NMHC 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"). NMHC subleases the Leased Premises from BFS Realty, LLC, an affiliate of our former 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 December 2004, which expires in December 2015. The Affiliate has the right to purchase the Leased Premises upon termination of that lease for the purchase price of one dollar. The Affiliate subleases a portion of the Leased Premises to NMHC (the "Lease"). As of November 1, 2001, NMHC and the Affiliate amended the Lease. The Lease provided that, effective August 1, 2001, the rent payable by NMHC would be an aggregate annual rent of $308,305. We make estimated monthly real estate tax, utility and maintenance-expense payments to the Affiliate. The annual rent would increase by 5% per year during the term of the Lease.
The following tables summarize certain selected financial information for each of the years in the five year period ended June 30, 2005 and provide certain supplemental data. The selected consolidated income statement data for the years ended June 30, 2005, 2004, and 2003 and the selected consolidated balance sheet data as of June 30, 2005 and 2004 have been derived from the audited consolidated financial statements of NMHC included in Item 8 hereof. The selected consolidated income statement data for the years ended June 30, 2002 and 2001 and the selected consolidated balance sheet data as of June 30, 2003, 2002 and 2001 have been derived from audited consolidated financial statements of NMHC that are not included in this Form 10-K. The information contained in this table should be read in conjunction with our consolidated financial statements and notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in
The audited Consolidated Financial Statements include the accounts of NMHC and its wholly owned subsidiaries, Pharmacy Associates, Inc.("PAI"), Interchange PMP, Inc. ("PMP"), Centrus Coorporation ("Centrus"), National Medical Health Card, IPA, Inc. ("IPA"), Specialty Pharmacy Care, Inc. ("Specialty"), NMHCRx Contracts, Inc. ("Contracts"), PBM Technology, Inc. ("PBM Tech"), NMHCRX Mail Order, Inc. ("NMHCmail"), Integrail, Inc. ("NMHC Integrail"), Portland Professional Pharmacy and Portland Professional Pharmacy Associates (collectively "NMHC Ascend"), Inteq Corp. and Inteq TX Corp. (collectively "Inteq") and Pharmaceutical Care Network ("PCN"). Also included are the accounts of NMHC Funding, Inc. ("Funding"). Unless the context otherwise requires, references herein to NMHC refer to National Medical Health Card Systems, Inc. and its subsidiaries on a consolidated basis. The results of operations and balance sheet of NMHC's acquisitions and subsidiaries have been included in the consolidation as of the effective date that NMHC acquired or established the entity as follows: PAI - July 20, 2000, PMP - March 5, 2001, Centrus and Funding - - January 29, 2002, NMHCmail - September 1, 2002, NMHC Integrail - November 1, 2002, NMHC Ascend - July 31, 2003, Inteq - April 1, 2004 and PCN - March 7, 2005. All material intercompany balances and transactions have been eliminated in the consolidation.
Revenue is recognized by NMHC Ascend at the point of shipment to the member. NMHC Ascend invoices individual members, insurance companies, Medicare and Medicaid, and the PBM. Revenue from intercompany sales are eliminated in consolidation.
Cost of claims includes the amounts paid to network pharmacies, including mail service pharmacies, for pharmaceutical claims, and reductions resulting from the gross rebates received from drug manufacturers. Cost of claims is recognized as follows: the contractual obligation of NMHC to pay for these drugs is recorded as cost of claims at the time of dispensing of the drug by the pharmacy network. Cost of claims is reduced by the rebates that NMHC receives. Rebates are earned from drug manufacturers based on drugs utilized by plan participants at the time of dispensing. These rebates, which vary by sponsor, are recorded monthly based upon the claims adjudicated in that month.
The Administrator provides estimates to us based on its analysis of the amount of rebates that our claims should generate. These estimates are prepared based on estimates of how our 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 our contract with the Administrator, we receive a specified minimum amount per claim 150 days after the end of a quarter. Amounts above the minimum are shared between the Administrator and NMHC with final settlement twelve months after a quarter-end. We accrue rebates based upon an estimate provided by the Administrator.
Credit risk relating to the rebates receivable is evaluated based on the financial strength of the rebate administrator and the drug manufacturers plus our collection history. The drug manufacturers contracted with are primarily Fortune 500 companies and NMHC has not had a history of write-offs related to rebate receivables. We do not believe a credit risk reserve is necessary.
The pharmacy benefit management industry is intensely competitive, generally resulting in continuous pressure on our 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, NMHC expects this competitive environment to continue for the foreseeable future.
Revenue increased $149.5 million, or approximately 23%, from $651.1 million for the fiscal year ended June 30, 2004, to $800.6 million for the fiscal year ended June 30, 2005. Revenue recognized for contracts recorded on a gross revenue basis was $794.8 million for the fiscal year ended June 30, 2005 and $648.5 million for the fiscal year ended June 30, 2004. Revenue recognized for contracts recorded on a net revenue basis was $5.8 million for the fiscal year ended June 30, 2005 and $2.6 million for the fiscal year ended June 30, 2004. The specific terms of the contracts that NMHC enters into with its sponsors will determine whether NMHC recognizes the gross revenue related to the cost of the prescriptions filled. For those contracts that NMHC recognizes net revenue, there is no impact on gross profit since neither the prescription revenue nor the related costs of the prescriptions is recorded. We include in revenue only those co-payments collected from NMHCmail. For the twelve months ended June 30, 2005, there were approximately $15.1 million of co-payments included in revenue versus approximately $2.3 million for the twelve months ended June 30, 2004. Co-payments retained by pharmacies on prescriptions filled for our members and not included in our revenue were $280.9 million and $203.4 million, for the twelve months ended June 30, 2005 and 2004, respectively.
Cost of claims increased $126.8 million, or approximately 22%, from $587.1 million for the fiscal year ended June 30, 2004, to $713.9 million for the fiscal year ended June 30, 2005. PCN accounted for $21.7 million, of the net increase, while Inteq accounted for another $35.2 million. New sponsors and the growth in existing sponsors accounted for $140.9 million of the increase. This increase was partially offset by the loss of sponsors which reduced cost of claims by $71.0 million (including a $1.1 million adjustment for previous pharmacy claims). As a percentage of revenue, cost of claims decreased from 90.2% to 89.2% for the fiscal years ended June 30, 2004 and June 30, 2005, respectively. The contracts that NMHC recognized on a net revenue basis decreased NMHC's overall costs as a percentage of revenue due to the cost not being recognized on the contracts recorded on the net revenue basis. In addition, the receipt of an additional $12.9 million in co-payments for NMHCmail operations resulted in a lower cost of claims as a percent of revenue, since no additional cost of claims are incurred related to these fees.
Gross profit increased from $64.0 million for the fiscal year ended June 30, 2004 to $86.7 million for the fiscal year ended June 30, 2005; a $22.7 million, or 35%, increase. In addition to the revenue volume increase described above, PCN accounted for $3.3 million, or 15%, of the increase. Inteq accounted for another $3.8 million, or 17% 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 $2.5 million, or 11%. The balance of the increase relates to the margins on the new business that replaced the lost business and growth in the existing business from additional services provided. Gross profit, as a percentage of revenue, increased from 9.8% to 10.8% for the twelve months ended June 30, 2004 and June 30, 2005, respectively. The contracts NMHC recognizes on a net revenue basis have the effect of improving the gross margin as a percentage of revenue due to the fact that recorded revenue and costs are lower since only the administrative fees related to these contracts are recorded. The increased activities at NMHCmail and NMHC Ascend also led to an increase in gross profit percentage, year-over-year. Partially offsetting the impact of the net revenue and new activities, NMHC has seen some decline in profit margins due to competitive pressures.
Selling, general, and administrative expenses as a percent of revenue increased from 7.8% for the fiscal year ended June 30, 2004 to 8.5% for the fiscal year ended June 30, 2005. The main reasons for the increase were the impact of recognizing more contracts on a net revenue basis.
For the fiscal year ended June 30, 2005, NMHC earned other income, net, of approximately $1.5 million. For the fiscal year ended June 30, 2004, we earned other income, net, of approximately $40,000. The primary component of the increase in other income was the realization of a $1.7 million gain from an insurance claim which represented the excess of the insurance proceeds over the carrying value of the assets covered by the claim.
Income before the provision for income taxes increased approximately $6.9 million, or 51%, from approximately $13.5 million, for the fiscal year ended June 30, 2004, to approximately $20.4 million for the fiscal year ended June 30, 2005. The primary factors leading to this increase were the rises in gross profit and other income, offset by the increase in selling, general and administrative expenses related to the new activities.
The effective tax rate decreased from 41.0% for the twelve months ended June 30, 2004 to 39.3% for the twelve months ended June 30, 2005. The main reason for the decrease was a reduction in NMHC's state income taxes.
In addition, there were three other charges recorded to determine income (loss) available to common stockholders related to the New Mountain Transaction. The first of these charges relates to preferred stock cash dividends, which amounted to approximately $5.6 million for the fiscal year ended June 30, 2005 and $1.6 million for the fiscal year ended June 30, 2004. The preferred stock provides for an initial cash dividend equal to 7% of the investment amount (currently $80 million), which decreases to 3.5% after the fifth anniversary of issuance. All dividends accrued in each fiscal year were paid by the end of the given fiscal year. The second charge during the fiscal year ended June 30, 2004 was the $80 million beneficial conversion feature. This non-recurring, non-cash charge represents the difference between the fair market value of our common stock on the date of the closing of the New Mountain Transaction and the effective conversion price of $11.29, and which is limited to the $80 million purchase price for the series A preferred stock. The third charge is for the accretion of transaction expenses. Certain transaction costs of approximately $4.7 million related to the New Mountain Transaction preferred stock investment are deducted from net proceeds and the carrying value of the series A preferred stock. These transaction costs are accreted to the series A preferred stock carrying value over the ten-year life of the preferred stock investment. Such accretion amounted to approximately $475,000 for the fiscal year ended June 30, 2005 and $135,000 for the fiscal year ended June 30, 2004. After deducting these three charges from net income there remained net income available to common stockholders of approximately $6.3 million for the fiscal year ended June 30, 2005, as compared to a net loss available to common stockholders of approximately $73.8 million for the fiscal year ended June 30, 2004.
While net income and net income available to common stockholders excluding the non-recurring Legal Settlement and 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 non-recurring Legal Settlement and the New Mountain Transaction on net income and net income available to common stockholders. Net income and net income available to common stockholders excluding the non-recurring Legal Settlement and 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 the non-recurring Legal Settlement and New Mountain Transaction items, is as follows (all amounts are in thousands, except per share amounts):
Fiscal Year Ended June 30, 2004 Compared to Fiscal Year Ended June 30, 2003
Revenue increased $77.8 million, or approximately 14%, from $573.3 million for the fiscal year ended June 30, 2003, to $651.1 million for the fiscal year ended June 30, 2004. Revenue recognized for contracts recorded on a gross revenue basis was $648.5 million for the fiscal year ended June 30, 2004 and $572.0 million for the fiscal year ended June 30, 2003. Revenue recognized for contracts recorded on a net revenue basis was $2.6 million for the fiscal year ended June 30, 2004 and $1.3 million for the fiscal year ended June 30, 2003. The specific terms of the contracts that NMHC enters into with its sponsors will determine whether NMHC recognizes the gross revenue related to the cost of the prescriptions filled. For those contracts that NMHC recognizes net revenue, there is no impact on gross profit since neither the prescription revenue nor the related costs of the prescriptions is recorded. NMHC includes in revenue only those co-payments collected from NMHCmail. For the twelve months ended June 30, 2004, there were approximately $2.3 million of co-payments included in revenue versus zero for the twelve months ended June 30, 2003. Co-payments retained by pharmacies on prescriptions filled for NMHC's members and not included in NMHC's revenue were $203.4 million and $168.5 million, for the twelve months ended June 30, 2004 and 2003, respectively.
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 NMHC 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 as a result of rebates payable to NMHC's sponsors increasing 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.
Cost of claims increased $61.6 million, or approximately 12%, from $525.5 million for the fiscal year ended June 30, 2003, to $587.1 million for the fiscal year ended June 30, 2004. Ascend and Inteq accounted for $28.4 million, of the net increase. New sponsors and the growth in existing sponsors accounted for $144.8 million of the increase. This increase was partially offset by the three factors described in the previous paragraph, namely, the loss of sponsors which reduced cost of claims by $89.1 million, the recognizing of a certain contract on a net revenue basis which reduced cost of claims by $9.0 million, and an increase of $13.5 million in gross rebates received, which is treated as a reduction in cost of claims. As a percentage of revenue, cost of claims decreased from 91.7% to 90.2% for the fiscal years ended June 30, 2003 and June 30, 2004, respectively. The same factors contributed to the declining costs as a percentage of revenue. The major sponsor, which terminated its contract, is a managed care organization. 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. The new business NMHC brought on during the fiscal year ended June 30, 2004, 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.
Of the remaining approximate $3.5 million increase in selling, general and administrative expenses during the twelve months ended June 30, 2004, the majority of the increase is related to the increased revenue and volume in the PBM. Salary and benefits related to new hires, temporary help, travel and entertainment, and commissions to internal sales people as well as external brokers have all increased year over year due to the increased volume of activity.
For the fiscal year ended June 30, 2004, NMHC earned other income, net, of approximately $40,000. For the fiscal year ended June 30, 2003, NMHC incurred other expense, net, of approximately $804,000. The components of the approximate $844,000 increase in other income, net were an approximate $506,000 decrease in interest expense, an approximate $342,000 increase in interest income, slightly offset by an approximate $4,000 reduced gain on assets sold. The primary reasons for the net increase in income were 1) interest expense declined due to the reduced borrowings under NMHC's revolving credit facility due to increasing profitability and additional cash flow from operations (see Item 1, "Description of Business-Recent Acquisitions and Developments," and Note 3 to the Consolidated Financial Statements comprising Item 8 hereof), and 2) interest income increased due to the interest portion of a settlement, with an outside party, related to past due rebates owed to NMHC, and excess cash balances related to some of NMHC's acquisitions. NMHC entered into a new sale leaseback with an unrelated third party in November 2003. This led to an approximate $35,000 gain on the sale of assets during the twelve months ended June 30, 2004. The total gain from this transaction was approximately $147,000 which was recorded as deferred revenue and is being recognized over the life of the lease, which is thirty-six (36) months. (See Note 11 to the Consolidated Financial Statements comprising Item 8 hereof.) This gain was offset by approximately $41,000 related to assets written-off when Ascend moved to a new facility in Portland.
The effective tax rate decreased from 41.8% for the twelve months ended June 30, 2003 to 41.0% for the twelve months ended June 30, 2004. The main reason for the decrease was a decline in NMHC's federal statutory rate.
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.
NMHC'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, NMHC requires cash to carry inventory in our mail service facility and specialty pharmacy. Also, we require cash for potential acquisitions of other pharmacy benefit management companies or of companies providing related services. As of June 30, 2005, we had a working capital deficit of $24.4 million as compared to a working capital deficit of $27.7 million as of June 30, 2004. The primary reason for the improvement in working capital was the profitability generated by NMHC during the fiscal year ended June 30, 2005 offset by the acquisition of PCN. NMHC has now acquired seven companies since July 2000 utilizing primarily cash. This has had the effect of increasing our working capital deficits until sufficient profitability is earned to offset these deficits.
Net cash provided by operating activities was $10.3 million for the fiscal year ended June 30, 2005, compared to $24.1 million for the fiscal year ended June 30, 2004. The primary factor contributing to this $13.8 million decrease in cash provided by operations was the timing of the PCN acquisition. On March 7, 2005, the date of the acquisition, PCN had cash on hand exceeding $16.7 million, the vast majority of which was earmarked for payment within the next few days to the various dispensing pharmacies. Generally accepted accounting principles require that all acquisitions be reported net of cash acquired. Because the $16.7 million of cash on hand exceeded the acquisition price of $13.0 million and related acquisition costs of $0.6 million, the PCN acquisition was reported as a $3.2 million cash source of funds. The timing of this event caused NMHC's cash provided by operations for the fiscal year ended June 30, 2005 to be $10.3 million. Whereas, had the PCN Acquisition not occurred, NMHC would have reported net cash provided by operating activities of $22.5 million and net cash used in investing activities of $7.3 million, and net cash used in financing activities of $2.3 for the fiscal year ended June 30, 2005.
While cash flow from operating and investing activities excluding the impact of the PCN acquisition 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 PCN acquisition on cash flow from operating and investing activities. Cash flow from operating and investing activities excluding the impact of the PCN acquisition is not meant to be considered a substitute or replacement for cash flow from operating and investing activities as prepared in accordance with U.S. generally accepted accounting principles. The reconciliation from cash flow from operating and investing activities to cash flow from operating and investing activities excluding the impact of the PCN acquisition, is as follows:
Historically, the timing of NMHC'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 our pharmacy network on the other hand. These terms generally lead to our payments to participating pharmacies being slower than our corresponding collections from plan sponsors. NMHC 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, we could require additional working capital financing. We have put in place a $65 million revolving credit facility for acquisitions and working capital financing. However, if such terms of trade were to change materially, and/or if NMHC were unable to obtain additional working capital financing, there could be a material adverse effect on our business, financial condition, or results of operations.
Net cash used in investing activities was $4.1 million for the twelve months ended June 30, 2005, as compared to $39.4 million for the twelve months ended June 30, 2004. This decrease of $35.2 million in net cash used in investing activities was primarily the result of a decrease in cash paid for acquisitions. Total cash expenditures in the fiscal year ended June 30, 2004 for acquisitions, primarily PPP and Inteq, amounted to $34.7 million, as compared to cash generated from acquisitions of $1.7 million for the fiscal year ended June 30, 2005. Also during the fiscal year ended June 30, 2004, $2.8 million of cash was generated from the repayment of affiliate and officer loans. Finally, capital expenditures were $7.4 million (including $2.3 millino of capitalized internal use software) for the fiscal year ended June 30, 2004 as compared to $5.8 million (including $3.2 million of capitalized internal use software)for the fiscal year ended June 30, 2005, a reduction of $1.6 million when comparing the two fiscal years.
On January 28, 2005, NMHC entered into a five-year $65.0 million cash flow based, line of credit with a syndicate of commercial banks led by JPMorgan Chase Bank, N.A. ("JPMorgan"). Subject to certain conditions, the new line of credit may be increased by an aggregate of $35.0 million. The line of credit facility contains various covenants that, among other things, require NMHC to maintain certain financial ratios, which are consolidated net worth, consolidated fixed charge ratio and consolidated debt to EBITDA ratio. As of June 30, 2005, there was no principal balance outstanding under the line of credit facility, and NMHC was in compliance with its financial covenants.
NMHC has entered into various real estate operating leases with both related and unrelated parties. NMHC has entered into various operating leases with unrelated third parties for office equipment. These leases have different payment terms and expirations dates. NMHC also entered into a sale-leaseback operating lease of certain fixed assets (principally mail service equipment. See Note 11 to the Consolidated Financial Statements comprising Item 8 hereof for a further description of these various real estate and operating leases.
The shareholders of the PCN are eligible to receive additional consideration of up to $30,000,000, if certain financial and performance targets are met over the three year period beginning March 1, 2005. As of June 30, 2005, $225,000 has been accrued based upon the tentative achievement of the financial and performance targets.
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 $1 million was paid in May 2005.
Unaudited quarterly financial data ($ in thousands, except per share amounts) for the fiscal years 2005 and 2004 are summarized as follows:
Management does not believe that inflation has had a material adverse impact on NMHC's net income for the three most recent fiscal years.
(c) NMHC includes in revenue only those co-payments collected from individual members by NMHCmail. Co-payments retained by pharmacies on the remainder of the prescriptions filled for our members are not included in our reported revenue. We disclose these amounts parenthetically on the face of our Consolidated Statement of Income.
In assessing the recoverability of our goodwill and other intangibles, we 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, we may be required to record impairment charges for these assets not previously recorded. On July 1, 2001 we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," and will be required to analyze our goodwill for impairment issues on a periodic basis thereafter. To date, we have not recorded 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 which provide additional functionality 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.