326.4 million for fiscal year 1994, an increase of $85.9 million or 36% from fiscal 1993. The increase was attributable primarily to the Company's entry into the retail pharmacy market with the acquisition of Perform during October 1993. Perform processed approximately 4.0 million prescription claims from its acquisition to March 31, 1994. Mail order prescription volume increased by 2% to 3,164,000 prescriptions despite the loss of a major customer which represented approximately 13% of prior year volume. Volume increases were primarily attributable to increases in the number of eligible plan participants (11.0 million covered lives compared with 7.7 million at March 31, 1993). Price per prescription remained about equal with prior year levels as drug supplier price increases (approximately 7%) were offset by increased lower priced generic product substitutions which resulted mainly from client sponsor benefit plan design changes.
Managed care pharmacy service revenues totaled $125.6 million for fiscal year 1995, a decrease of $27.9 million or 18% from fiscal 1994 primarily due to the early termination of the Company's CIGNA contracts ($37.4 million decrease from fiscal 1994) in September of 1994. Excluding this contract, revenue increased $17.3 million due to internal growth and new client contracts; offset partly by terminated or unrenewed contracts ($7.8 million).
Managed care pharmacy service operating income totaled $9.2 million for fiscal 1994, an increase of $2.7 million or 42% from fiscal 1993. The increase in operating income was attributable primarily to higher volume ($1.5 million) and improved profit margins ($2.0 million), offset partly by increased selling and marketing costs ($0.7 million).
Diagnostek's working capital and liquidity requirements for its existing operations have been met mainly from cash flows generated from operations.
During December 1994 the Company established a $25.0 million revolving credit line with Bank of America Illinois NA. The agreement has a two year term, with two one year renewal periods and requires a 0.25% annual facility fee and requires interest payments on borrowings at the prime rate or 0.375% over LIBOR. Amounts outstanding under this agreement totaled $10.0 million at March 31, 1995.
The Company has purchased insurance policies, customary in the retail pharmacy industry, including product liability coverage, of a type and amount which management deems adequate. The Company is not licensed to practice medicine and, as a result, is unable to obtain medical malpractice coverage. The Company requires all users (including radiologists, hospitals, or health care providers) of its owned
medical imaging facility to both maintain adequate medical malpractice liability coverage and indemnify the Company against all claims that may arise from the use of its equipment. Diagnostek also maintains various forms of traditional business liability coverage.
As discussed in note 12 to the consolidated financial statements, the Company is a defendant in shareholder litigation alleging disclosure violations. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been recognized in the accompanying consolidated financial statements.
The consolidated financial statements represent the adding together of all companies of which Diagnostek, Inc. (the "Company" or "Diagnostek"), directly or indirectly has majority ownership. Significant intercompany accounts and transactions have been eliminated.
The Company's consolidated financial statements include the accounts of its wholly-owned subsidiaries, Health Care Services, Inc. ("HCS"), HPI Health Care Services, Inc. ("HPI"), and Diagnostek Pharmacy, Inc. ("DPI"), together with their subsidiaries, and other controlled affiliates.
Sales of goods and services are recorded on medication dispensing or passage of title to customers in accordance with contractual terms. Cost of sales are recorded based on the cost of pharmaceuticals dispensed, net of related rebates and discounts, and related direct costs. In addition, the Company accrues costs associated with its risk/reward contracts which it estimates will not be recovered through projected revenues.
Property, plant, and equipment are stated at cost. Provisions for depreciation are recorded using both straight-line and accelerated methods over the useful lives of the respective assets. Leasehold improvements are amortized on a straight-line basis over the shorter of economic life or terms of the respective leases.
Goodwill is amortized using the straight-line method, over fifteen to forty years. Other intangible assets consist primarily of acquired contract rights and covenants not to compete and are amortized on a straight-line basis over periods ranging from three to twelve years.
The Company evaluates the recoverability of goodwill based on estimated undiscounted operating income over the goodwill amortization periods, giving consideration to sales and cost benefits expected to be realized by the consolidated group from the acquisition of the acquired company. The Company also evaluates industry trends and historical trends of the acquired companies, the potential impact of pending and proposed regulations and the effect of competition.
During 1995 the Company purchased substantially all of the remaining outside ownership (72 partnership units or approximately 62%) of Springfield Diagnostek Imaging Center ("SDIC") from approximately 50 individuals in exchange for 43,200 shares (valued at approximately $662,000) of Company common stock held by the Company as treasury stock. SDIC is part of the Company's original medical imaging business. The transaction was accounted for using the purchase method of accounting and resulted in goodwill of approximately $662,000 which is being amortized over a period of 22 years. The proforma results of operations for 1995 and 1994 reflecting the acquisition of SDIC would be substantiality the same as the Company's historical results.
Other assets - not current include notes receivable from officers and directors of approximately $2.9 million and $3.0 million at March 31, 1995 and 1994, respectively. Of such notes $0.7 million bear 7.5% interest, payable annually, with principal amounts due during 2000. A note for $2.2 million is payable in monthly installments, including interest at 7.5%, with final payments due during December 2021.
A $25 million revolving credit line with Bank of America Illinois NA was established by the Company in December 1994. The agreement has a two year term, with two one year renewal periods and requires a 0.25% annual facility fee as well as compliance with certain financial covenants, all of which the Company complied with at March 31, 1995. Borrowings under the agreement require interest at rates equal to the prime rate or 0.375% over LIBOR, at the Company's option. $6.0 million of borrowings under the line of credit have been classified as non-current liabilities at March 31, 1995.
All stock options have been granted to employees and non-employees at exercise prices equal to market value on the date of each grant.
On December 31, 1992, the Board of Directors declared a dividend distribution of one preferred share purchase right ("Rights") for each outstanding share of the Company's common stock. Rights are exercisable ten days after a person, or group of affiliated persons, acquire, or initiate a tender offer for 20% or more of the outstanding common stock of the Company, or the Board of Directors of the Company determine that a person or group of affiliated persons are an Adverse Person as defined in the Rights Agreement. Upon exercise, the issued shares will have a market value equal to twice the exercise price. If the Company is involved in a merger or other business combination at any time after the Rights become exercisable, the Rights will be modified so as to entitle a holder to buy a number of shares of common stock of the surviving company having a market value of twice the exercise price of each Right. The Rights expire on December 31, 2002, unless redeemed by the Company at a price of $.01 per Right, according to the terms and definitions of the Rights Agreement. Until exercised, the Rights do not entitle the holder to any rights as a shareholder including the right to vote or receive dividends.
Deferred tax assets include benefits estimated to be realized from the utilization of net operating loss carryforwards of $12.5 million, which expire in 2008. Tax benefits from the tax loss carryforwards, which were obtained in the acquisition of Perform (note 3) have been recorded as a reduction of goodwill. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.
On July 15,1994, the Company became aware of a lawsuit against it and several officers seeking Class Action status by two purported shareholders of the Company. The complaint and its subsequent amendments alleges disclosure violations in connection with the early termination of the Company's largest pharmacy management service contracts, purported concealed purchasing practices which allegedly allowed the Company to report lower costs and higher profits, and allegations related to the Company's mail service contract with the Department of Defense. Plaintiffs purport to represent a class of persons who purchased or otherwise acquired the Company's common stock from April 28, 1994 to March 24, 1995. The Company has denied any liability and intends to vigorously defend the action, although the ultimate outcome of the litigation cannot presently be determined.
During August 1992, Diagnostek entered into a definitive merger agreement with Medco Containment Services, Inc. ("Medco"). On November 12, 1992, Medco terminated the merger agreement, and the Company initiated litigation. Medco filed a counterclaim, alleging generally that the Company had breached certain representations and warranties in the merger agreement giving rise to Medco's termination of the agreement. On March 29, 1993, Diagnostek and Medco agreed to settle the pending litigation, with neither party admitting to asserted allegations, in exchange for a payment to Medco from the Company of $3.0 million. The Company's decision to pay the settlement amount was in part based upon the Company's assessment of the likely ongoing costs and expenses associated with protracted litigation, its belief that ongoing litigation would have diverted management's full attention from the Company's daily operations and the concern that the litigation would have been disruptive to the Company's customer relationships.
Costs related to the proposed Medco merger, resultant litigation, and settlement are as follows:
Company, there is no assurance the Company could comply, and noncompliance could adversely affect the Company's integrated pharmacy service programs.
Diagnostek and its subsidiaries are subject to various claims and lawsuits in the ordinary course of business, none of which is material.
Lease commitments for the next five years (in thousands) are summarized as follows:
Other income includes realized gains and losses arising from marketable securities transactions calculated on a first-in first-out basis and other miscellaneous non-operating events as follows:
The Company utilizes the legal services of firms whose partners include a director of the Company. Legal fees to the firms totaled approximately $952,000, $687,000 and $2,193,000 during the years ended March 31, 1995, 1994 and 1993, respectively.
Financial information related to quarterly earnings of Diagnostek for the last two fiscal years ended March 31 is summarized below (in thousands):