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 purchase 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 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. Additional space is currently being built in the Leased Premises which will allow the Company to reconfigure its existing space and to move all of its employees in Port Washington into contiguous space. As part of this process, the Company will reassess its space needs and occupy additional space as required. It is expected that any additional space taken would not exceed an annual rent of $200,000. The space is currently planned to be available by January 2004. Leasehold improvements made to this space during the years ended June 30, 2002 and 2003 were approximately $60,000 and $1,000 respectively.
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 as a pharmacy. The landlord for these premises is 61 Manorhaven Boulevard, LLC, of which the Company's Chairman is the sole member. The current rent is $1,914 per month. The annual rent increases by 5% per year. Additional rent, in the form of certain expenses, is also payable.
The audited Consolidated Financial Statements include the accounts of Health Card and its wholly owned subsidiaries, PAI, PMP, Centrus, IPA, Specialty, NMHCRX Contracts, Inc. ("Contracts"), PBM Technology, Inc. ("PBM Tech"), NMHCmail and Integrail. Also included are the accounts of Funding. Unless the context otherwise requires, references herein to the "Company" or "Health Card" refer to the Company and its subsidiaries on a consolidated basis. The results of operations and balance sheet of PAI have been included in the consolidation as of July 20, 2000, the effective date that the Company acquired PAI. The results of operations and balance sheet of PMP have been included in the consolidation as of March 5, 2001, the effective date that the Company acquired PMP. The results of operations and balance sheet of Centrus and Funding have been included in the consolidation as of January 29, 2002, the effective date that the Company acquired Centrus. The results of operations and balance sheet of Integrail have been included in the consolidation as of November 1, 2002, the effective date that the Company acquired Integrail. All material intercompany balances and transactions have been eliminated in the consolidation.
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. Since January 1, 2000, all services have been provided on a fee for service basis only. 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 revenue nor the related cost of the prescriptions is recorded.
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. Quarterly, Health Card reconciles its estimates to amounts received from the manufacturers.
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, 2001, 2002 and 2003 the rebates retained by Health Card has equaled 19%, 19% and 11%, 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.
Credit risk relating to the rebates receivable is evaluated based on the financial strength of the rebate administrator and the drug manufacturers. Health Card believes that most of the drug manufacturers are Fortune 500 companies. Health Card does not believe a credit risk reserve is necessary.
Cost of claims increased $100.7 million, or approximately 24%, from $424.7 million for the fiscal year ended June 30, 2002, to $525.4 million for the fiscal year ended June 30, 2003. Centrus accounted for $151.6 million, of the increase. This increase was partially offset by the two factors described in the previous paragraph, namely, the loss of two major sponsors and the recognizing of certain contracts on a net revenue basis. An increase of $22.1 million in gross rebates received, which is treated as a reduction in cost of claims, for the fiscal year ended June 30, 2003 as compared to the fiscal year ended June 30, 2002 also led to a reduction in the year-over-year increase. The balance of the increase in cost of claims is related to the increased revenue as described above related to both new and existing sponsors. As a percentage of revenues, cost of claims decreased from 92.4% to 91.7% for the fiscal years ended June 30, 2002 and June 30, 2003, respectively. These same two factors contributed to the declining costs as a percentage of revenue. The two major sponsors are managed care organizations. Industry-wide, managed care clients have a greater cost of claims, and consequently a lower gross margin, than other types of business in the PBM industry. While not all of the revenue associated with these two sponsors was replaced by new business, the new business, for the most part was not managed care, so consequently the cost of claims on the new business was lower than on the business it replaced. In addition, the contracts recognized on a net revenue basis decrease the overall Company costs as a percentage of revenue due to the cost not being recognized on the contracts recorded on the net revenue basis. The decline in cost of claims as a percentage of revenues was moderated by the higher cost of claims on the Centrus book of business, which serves managed care clients primarily. Centrus' cost of claims for the fiscal year ended June 30, 2003 ran about 6 - 9 percentage points greater than the rest of the Company's business, and since Centrus accounted for 49% of the Company's revenue in the fiscal year, this impacted the overall cost of claims percentage.
General and administrative expenses charged by affiliates decreased approximately $1.0 million, or 54%, year-over-year from $1.9 million to $0.9 million for the fiscal years ended June 30, 2002 and June 30, 2003, respectively. The Company has eliminated many of the related party transactions effective January 1, 2002. The majority of the decrease related to reduced information technology services and management and consulting services procured from affiliated companies. The hiring of full time employees and the use of outside consultants replaced the use of affiliated companies to update the information technology infrastructure.
Income before the provision for income taxes increased approximately $3.6 million, or 50%, from approximately $7.4 million, for the fiscal year ended June 30, 2002, to approximately $11.0 million for the fiscal year ended June 30, 2003. 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. As mentioned previously, the acquisition of Integrail and the start-up of the mail order facility had the impact of reducing profitability in the year ended June 30, 2003.
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 a 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.
Cost of claims increased $175.1 million, or approximately 70%, from $249.6 million for the fiscal year ended June 30, 2001, to $424.7 million for the fiscal year ended June 30, 2002. Centrus accounted for $122.9 million, or 70% of the increase. PMP accounted for another $17.3 million, or 10% of the increase. The balance of the increase is related to the increased revenue as described above. An increase of $12.4 million, $9.1 million of which is related to Centrus, in gross rebates received, which is treated as a reduction in cost of claims, for the fiscal year ended June 30, 2002 as compared to the fiscal year ended June 30, 2001 led to a reduction in the year-over-year increase. As a percentage of revenues, cost of claims increased from 91.7% to 92.4% for the fiscal years ended June 30, 2001 and June 30, 2002, respectively. The increase relates primarily to the higher cost of claims on the Centrus book of business, which serves managed care clients primarily. Industry-wide, managed care clients have a greater cost of claims, and consequently a lower gross margin, than other types of business in the PBM industry. Centrus' cost of claims for the fiscal year ended June 30, 2002 ran about 3 - 6 percentage points greater than the rest of the Company's business, and since Centrus accounted for 28% of the Company's revenue in the fiscal year, this impacted the overall cost of claims percentage.
Gross profit increased from $22.5 million for the fiscal year ended June 30, 2001 to $35.1 million for the fiscal year ended June 30, 2002; a $12.6 million, or 56%, increase. In addition, to the revenue volume increase, Centrus accounted for $4.2 million, or 33%, of the increase. PMP accounted for another $1.9 million, or 15%, of the increase. The increase in rebates (and administrative fees related to the collection of rebates) after accounting for the amount of rebates that are shared with sponsors, accounted for another $4.6 million, or 37%. Gross profit, as a percentage of revenue, declined from 8.3% to 7.6% for the fiscal years ended June 30, 2001 and June 30, 2002, respectively. The decrease year-over-year is again principally related to the lower margins achieved by Centrus. The Company has also seen a decline in profit margins due to competitive pressures.
Selling, general, and administrative expenses, which include amounts charged by affiliates, increased $5.8 million, or approximately 27%, from $21.4 million for the fiscal year ended June 30, 2001 to $27.2 million for the fiscal year ended June 30, 2002. Approximately 67% of the increase, or $3.9 million, was related to the acquisition of Centrus. There were also year-over-year increases in the following areas: (i) an approximate $1,202,000 increase in expenditures related to increases in compensation and benefits, primarily associated with new employees including senior management; (ii) an approximate $709,000 increase in depreciation and amortization expenses related to increased hardware procurement and software development in prior periods; (iii) an approximate $1,189,000 increase in the use of outside consultants primarily to update the Company's information technology infrastructure; and (iv) an approximate $360,000 increase in commission expense related to the increase in new revenues not related to the acquisitions. Partially offsetting these increases were: (i) a reduction of approximately $1,376,000 related to actual payments made and/or reserves accrued during the fiscal year ended June 30, 2001, but not the fiscal year ended June 30, 2002 related to the following matters: (A) the settlement of the West Contra Costa lawsuit (see Note 9 to the Consolidated Financial Statements that comprise 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, in April of 2001, of a certain patent infringement litigation involving the use by the Company of certain PBM information technology systems; (ii) the reduction in general and administrative expenses charged by affiliates described below, and (iii) an approximate $396,000 decrease in intangible amortization due to the adoption of SFAS 142. Per SFAS 142, the Company no longer amortizes goodwill as of July 1, 2001 (see Note 1 to the Consolidated Financial Statements Comprising Item 8 hereof).
Income before the provision for income taxes increased approximately $5.4 million, or 268%, from approximately $2.0 million, for the fiscal year ended June 30, 2001, to approximately $7.4 million for the fiscal year ended June 30, 2002. The primary reason for the increase was the improving efficiencies that come with scale. For the fiscal year ended June 30, 2002 revenues increased 69% over the fiscal year ended June 30, 2001, while selling, general, and administrative expenses increased only 27%. In addition, while gross margin percentages declined year-over-year due to the acquisition of Centrus, the gross profit dollars increased by 56%. These factors contributed to the marked improvement - 268% - in profitability.
The Company has acquired four companies in the last three years. In addition, the Company has made, in prior years, significant information technology infrastructure investments in terms of purchased hardware and internally developed software. Consequently, there is a significant amount of depreciation and amortization that flows through the Company's current financial statements related to these investments. Therefore, the Company believes that EBITDA is an important measure of its current financial performance. EBITDA is presented as net income plus the provision for income taxes, other expenses, net, and depreciation and amortization. While EBITDA is not a measure of financial performance under generally accepted accounting principles, it is provided as information for certain investors for analysis purposes for two reasons: (1) it excludes the impact of depreciation and amortization related to prior investments and (2) these items are not controllable in the current period. EBITDA is not meant to be considered a substitute or replacement for net income as prepared in accordance with accounting principles generally accepted in the United States. EBITDA is calculated as follows:
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. Effective July 2003, the Company requires cash to carry inventory in its mail order facility and specialty pharmacy. The Company also requires cash for potential acquisitions of other pharmacy benefit management companies or of companies providing related services. As of June 30, 2003, the Company had a working capital deficit of $32.6 million as compared to a working capital deficit of $42.7 million as of June 30, 2002. The primary reason for the improvement in working capital was the profitability generated by the Company during the fiscal year ended June 30, 2003. The Company has now acquired four companies since July 2000 (and a fifth in July 2003) 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. In addition, the Company's revolving credit facility is treated all as a short-term liability per generally accepted accounting principles even though its terms do not expire until January 2005.
Net cash used in investing activities was $6.0 million for the year ended June 30, 2003, as compared to $42.9 million for the year ended June 30, 2002. The primary differences in the two periods were the acquisition of Centrus for $40 million in the year ended June 30, 2002, and the acquisition of Integrail in the year ended June 30, 2003. The net cash outlay for Integrail was $1,472,425, representing the initial payment of $1,400,000 plus $72,425 of related expenses. No cash was assumed in the acquisition.
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 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 15, 2003, approximately $19.1 million was outstanding under the Facility, and the Company was in compliance with its financial-ratios covenants.
The Sellers of Integrail are eligible to receive from monies put in escrow up to $700,000 if certain operational milestones are achieved over the first twelve months.
The Company anticipates that current cash positions, after its five 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, anticipated inventory levels 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, evidenced by the five acquired since July 2000. This will require cash and depending on the Company's evaluation of future acquisitions, additional cash may be required. In addition, the Company is completing the build out of its mail order facility in Florida which will require cash to build out the facility and to acquire inventory. 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.
On July 31, 2003, the Company entered into a Stock Purchase Agreement with Portland Professional Pharmacy ("PPRX"), Professional Pharmacy Associates ("PRXA", and together with PPRX, "PPP") and the individual shareholders (the "PPP Shareholders") to purchase all of the shares of PPP for $3,150,000 (the "PPP Acquisition"). In addition, the Company agreed to pay to the PPP Shareholders up to $7,000,000 over a three-year period if the PPP business achieved certain financial targets. PPP provides specialty-pharmacy services in a broad range of areas, including women's health, pediatric care, men's health and transplant. Funds for the PPP Acquisition were supplied by the Company's revolving credit facility.
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 revenue nor the related cost of the prescriptions is recorded.
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, 2003, the Company did not record any impairment losses related to goodwill and other intangible assets.
The costs of software developed for internal use incurred during the preliminary project stage are expensed as incurred. Direct costs incurred during the application development stage are capitalized. Costs incurred during the post-implementation/operation stage are expensed as incurred. Capitalized software development costs are amortized on a straight-line basis over their estimated useful lives, commencing on the date the software is placed into use, primarily three years.