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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to ___________
Commission File Number 0-31014
HEALTHEXTRAS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2181356
- ------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2273 Research Boulevard, 2nd Floor, Rockville, Maryland 20850
-------------------------------------------------------------
(Address of principal executive offices, zip code)
(301) 548-2900
--------------
(Registrant's phone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act: Common Stock, $0.01 par
value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: ( __ )
The number of shares of Common Stock, par value $.01 per share, outstanding on
March 26, 2002 was 31,969,087. As of March 26, 2002, assuming as fair value the
last sale price of 2.80 per share on The Nasdaq National Market, the aggregate
fair value of shares held by non-affiliates was approximately $41,562,082.
Documents incorporated by reference: ------------------------------------ The
Company's Proxy Statement for its annual meeting of stockholders to be held in
June, 2002, a definitive copy of which will be filed within 120 days of December
31, 2001, is incorporated by reference in Part III of this Report on Form 10-K.
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business....................................................3
Item 2. Properties.................................................14
Item 3. Legal Proceedings..........................................14
Item 4. Submission of Matters for a Vote of Security Holders.......14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................15
Item 6. Selected Financial Data....................................16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................17
Item 7A Quantitative and Qualitative Disclosures About Market
Risk.......................................................29
Item 8. Financial Statements and Supplementary Data................29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................29
PART III
Item 10. Directors and Executive Officers of the Registrant.........30
Item 11. Executive Compensation.....................................30
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................30
Item 13. Certain Relationships and Related Transactions.............30
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K................................................31
SIGNATURES
This Form 10-K, including the documents incorporated by reference, contains
certain forward-looking statements, including without limitation, statements
concerning the Company's operations, economic performance and financial
condition. These forward-looking statements are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The words
"believe," "expect," "anticipate" and other similar expressions generally
identify forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of their
dates. These forward-looking statements are based largely on the Company's
current expectations and are subject to a number of risks and uncertainties,
including, without limitation, those identified under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere in
this Form 10-K, including the documents incorporated by reference. Actual
results could differ materially from results referred to in the forward-looking
statements. In addition, important factors to consider in evaluating such
forward-looking statements include changes in external market factors, changes
in the Company's business or growth strategy or an inability to execute its
strategy due to changes in its industry or the economy generally. In light of
these risks and uncertainties, there can be no assurances that the results
referred to in the forward-looking statements contained in this Form 10-K will
in fact occur. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect any future events or circumstances.
2
PART 1
ITEM 1. BUSINESS
- ------- --------
OVERVIEW
HealthExtras, Inc. (the "Company" or "HealthExtras") is a diversified
provider of pharmacy, health and disability benefits. The Company currently
provides benefits to over 1.2 million members and the Company's clients include
managed care organizations, large employer groups, unions, government agencies,
small businesses, as well as individual consumers. Since its inception
HealthExtras has focused on the sale of supplemental health programs to
individual consumers and small businesses. While the Company will continue to
benefit from its supplemental health membership base, the Company's primary
strategic focus is expanding its pharmacy benefit management (PBM) business
through sales to self-insured employer groups and managed care organizations.
The Company operates and reports in two segments: pharmacy benefit management
and supplemental health. Financial information about each segment is presented
in the footnotes to the financial statements filed with this Form 10-K.
The Company was incorporated in Delaware in July 1999, as the successor
to certain predecessor companies. Our principal executive offices are located at
2273 Research Boulevard, Rockville, Maryland 20850. Our telephone number is
301-548-2900.
Pharmacy Benefit Management
---------------------------
The Company's integrated pharmacy benefit management services include:
network pharmacy claims processing, mail order services, benefit design
consultation, drug utilization review, formulary management and drug data
analysis services. Additionally, the Company operates a national retail pharmacy
network with over 50,000 participating pharmacies. The significant majority of
the Company's pharmacy benefit management revenues are derived from pharmacy
benefit management services provided to health plan sponsors, including
self-insured employers. Our PBM services entail managing member prescription
drug utilization to ensure high-quality, cost-effective pharmaceutical care
through a combination of managed care principles, advanced data analysis and
technologies, and active client specific program management.
INDUSTRY OVERVIEW
Prescription drug spending is the fastest growing component of health
care costs in the United States. The Centers for Medicare and Medicaid (CMS)
estimate that 2000 U.S. prescription drug spending ($116.9 billion) made up
almost 9% of total U.S. health care expenditures ($1.3 trillion) for the year.
CMS projects that by 2010, prescription drug spending will be $366 billion,
making up almost 14% of total U.S. health care expenditures. CMS is projecting
average annual increases in prescription drug spending of over 12% through 2010,
compared to approximately 7% per year increases for total health costs during
this period.
Some of the primary factors influencing these trends include:
* Higher drug utilization as pharmaceuticals increasingly become the
first approach in disease treatment
* Increasing availability of prescription benefits to health plan
members, individuals, and retirees
* An anticipated increase in new drugs available in the marketplace
due to ongoing research and development on the part of
pharmaceutical companies
* Higher costs for newly-developed drug therapies
* An aging population
* Growing demand for prescription drugs due to effective
direct-to-consumer advertising by drug manufacturers
These trends create significant challenges for health insurers,
employers, government entities, and other payors that provide a drug benefit as
part of the health plans they offer to members of their respective
organizations. Many of these payors utilize the services of pharmacy benefit
management companies to assist them in providing a cost-effective prescription
drug benefit as part of their health plan, and to better understand the impact
of prescription drug utilization on their overall health expenditures and the
quality of the treatments members receive.
3
Market share for PBM services in the U.S. is highly concentrated with a
small number of firms controlling over 70% of prescription volume and member
lives. Even though this market is highly competitive, HealthExtras believes it
can capitalize on market segments that are not well served by these large PBMs
and become a national alternative to the larger competitors in the PBM industry.
ACQUISITION OF CATALYST RX, INC.
On November 14, 2001 the Company acquired control of Catalyst Rx, Inc.
and Catalyst Consultants, Inc. ("Catalyst"). The acquisition is intended to
accelerate our marketing of pharmacy benefits to large employer groups, managed
care organizations and third party administrators. Catalyst's success is
attributable to offering employer groups differentiated benefit design options,
personal service, consultative expertise, clinical review programs and access to
market specific retail pharmacy networks, all of which enhances its ability to
manage pharmacy benefit costs for clients. Catalyst provides pharmacy benefit
management services to a variety of organizations including governmental
sponsors, self-insured employers and third party administrators. Catalyst's
website allows clients and members access to plan-specific information including
covered and excluded benefits, member copayments and drug/disease information.
The operations of Catalyst are located in Las Vegas, Nevada.
PRESCRIPTION BENEFIT MANAGEMENT PRODUCTS
Our PBM services entail managing member prescription drug utilization
to ensure high-quality, cost-effective pharmaceutical care through a combination
of managed care principles, advanced data analysis and technologies, and
pro-active client specific program management. Our PBM services include:
* Benefit plan design and consultation
* Formulary administration
* Development of formulary compliance and therapeutic intervention
programs
* Retail pharmacy network contracting and administration
* Advanced decision support and data analysis services
* Flexible, customized reporting available via secure Internet
connection
* Mail order pharmacy
* Prescription benefits and discount programs tailored for businesses
with a high percentage of low wage or part time employees
BUSINESS STRATEGY
Prescription drug costs continue to grow rapidly, reflecting both
increased drug utilization and price inflation. These factors should contribute
to an increasing opportunity to market cost effective pharmacy benefits.
Additionally, we believe that there will be a growing market for pharmacy
benefits including potentially significant opportunities with Medicare
eligibles. Pharmacy programs are attractive because the discount pricing and
benefit administration are highly automated and reliable at the point of sale.
We anticipate that the refinement and distribution of pharmacy benefits and
services will be the major focus of our growth strategy in the future. We
believe this growth will be driven by traditional pharmacy benefit
administration services marketed to employer groups, managed care organizations,
and third party administrators, as well as direct to consumer and small business
offerings. HealthExtras provides its clients the tools, information, and
specialized expertise needed to provide the best drug therapy to their
membership, while simultaneously working to lower the costs associated with a
pharmacy benefit plan.
We Intend to Increase Our Pbm Client Base by Targeting Certain Market
Segments
- ------------------------------------------------------------------------------
* Mid-Tier Managed Care Organizations (MCOs):
---------------------------------------------
MCOs represent over 20 million lives and $8 billion in annual drug
spending. There are hundreds of MCOs which cover under 200,000
lives. We are targeting these MCOs as a source of significant
growth. MCOs of this size are increasingly dissatisfied with the
level of service and results they are receiving from larger PBM
companies that devote most of their attention to one-million-plus
member MCOs. HealthExtras has demonstrated that it can provide these
Mid-Tier MCOs with a complete, full-service PBM that includes all of
the features larger PBMs offer, with superior customer service,
market specific retail networks and customized benefit plans.
4
* Large Employer Groups (Self-Insured):
-------------------------------------
Representing over 12 million lives, employers in this segment are
large enough to need a full-service PBM solution to manage their
increasing prescription benefits costs, but are not Fortune 500-size
companies that the largest PBMs typically serve. HealthExtras has a
significant number of clients in this segment, particularly in the
Western United States where many of Catalyst's self-insured employer
clients are based. By utilizing the information-based cost
containment strategies described below, HealthExtras offers these
clients favorable results as compared to larger PBMs, and greater
level of customer service.
* Third Party Administrators (TPAs):
------------------------------------
There are over 150 TPAs in the U.S. which focus primarily on
administering the health benefits of their clients. TPAs provided
services to over 17 million employees, dependents, and retirees in
2001, paying over $17 billion in total health claims. As the TPA
market continues to consolidate, and TPA clients increasingly seek
out complete health benefits solutions from their TPA, we believe an
increasing number of TPAs will be seeking a PBM partner to
administer the prescription benefits of their clients.
* State and Local Governments:
----------------------------
Clients in this market segment often have fixed budgets for the
prescription benefits that are offered to current members as well as
retirees. With some state governments having a workforce and retiree
population that rivals a Fortune 1000 employer, these clients are
seeking the same customer service, attention to detail, and bottom
line results. Because the vast majority of members in this market
segment are geographically concentrated, HealthExtras can analyze
the prescribing and utilization trends associated with a state and
local government entity and actively influence physicians'
prescribing practices in a particular region. These physician
interactions draw on peer-reviewed clinical studies, generic drug
utilization patterns, and the insights offered by the physicians
themselves to deliver better care at lower costs.
* Seniors and Medicare-Eligibles:
-------------------------------
This market segment is the least 'mature' of any in the prescription
benefits arena. More than 40% of all prescriptions written in the
U.S. are for retirees, who make up only 13% of the U.S. population.
In addition, the Medicare health care program for the 39 million
Americans over age 65 does not include any prescription benefit.
Similarly, 3.2 million Americans between ages 55 and 64 have no
prescription benefit. Total drug spending for the Medicare
population is estimated to be $71 billion in 2001, with the average
annual per capita drug spending for the Medicare population reaching
$1,750. Through targeted marketing of the affordable generic copay
products, fully insured products, and prescription discount
programs, we believe we will be successful in generating revenue by
providing seniors and retirees prescription benefits that may
otherwise be unavailable or prohibitively expensive. Additionally,
in August of 2001, HealthExtras submitted its application to the
Centers for Medicare and Medicaid (CMS) to become a
Medicare-endorsed provider of Prescription Discount Cards to members
of the Medicare population. This discount card program was proposed
by President Bush in July 2001 as a near-term effort to provide
Medicare enrollees some form of savings on prescription drug costs,
while Congress begins to develop a more comprehensive Medicare
prescription benefit. Although initial implementation of the
discount card program was delayed, the CMS has stated that it still
intends on proceeding with the program.
We Seek to Leverage Local Market Dynamics to Build Customized Networks
and Manage Drug Spending
- --------------------------------------------------------------------------------
Although clients contract with HealthExtras to provide PBM services
nationwide, capitalizing on local and regional market dynamics is an effective
way to manage drug spending and differentiate our PBM services from those
offered by our competitors.
* Customized Pharmacy Networks:
-----------------------------
In order to obtain greater pharmacy discounts for its clients,
HealthExtras works with clients to identify pharmacies that will
agree to deeper prescription discounts in a specific locality, based
on the concentration of client members in that area, and the
`foot-traffic' those members represent to a drug, grocery, or retail
chain's non-pharmacy business. HealthExtras has established
customized pharmacy networks in the Las Vegas, NV, Tidewater, VA and
Albuquerque, NM regions and intends to develop similar networks in
other parts of the country.
5
* Physician `Counter-Detailing':
-------------------------------
To help its clients effectively manage their prescription drug
spending without compromising patient care, HealthExtras works
closely with its clients' top prescribing physicians to identify
opportunities for cost savings, through the use of generic
equivalents, formulary compliance, and over-the-counter medications.
This `counter-detailing' is performed by HealthExtras clinical
pharmacists who meet with physicians at their practices and review
their prescribing trends for members of PBM programs that
HealthExtras offers or manages. The interaction in these meetings is
clinician-to-clinician, and is usually welcomed by physicians, who
often do not realize the savings they can help a patient or plan
sponsor achieve through increased utilization of generic
equivalents, lower-priced brands, or over-the-counter products. Our
experience indicates that client savings through `counter-detailing'
can range from five to twenty percent.
Data Analysis and Reporting to Improve Cost Experience and Quality of Care
- -------------------------------------------------------------------------------
HealthExtras manages prescription drug spending while enhancing patient
care by performing client-specific data analysis to develop trends, insights,
and conclusions that result in improved care while reducing costs. Many PBMs
offer a variety of data analysis techniques from both a clinical and financial
perspective. HealthExtras differentiates itself by using the information it
derives from its systems to obtain regionally favorable prescription pricing; to
pro-actively influence the drivers of prescription drug utilization; and to
monitor clinical formulary and disease management trends.
HealthExtras provides its clients Web-enabled decision support for
prescription benefit plan management, clinical evaluations, disease management,
and compliance monitoring. These data analysis and reporting capabilities allow
clients to assess top-level trend information for total population management
and to analyze detail in a particular drug, prescriber, member, or pharmacy.
This functionality enables HealthExtras' clients to measure successes relative
to formulary and disease management initiatives and will assist in the
identification of specific patient populations that will benefit from specialty
pharmacy programs.
COMPETITION
We believe the primary competitive factors in our PBM businesses are
price, quality of service and scope of available services. Scale is an important
factor in negotiating prices with pharmacies and manufacturers. Though we have
other advantages to offset our comparatively small size, we could face more
pricing competition in the future. We believe our principal competitive
advantages are our commitment to provide flexible and customized service to our
clients, our ability to leverage local market dynamics to build customized
networks and manage prescription drug spending, and the information-based
cost-containment methods we use to enhance care while lowering costs.
There are a significant number of national and regional PBMs in the
United States, several of which have significantly greater financial, marketing
and technological resources at their disposal to expand their client base and
grow their businesses. The largest, national companies include Merck-Medco
Managed Care, L.L.C., a subsidiary of Merck & Co., Inc., ("Merck-Medco");
AdvancePCS, Express Scripts, and CaremarkRx, Inc.; as well as large health
insurers and certain HMOs which have their own PBM capabilities. In addition, a
competitor that is owned by a pharmaceutical manufacturer may have pricing
advantages that are unavailable to us and other independent PBMs. However, we
believe our independence from pharmaceutical manufacturer ownership allows us to
make unbiased formulary recommendations to our clients, balancing both clinical
efficacy and cost.
Consolidation has been, and may continue to be, an important factor in
all aspects of the pharmaceutical industry, including the PBM segment. We will
continue to evaluate additional acquisition and joint venture opportunities to
enhance our business strategy of differentiated pharmacy services.
Some of our PBM services, such as disease management services, informed
decision counseling services and medical information management services,
compete with those being offered by pharmaceutical manufacturers, other PBMs,
large national companies, specialized disease management companies and
information service providers.
6
Supplemental Health Programs
----------------------------
HealthExtras is a provider of supplemental health programs that
utilizes a variety of direct marketing channels to offer individuals, small
businesses and employer groups customizable and affordable benefits. The Company
has strategic relationships with nationally recognized insurance underwriters,
and its marketing partners include many of the nation's largest financial
institutions, along with leading affinity groups, associations, and Internet
companies. Additionally, HealthExtras has a relationship with actor and advocate
Christopher Reeve to promote its supplemental health programs. We have
contracted with insurance companies to underwrite the insurance components of
our programs. As a result, we do not assume any insurance underwriting risk. The
financial responsibility for the payment of claims resulting from a qualifying
disability, or other event covered by the insurance features of our programs, is
borne by third-party insurers. All of the insurance and service features
included in these programs are supplied by outside vendors.
The benefits of our supplemental health programs have historically been
uneconomic to offer to consumers through traditional, commission-driven
distribution channels. By leveraging our membership base to obtain group rates,
we are able to offer benefits to members at a cost which we believe is less than
they would have to pay individually for comparable benefits.
BUSINESS STRATEGY
We have established strategic marketing relationships with many of the
nation's largest credit card issuing banks for access to their customers. We
have also entered into agreements with national insurance companies and direct
insurance marketers to expand the distribution of our products. These agreements
provide for various marketing initiatives, including telemarketing, direct mail,
statement inserts, statement messages, direct-response television, banner
placements and e-mail. These communications feature Christopher Reeve and
provide information about HealthExtras supplemental health programs.
HealthExtras compensates these partners based principally on a commission basis
for the supplemental health programs purchased in response to these
communications.
Our marketing partner agreements are typically for a term of 12 months,
with automatic annual renewal unless cancelled upon written notice 30 or 90 days
prior to an anniversary date. Some contracts also provide for termination by
either party without cause upon 30 or 90 days prior written notice.
COMPETITION
We consider that our supplemental health programs compete with the
traditional distributors of insurance, such as captive agents, independent
brokers and agents, and direct distributors of insurance. Insurance companies
and distributors of insurance products are increasingly competing with banks,
securities firms and mutual fund companies that sell insurance or alternative
products to similar consumers. Traditionally, regulation separated much of the
activity in the financial services industry; however, recent regulatory changes
have begun to permit other financial institutions to sell insurance.
We believe that the principal competitive factors in our supplemental
health markets are price, brand recognition, marketing expertise, ability to
fulfill customer purchase requests, customer service, reliability of delivery,
ease of use, and technical expertise and capabilities. Many of our current and
potential competitors, including Internet directories and search engines and
traditional insurance agents and brokers, have longer operating histories,
larger consumer bases, greater brand recognition and significantly greater
financial, marketing, technical and other resources than our own. Certain of
these competitors may be able to secure products and services on more favorable
terms than we can obtain.
Any of the firms described above could seek to compete against us in
providing supplemental health benefits through traditional channels or by
copying our products or business model. Increased competition may result in
reduced operating margins, loss of market share and damage to our brand. We
cannot assure you that we will be able to compete successfully against current
and future competitors or that competition will not harm our business, results
of operations and financial condition.
7
GOVERNMENT REGULATION
Various aspects of our businesses are governed by federal and state
laws and regulations. Since sanctions may be imposed for violations of these
laws, compliance is a significant operational requirement. We believe we are in
substantial compliance with all existing legal requirements material to the
operation of our businesses. There are, however, significant uncertainties
involving the application of many of these legal requirements to our business.
In addition, there are numerous proposed health care laws and regulations at the
federal and state levels, many of which could adversely affect our business or
financial position. We are unable to predict what additional federal or state
legislation or regulatory initiatives may be enacted in the future relating to
our business or the health care industry in general, or what effect any such
legislation or regulations might have on us. We cannot provide any assurance
that federal or state governments will not impose additional restrictions or
adopt interpretations of existing laws that could have a material adverse affect
on our business or financial position.
* Pharmacy Benefit Management Regulation.
--------------------------------------
Certain federal and state laws and regulations affect or may affect
aspects of our PBM business. Among these are the following:
- FDA Regulation.
----------------
The U.S. Food and Drug Administration ("FDA") generally has
authority to regulate drug promotional materials that are
disseminated "by or on behalf of" a drug manufacturer. In January
1998, the FDA issued a Notice and Draft Guidance regarding its
intent to regulate certain drug promotion and switching
activities of pharmacy benefit managers that are controlled,
directly or indirectly, by drug manufacturers. After extending
the comment period due to numerous industry objections to the
proposed draft, the FDA withdrew the Notice and Draft Guidance in
the fall of 1998, stating that it would reconsider the basis for
such Guidance. The FDA has not addressed the issue since the
withdrawal. However, there can be no assurance that the FDA will
not again attempt to assert jurisdiction over certain aspects of
our PBM business in the future and, in such event, the impact
could materially adversely affect our operations, business or
financial position.
- Anti-Remuneration/Fraud and Abuse Laws.
---------------------------------------
Federal law prohibits, among other things, an entity from paying
or receiving, subject to certain exceptions and "safe harbors,"
any remuneration to induce the referral of individuals covered by
federally funded health care programs, including Medicare,
Medicaid and CHAMPUS or the purchase (or the arranging for or
recommending of the purchase) of items or services for which
payment may be made under Medicare, Medicaid, CHAMPUS or other
federally funded health care programs. Several states also have
similar laws that are not limited to services for which Medicare
or Medicaid payment may be made. Sanctions for violating these
federal and state anti-remuneration laws may include
imprisonment, criminal and civil fines, and exclusion from
participation in the Medicare and Medicaid programs.
The federal statute has been interpreted broadly by courts, the
Office of Inspector General ("OIG") within the Department of
Health and Human Services, and administrative bodies. Because of
the federal statute's broad scope, federal regulations establish
certain "safe harbors" from liability. Safe harbors exist for
certain properly reported discounts received from vendors,
certain investment interests, certain properly disclosed payments
made by vendors to group purchasing organizations, and certain
discount and payment arrangements between PBMs and HMO risk
contractors serving Medicaid and Medicare members. A practice
that does not fall within a safe harbor is not necessarily
unlawful, but may be subject to scrutiny and challenge. In the
absence of an applicable exception or safe harbor, a violation of
the statute may occur even if only one purpose of a payment
arrangement is to induce patient referrals or purchases. Among
the practices that have been identified by the OIG as potentially
improper under the statute are certain "product conversion
programs" in which benefits are given by drug manufacturers to
pharmacists or physicians for changing a prescription (or
recommending or requesting such a change) from one drug to
another. Such laws have been cited as a partial basis, along with
state consumer protection laws discussed below, for
investigations and multi-state settlements relating to financial
incentives provided by drug manufacturers to retail pharmacies in
connection with such programs.
8
To our knowledge, these anti-remuneration laws have not been
applied to prohibit PBMs from receiving amounts from drug
manufacturers in connection with drug purchasing and formulary
management programs, to therapeutic intervention programs
conducted by independent PBMs, or to the contractual
relationships such as those we have with certain of our clients.
In late 1999, it was reported that the U.S. Attorney's Office in
Philadelphia had issued subpoenas to Merck-Medco and PCS (now
AdvancePCS), both PBMs, and Schering-Plough Corp., a
pharmaceutical manufacturer. We believe that we are in
substantial compliance with the legal requirements imposed by
such laws and regulations. However, there can be no assurance
that we will not be subject to scrutiny or challenge under such
laws or regulations. Any such challenge could have a material
adverse effect on us.
- ERISA Regulation.
-----------------
The Employee Retirement Income Security Act of 1974 ("ERISA")
regulates certain aspects of employee pension and health benefit
plans, including self-funded corporate health plans with which we
have agreements to provide PBM services. We believe that the
conduct of our business is not generally subject to the fiduciary
obligations of ERISA. However, there can be no assurance that the
U.S. Department of Labor, which is the agency that enforces
ERISA, would not assert that the fiduciary obligations imposed by
the statute apply to certain aspects of our operations.
In addition to its fiduciary provisions, ERISA imposes civil and
criminal liability on service providers to health plans and
certain other persons if certain forms of illegal remuneration
are made or received. These provisions of ERISA are similar, but
not identical, to the health care anti-remuneration statutes
discussed in the immediately preceding section; in particular,
ERISA does not provide the statutory and regulatory "safe harbor"
exceptions incorporated into the health care statute. Like the
health care anti-remuneration laws, the corresponding provisions
of ERISA are broadly written and their application to particular
cases is often uncertain. We have implemented policies, which
include disclosure to health plan sponsors with respect to any
commissions paid by us that might fall within the scope of such
provisions, and accordingly believe we are in substantial
compliance with these provisions of ERISA. However, we can
provide no assurance that our policies in this regard would be
found by the appropriate enforcement authorities to meet the
requirements of the statute.
Numerous state laws and regulations also affect aspects of our
business.
Among these are the following:
* Comprehensive PBM Regulation.
--------------------------------
Although no state has passed legislation regulating PBM activities
in a comprehensive manner, such legislation has been introduced
previously in a number of states. In addition, certain
quasi-regulatory organizations, such as the National Association of
Boards of Pharmacy ("NABP", an organization of state boards of
pharmacy), the National Association of Insurance Commissioners
("NAIC", an organization of state insurance regulators), and the
National Committee on Quality Assurance ("NCQA", an accreditation
organization) are considering proposals to regulate PBMs and/or PBM
activities, such as formulary development and utilization
management. While the actions of the NABP and NAIC would not have
the force of law, they may influence states to adopt any
requirements or model acts they promulgate. In addition, standards
established by NCQA could materially impact us directly as a PBM,
and indirectly through the impact on our health plan clients, where
applicable.
* Consumer Protection Laws.
-------------------------
Most states have consumer protection laws that have been the basis
for investigations and multi-state settlements relating to financial
incentives provided by drug manufacturers to retail pharmacies in
connection with drug switching programs. In addition, pursuant to a
settlement agreement entered into with seventeen states on October
25, 1995, Merck-Medco Managed Care, LLC ("Medco"), the PBM
subsidiary of pharmaceutical manufacturer Merck & Co., agreed to
have pharmacists affiliated with Medco mail service pharmacies
disclose to physicians and patients the financial relationships
between Merck-Medco and the mail service pharmacy when such
pharmacists contact physicians seeking to change a prescription from
one drug to another. We believe that our contractual relationships
with drug manufacturers and retail pharmacies do not include the
9
features that were considered problematic in these settlement
agreements. However, no assurance can be given that we will not be
subject to scrutiny or challenge under one or more of these laws.
* Network Access Legislation.
--------------------------
A majority of states now have some form of legislation affecting our
ability to limit access to a pharmacy provider network or removal of
a network provider. Such legislation may require us or our clients
to admit any retail pharmacy willing to meet the plan's price and
other terms for network participation ("any willing provider"
legislation); or may provide that a provider may not be removed from
a network except in compliance with certain procedures ("due
process" legislation). We have not been materially affected by these
statutes.
* Legislation Affecting Plan Design.
----------------------------------
Some states have enacted legislation that prohibits certain types of
managed care plan sponsors from implementing certain restrictive
design features, and many states have legislation regulating various
aspects of managed care plans, including provisions relating to the
pharmacy benefit. For example, some states, under so-called "freedom
of choice" legislation, provide that members of the plan may not be
required to use network providers, but must instead be provided with
benefits even if they choose to use non-network providers. Other
states have enacted legislation purporting to prohibit health plans
from offering members financial incentives for use of mail service
pharmacies. Legislation has been introduced in some states to
prohibit or restrict therapeutic intervention, or to require
coverage of all FDA-approved drugs. Other states mandate coverage of
certain benefits or conditions and require health plan coverage of
specific drugs, if deemed medically necessary by the prescribing
physician. Such legislation does not generally apply to us directly,
but it may apply to certain of our clients, such as HMOs and health
insurers. If such legislation were to become widely adopted and
broad in scope, it could have the effect of limiting the economic
benefits achievable through pharmacy benefit management. This
development could have a material adverse effect on our business.
* Licensure Laws.
---------------
Many states have licensure or registration laws governing certain
types of ancillary health care organizations, including PPOs, TPAs,
and companies that provide utilization review services. The scope of
these laws differs significantly from state to state, and the
application of such laws to the activities of pharmacy benefit
managers often is unclear. We have registered under such laws in
those states in which we have concluded, after discussion with the
appropriate state agency, that such registration is required.
* Legislation Affecting Drug Prices.
----------------------------------
Some states have adopted so-called "most favored nation" legislation
providing that a pharmacy participating in the state Medicaid
program must give the state the best price that the pharmacy makes
available to any third-party plan. Such legislation may adversely
affect our ability to negotiate discounts in the future from network
pharmacies. Other states have enacted "unitary pricing" legislation,
which mandates that all wholesale purchasers of drugs within the
state be given access to the same discounts and incentives.
In addition, various federal and state Medicaid agencies have raised
the issue of how average wholesale price ("AWP") is calculated. AWP
is a standard pricing unit used throughout the industry, as well as
by us, as the basis for calculating drug pricing under our contracts
with clients, pharmacies and pharmaceutical manufacturers. Changes
to the standard have been suggested that could alter the calculation
of drug prices for federal programs. We are unable to predict
whether any such changes will be adopted, and if so, if such changes
would have a material adverse impact on our financial operations.
* Regulation of Financial Risk Plans.
-------------------------------------
Fee-for-service prescription drug plans are generally not subject to
financial regulation by the states. However, if the PBM offers to
provide prescription drug coverage on a capitated basis or otherwise
accepts material financial risk in providing the benefit, laws in
various states may regulate the plan. Such laws may require that the
party at risk establish reserves or otherwise demonstrate financial
responsibility. Laws that may apply in such cases include insurance
laws, HMO laws or limited prepaid health service plan laws.
10
Many of the state laws described above may be preempted in whole or
in part by ERISA, which provides for comprehensive federal
regulation of employee benefit plans. However, the scope of ERISA
preemption is uncertain and is subject to conflicting court rulings,
and we provide services to certain clients, such as governmental
entities, that are not subject to the preemption provisions of
ERISA. Other state laws may be invalid in whole or in part as an
unconstitutional attempt by a state to regulate interstate commerce,
but the outcome of challenges to these laws on this basis is
uncertain. Accordingly, compliance with state laws and regulations
remains a significant operational requirement for us.
* Privacy and Confidentiality Legislation.
----------------------------------------
Our activities may involve the receipt or use of confidential,
medical information concerning individual members. In addition, we
use aggregated and anonymized data for research and analysis
purposes. Regulations have been proposed at the federal level and
legislation has been proposed, and in some cases enacted, in several
states to restrict the use and disclosure of confidential medical
information. To date, no such legislation has been enacted that
adversely impacts our ability to provide our services, but there can
be no assurance that federal or state governments will not enact
legislation, impose restrictions or adopt interpretations of
existing laws that could have a material adverse effect on our
operations.
In December 2000, the Department of Health and Human Services issued
final privacy regulations, pursuant to the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA"), which impose
extensive restrictions on the use and disclosure of individually
identifiable health information by certain entities. We may be
required to comply with certain aspects of the regulations. We are
assessing the steps we will have to take in complying with these
regulations, which provide for a two-year implementation period.
While this assessment is not yet complete, we believe compliance
with these regulations may have a significant impact on our business
operations. We have not yet completed an assessment of the costs we
will incur in complying with these regulations, and can give no
assurance that such costs will not be material to us.
Even without new legislation and beyond the final federal
regulations, individual health plan sponsor customers could prohibit
us from including their patients' medical information in our various
databases of medical data. They could also prohibit us from offering
services that involve the compilation of such information.
* Regulation of Supplemental Health Benefits.
-------------------------------------------
Since the HealthExtras programs include insurance benefits,
distribution of our programs must satisfy applicable legal
requirements relating, among other things, to policy form and rate
approvals, the licensing laws for insurance agents and insurance
brokers, and the satisfaction by a HealthExtras member who receives
the insurance benefit of requisite criteria, for example being a
resident of a state which has approved the insurance policy. We
believe we satisfy applicable requirements. The underwriter of the
insurance benefits included in HealthExtras programs is responsible
for obtaining regulatory approvals for those benefits. Independent
licensed insurance agencies are responsible for the solicitation of
insurance benefits involved in HealthExtras programs.
Complex laws, rules and regulations of each of the 50 states and the
District of Columbia pertaining to insurance impose strict and
substantial requirements on insurance coverage sold to consumers and
businesses. Compliance with these laws, rules and regulations can be
arduous and imposes significant costs. Each jurisdiction's insurance
regulator typically has the power, among other things, to:
* administer and enforce the laws and promulgate rules and
regulations applicable to insurance, including the quotation of
insurance premiums;
* approve policy forms and regulate premium rates;
* regulate how, by which personnel and under what circumstances an
insurance premium can be quoted and published; and
11
* regulate the solicitation of insurance and license insurance
companies, agents and brokers who solicit insurance.
State insurance laws and regulations are complex and broad in scope
and are subject to periodic modification as well as differing
interpretations. There can be no assurance that insurance regulatory
authorities in one or more states will not determine that the nature
of our business requires us to be licensed under applicable
insurance laws. A determination to that effect or that we or our
business partners are otherwise not in compliance with applicable
regulations could result in fines, additional licensing requirements
or inability to market our products in particular jurisdictions.
Such penalties could significantly increase our general operating
expenses and harm our business. In addition, even if the allegations
in any regulatory or legal action against us turn out to be false,
negative publicity relating to any such allegation could result in a
loss of consumer confidence and significant damage to our brand.
The distribution of our programs including an insurance component
over the Internet subjects us to additional risk as most insurance
laws and regulations have not been modified to clarify or amend
their application to Internet transactions. Currently, many state
insurance regulators and legislators are exploring the need for
specific regulation of insurance sales over the Internet. Such
regulation could dampen the growth of the Internet as a means of
providing insurance services. Moreover, the application of laws
governing general commerce on the Internet remains largely
unsettled, even in areas where there has been some legislative
action. It may take years to determine whether and how existing laws
such as those governing insurance, intellectual property, privacy
and taxation apply to the Internet. In addition, the growth and
development of the market for electronic commerce may prompt calls
for more stringent consumer protection laws and regulations that may
impose additional burdens on companies conducting business over the
Internet. Any new laws or regulations or new interpretations of
existing laws or regulations relating to the Internet could harm our
business.
We believe that we are currently in compliance with applicable legal
requirements. However, the future regulation of insurance sales via
the Internet as a part of the new and rapidly growing electronic
commerce business sector is unclear. If additional state or federal
laws or regulations are adopted, they may have an adverse impact on
us.
One of the means by which the Company markets its programs is
telemarketing, which it generally out sources to third parties.
Telemarketing has become subject to an increasing amount of Federal
and state regulation as well as general public scrutiny in the past
several years. For example such regulation limits the hours during
which telemarketers may call consumers and prohibits the use of
automated telephone dialing equipment to call certain telephone
numbers. The Federal Telemarketing and Consumer Fraud and Abuse
Prevention Act of 1994 and Federal Trade Commission ("FTC")
regulations prohibit deceptive, unfair or abusive practices in
telemarketing sales. Both the FTC and state attorneys general have
authority to prevent certain telemarketing activities deemed by them
to violate consumer protection. Some states have enacted laws and
others are considering enacting laws targeted directly at regulating
telemarketing practices, and there can be no assurance that any such
laws, if enacted, will not adversely affect or limit the Company's
current or future operations. Compliance with these regulations is
generally the shared responsibility of the Company, its
sub-contractors and its marketing partners.
* Future Regulation.
------------------
We are unable to predict accurately what additional federal or state
legislation or regulatory initiatives may be enacted in the future
relating to our businesses or the health care industry in general,
or what effect any such legislation or regulations might have on us.
There can be no assurance that federal or state governments will not
impose additional restrictions or adopt interpretations of existing
laws that could have a material adverse effect on our business or
financial position.
12
EMPLOYEES
As of December 31, 2001, we had 82 personnel whose services are devoted
full time to HealthExtras and its subsidiaries. We have never had a work
stoppage. A collective bargaining unit does not represent our personnel. We
consider our relations with our personnel to be good. Our future success will
depend, in part, on our ability to continue to attract, integrate, retain and
motivate highly qualified technical and managerial personnel, for whom
competition is intense.
13
ITEM 2. PROPERTIES
- ------- ----------
Our offices are located in approximately 19,700 square feet of office
space in Rockville, Maryland under a sublease that expires on May 30, 2004. Our
subsidiaries lease a total of approximately 10,000 square feet under leases
which expire in the first quarter of 2003. We believe that our office space is
adequate for our existing needs and that suitable additional space on
commercially reasonable terms will be available as required.
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
From time to time we become subject to legal proceedings and claims in
the ordinary course of business. Such legal proceedings and claims could include
claims of alleged infringement of third party intellectual property rights,
notices from state regulators that we may have violated state regulations, and
employment-related disputes. Such claims, even if without merit, could result in
the significant expenditure of our financial and managerial resources. We are
not aware of any legal proceedings or claims that we believe will, individually
or in the aggregate, significantly harm our business, financial condition or
results of operations in any material respect.
ITEM 4. SUBMISSION OF MATTERS FOR A VOTE OF SECURITY HOLDERS
- ------- ----------------------------------------------------
There were no matters submitted to a vote of security holders during
the quarter ended December 31, 2001.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------- ---------------------------------------------------------------------
The common stock has been quoted on the NASDAQ National Market under
the symbol "HLEX" since the Company's initial public offering on December 14,
1999. The following table sets forth for the period indicated the high and low
sales prices for the common stock:
High Low
---- ---
1999
----
December 14 - December 31................... $ 12.38 $ 7.38
2000
----
First quarter............................... $ 11.97 $ 3.88
Second quarter.............................. $ 6.13 $ 3.31
Third quarter............................... $ 6.06 $ 2.50
Fourth quarter.............................. $ 6.00 $ 2.38
2001
----
First quarter............................... $ 6.44 $ 3.25
Second quarter.............................. $ 10.25 $ 4.88
Third quarter............................... $ 11.01 $ 4.10
Fourth quarter.............................. $ 6.80 $ 4.09
2002
----
First quarter (through March 26, 2002)...... $ 6.63 $ 2.80
On March 26, 2002, the last closing sale price of the common stock, as
reported by the Nasdaq National Market was $2.80 per share. As of March 26,
2002, the Company had approximately 572 stockholders of record. The Company did
not pay any cash dividends in 2001 and has no plans to do so in the foreseeable
future.
In connection with the acquisition of Catalyst, the Company issued an
aggregate of 366,730 shares of its common stock to Kevin C. Hooks, the sole
shareholder of Catalyst. The shares of stock were valued at $6.30. The Company
relied upon the exemptions from the registration requirements of the Securities
Act of 1933 provided by Section 4(2) of the Act.
15
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
(In thousands except per share data)
The following selected financial data has been derived from the audited
financial statements of the Company and its predecessor companies. The selected
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the audited
consolidated financial statements, including notes thereto.
For the Years Ended December 31,
--------------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
Statement of Operations Data:
Revenue............................... $ -- $ -- $ 5,327 $ 44,178 $ 124,351
Direct expenses....................... -- -- 3,096 24,303 93,668
Product development and
marketing........................ 3,380 4,936 10,331 31,211 27,212
General and administrative............ 1,306 1,598 2,996 8,458 11,242
--------- -------- --------- --------- ---------
Operating loss........................ (4,686) (6,534) (11,096) (19,794) (7,771)
Interest income (expense), net........ (556) (110) (351) 2,069 1,092
Other income (expense), net 589 -- (73) 499 --
Minority Interest..................... -- -- -- -- (96)
--------- -------- ---------- --------- -------
Net loss.............................. $ (4,653) $(6,644) $(11,520) $(17,226) $ (6,775)
========= ======== ========= ========= =========
Basic and diluted net loss per share. -- -- $ (0.56) $ (0.62) $ (0.23)
Weighted average shares of
common stock outstanding......... -- -- 20,588 28,010 29,731
Pro forma basic and diluted net loss . $ (0.26) $ (0.38) -- -- --
per share (1)....................
Pro forma weighted average shares of
common stock outstanding (1)..... 17,680 17,680 -- -- --
December 31,
----------------------------------------------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
Balance Sheet Data:
Cash and cash equivalents........... $ 9,651 $ 219 $ 46,971 $ 28,921 $ 32,009
Total assets........................ 12,710 4,608 53,662 52,044 88,153
Total liabilities................... 7,770 5,531 6,298 15,806 42,372
Total stockholders' (members') equity
(deficit)........................... 4,940 (923) 47,364 36,239 45,237
- --------------
(1) Reflects the formation of HealthExtras, Inc. and the Reorganization as
if those events had taken place at the beginning of the period, except that no
effect is given to the investment by Capital Z Healthcare Holding Corp. in
HealthExtras prior to May 27, 1999.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- ------- ---------------------------------------------------------------
This Form 10-K may contain forward-looking statements (see "Certain Factors
That May Affect Future Operating Results or Stock Prices") within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements involve a number of risks and uncertainties. We
undertake no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may arise after the date of this report.
Readers are urged to carefully review and consider the various disclosures made
in this report and in our other filings with the Securities and Exchange
Commission that attempt to advise interested parties of the risks and factors
that may affect our business.
OVERVIEW
- --------
Since its inception HealthExtras has focused on the sale of supplemental
health programs to individual consumers. These products are generally marketed
to consumers in collaboration with nationally recognized financial institutions
through means including telemarketing, direct mail and statement inserts.
However, over the past year, the Company has changed its strategic emphasis
through its acquisitions of International Pharmacy Management, Inc., ("IPM"),
now operating as HealthExtrasRx, and Catalyst both of which provide pharmacy
benefit management services to self-insured employer groups and managed care
organizations. These acquisitions have positioned the Company to aggressively
grow this segment of its business. The Company expects this portion of its
business to be the primary source of growth and profit potential in the years
ahead. The consumer segment will continue to provide revenue and gross margin
contributions but the Company expects to be more selective in marketing and
product development expenditures as a result of increasing direct expenses for
the components of our programs, increasing customer acquisition costs and higher
attrition rates.
PHARMACY BENEFIT MANAGEMENT
Our primary PBM services consist of the automated online processing of
prescription claims on behalf of our employer and managed care customers. When a
member of one of our customer accounts presents a prescription or health plan
identification card to a retail pharmacist in our network, our system provides
the pharmacist with accesses to online information regarding eligibility,
patient history, health plan formulary listings, and contractual reimbursement
rates. The member generally pays a co-pay to the retail pharmacy and the
pharmacist fills the prescription. On behalf of our customer accounts, we
electronically aggregate pharmacy benefit claims, which include prescription
costs plus our claims processing fees for consolidated billing and payment. We
receive payments from customer accounts and remit the amounts owed to the retail
pharmacies pursuant to our negotiated rates and retaining the difference,
including claims processing fees.
We have established a nationwide network of over 50,000 retail pharmacies.
In general, self-insured employers and managed care organizations contract with
us to access our negotiated retail pharmacy network rates, participate in
certain rebate arrangements with manufacturers based on formulary design and the
other care enhancement protocols in our system. Under these contracts, we have
an independent obligation to pay network retail pharmacies for the drugs
dispensed and accordingly have assumed that risk independent of our customers.
Pharmacy benefit claim payments from our health plan sponsors are recorded as
revenues, and reflect prescription costs to be paid to retail pharmacies are
recorded as direct expenses.
Acquisitions
We have made two acquisitions in order to generate increased revenues and
scale in the pharmacy benefit management business. The revenues from this
business segment are now larger than those of the health and disability segment
and are growing at a higher rate as well. On November 14, 2001, we completed the
acquisition of an 80% interest in Catalyst for an aggregate purchase price of
approximately $14.3 million. Consideration for the transaction consisted of
$10.4 million in cash, $8.9 million of which was payable at December 31, 2001,
and the remainder consisted of the assumption of debt and the issuance of common
stock. The acquisition of Catalyst was accounted for using the purchase method
of accounting. The excess of the purchase price paid over the net fair value of
identifiable assets and liabilities of Catalyst was recorded as goodwill.
17
The terms of the Catalyst acquisition agreements also require the Company to
purchase the remaining 20% of the Catalyst common stock outstanding by March 14,
2003, for a price based on the future EBITDA of Catalyst. Effective March 1,
2002, this clause was amended when the Catalyst minority interest agreed to the
sell the remaining 20% ownership of Catalyst to the Company for additional
consideration of $5,280,000. The consideration consists of 319,033 shares of
Company stock, valued at $1,056,000 on the closing date of the amendment, and
$4,224,000 in cash. The stock is to be transferred to the seller on April 1,
2002, and the cash will be paid in four installments of $1,056,000, due on April
1, 2002, October 1, 2002, January 1, 2003 and March 1, 2003.
Effective November 1, 2000, we completed the acquisition of IPM for an
aggregate purchase price of approximately $9.2 million. Consideration for the
transaction consisted of approximately 95% cash and the remainder in newly
issued common stock. The acquisition of IPM was accounted for using the purchase
method of accounting.
Anticipated Advantages Related to Catalyst Acquisition
We anticipate being able to generate competitive and operational
efficiencies as a result of the Catalyst acquisition by:
* Pursuing new marketing opportunities with a broader set of plan
sponsors and pharmaceutical manufacturers. Our acquisition of Catalyst
provides us with a more diverse and complete set of products and
services to sell to a larger customer base. For example, Catalyst is
engaged in demand management, generic substitution and other clinical
programs that will significantly enhance our ability to serve larger
and more sophisticated customers.
* Generating corporate overhead and information technology efficiencies.
Our combination with Catalyst will allow us to better capture
efficiencies in corporate overhead and information technology
investments. We expect cost savings to result from the consolidation of
certain corporate activities and the elimination of certain duplicated
components of our corporate operations.
Integration of the Catalyst Acquisition
We have successfully completed the initial steps in integrating Catalyst
that are necessary for us to operate as a single, combined company. We intend to
operate with a combined financial, organizational and management structure so
that all of our customers and employees and suppliers have access to consistent
and reliable organizational infrastructure. Over the next several quarters we
expect to complete additional integration steps around data processing platforms
and other technology systems.
SUPPLEMENTAL HEALTH PROGRAMS
We generate a significant portion of our revenue from the sale of membership
programs which provide disability insurance benefits. To date, we have primarily
focused on the distribution of our programs to customers of our financial
institution partners. Christopher Reeve is featured prominently in our marketing
campaigns for these programs.
Revenue is generated by payments for program benefits and payments from
certain business partners related to new member enrollments. For program
benefits, revenue reflects the numbers of individuals enrolled as well as the
price level of the benefits selected. The factors which most directly effect
this business include customer acquisition costs, the cost of the benefits
provided relative to the fee charged, the level of compensation shared with our
business partners and the attrition rate in our membership base. Over the past
year we have generated lower average fees while facing increasing direct costs
for benefits provided and the compensation shared with our partners. Accordingly
we are evaluating opportunities to maintain the profitability of this business
segment while shifting more of the up front customer acquisition cost risk to
our business partners.
18
The primary determinant of HealthExtras' program revenue recognition is
monthly program enrollment and payments from business partners related to new
member enrollments. In general, program revenue is recognized based on the
number of members enrolled in each reporting period multiplied by the applicable
fee collected from the member or paid by the marketing partner for their
specific membership program. The program revenue recognized by HealthExtras
includes the cost of the membership benefits, which are supplied by others,
including the insurance components. Payments from business partners related to
new member enrollments are recorded as revenue to the extent of related direct
expenses, which to date have exceeded payments from business partners.
Direct expenses consist principally of marketing and processing fees and the
cost of benefits provided to program members. Direct expenses are a function of
the level of membership during the period and the specific set of program
features selected by members. The coverage obligations of our benefit suppliers
and the related expense are determined monthly, as are the remaining direct
expenses.
Revenue from program payments received, and related direct expenses, are
deferred to the extent that they are applicable to future periods or to any
refund guarantee we offer. As of December 31, 2001, more than 725,000 members
had enrolled in our supplemental health programs. As of December 31, 2001,
initial program revenue was deferred for approximately 65,000 program members.
HealthExtras has committed to minimum premium volumes with respect to the
insurance features of its programs supplied by others. In the event that there
were insufficient members to utilize the minimum premium commitment, the
differential would be expensed by HealthExtras without any related revenue.
HealthExtras believes that current enrollment trends will allow the minimum
future commitments at December 31, 2001 to be fully utilized by current
enrollment levels.
RESULTS OF OPERATIONS
- ---------------------
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
---------------------------------------------------------------------
HealthExtras incurred an operating loss of $7.8 million for the year
ended December 31, 2001, including a non-cash warrant charge of approximately
$6.1 million relating to services provided under a marketing agreement. Total
revenues of $124.4 million for 2001 included $77.5 million earned from the
supplemental health segment and $46.9 million earned from pharmacy benefit
management services. Total revenues increased $80.2 million in 2001 with revenue
from pharmacy benefit management, program member payments and business partner
revenues contributing 52.4%, 25.1% and 22.5% respectively of that growth. As the
Company has increased its strategic focus on pharmacy services during the year,
the majority of its revenue and revenue growth were derived from such services
by the end of 2001. Much of the growth in pharmacy service revenue was
attributable to the acquisitions of HealthExtras Rx (formerly IPM) and Catalyst
during the fourth quarters of 2000 and 2001 respectively. HealthExtras incurred
an operating loss of $19.8 million for the year ended December 31, 2000. Total
revenues of $44.2 million for 2000 included $39.3 million from the supplemental
health segment and $4.9 million from the pharmacy benefit management segment.
The following table details financial data by segment for the years
ended December 31, 2000 and December 31, 2001. PBM services operating results
include the results for HealthextrasRx and Catalyst from the dates of
acquisition.
Supplemental
Health and
Year Ended December 31, 2000 Disability PBM Total
Revenue $ 39,300,891 $ 4,877,149 $ 44,178,040
Operating expenses 58,983,554 4,988,403 63,971,957
Net loss (17,122,208) (104,008) (17,226,216)
Total assets 47,795,234 4,248,872 52,044,106
19
Supplemental
Health and
Year Ended December 31, 2001 Disability PBM Total
Revenue $ 77,457,307 $ 46,893,749 $ 124,351,056
Operating expenses 84,832,141 47,290,368 132,122,509
Net loss (6,774,263) (386) (6,774,649)
Total assets 39,637,025 48,516,310 88,153,335
Accounts receivable 2,758,367 19,652,601 22,410,968
Accounts payable 3,128,698 22,580,270 25,708,968
Operating expenses for the year ended December 31, 2001, totaled $132.1
million. Direct expenses of $93.7 million, consisted of $50.1 million in benefit
costs, warrant charges and fees payable to our distribution partners for our
supplemental health and disability products and $43.6 million in direct costs
associated with pharmacy benefit services consisting largely of reimbursements
to network pharmacies. These direct expenses represented 70.9% of operating
expenses for the period. For the year ended December 31, 2001, HealthExtras
incurred $27.2 million in product development and marketing expenses, or 20.6%
of total operating expenses. The primary component of the expenditures related
to direct sales activities including telemarketing, direct mail and statement
inserts. The expenses for these direct sales activities were approximately $21.4
million. In addition, the Company incurred approximately $2.0 million in product
endorsement costs, $2.6 million for media production, including television,
radio, Internet and print advertisements and $1.2 million in other
marketing-related expenses. General and administrative expenses for the year
totaled $11.2 million or 8.5% of total operating expenses, $7.5 million of which
was related to the Company's supplemental health and disability segment while
the remaining $3.7 million was related to the management of pharmacy benefits.
These expenses included $6.1 million in compensation and benefits, $1.1 million
in professional fees, $843,000 in facility costs, $313,000 in telephone and
software costs, $466,000 in travel expenses, and $1.8 million in depreciation
and amortization. Interest income for the period was approximately $ 1.1
million.
Operating expenses for the year ended December 31, 2000, totaled $64.0
million. Direct expenses of $24.3 million, consisted of $19.8 million in benefit
costs, warrant charges and fees payable to our distribution partners for our
supplemental health and disability products and $4.5 million in direct costs
associated with pharmacy benefit services, consisting largely of reimbursements
to network pharmacies. These direct expenses represented 38.0% of operating
expenses for the period. For the year ended December 31, 2000, HealthExtras
incurred $31.2 million in product development and marketing expenses, or 49.0%
of total operating expenses. The primary component of the expenditures related
to direct sales activities including telemarketing, direct mail and statement
inserts. The expenses for these direct sales activities were approximately $26.1
million. In addition, the Company incurred approximately $1.1 million in product
endorsement costs, and $4.0 million in other product development and marketing
related expenses. General and administrative expenses for the year totaled $8.5
million or 13.0% of total operating expenses, $8.0 million of which was related
to the Company's supplemental health and disability segment while the remaining
$448,000 was related to the management of pharmacy benefits. These expenses
included $4.2 million in compensation and benefits, $653,000 in professional
fees, $467,000 in facility costs, $308,000 in telephone and software costs,
$380,000 in other personnel costs, $274,000 in travel expenses, and $702,000 in
depreciation and amortization. Interest income for the period was approximately
$2.1 million.
20
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
---------------------------------------------------------------------
HealthExtras incurred an operating loss of $19.8 million for the year
ended December 31 2000, consisting of a $19.7 million loss from the Company's
supplemental health operations, and a $100,000 loss from IPM. Revenue of $44.2
million consisted of program member payments earned during the period of $39.3
million and sales revenue for 2000 generated by IPM's pharmacy benefit
management services of $4.9 million from the acquisition date of November 1,
2000. HealthExtras incurred an operating loss of $11.1 million for the year
ended December 31, 1999. Revenue of $5.3 million consisted of annual program
member payments earned during the period. The increase in revenue and program
receipts was primarily attributable to the net growth in our membership for the
year ended December 31, 2000. The increase in the net loss was primarily
attributable to significantly increased marketing expenses.
Operating expenses for the year ended December 31, 2000 totaled $64.0
million. Direct expenses of $24.3 million, consisted of $19.8 million in costs
for benefits included in our programs and fees payable to our distribution
partners and $4.5 million in direct costs associated with IPM operations. These
direct expenses represented 38% of operating expenses for the period. For the
year ended December 31, 2000, HealthExtras incurred $31.2 million in product
development and marketing expenses, or 49% of total operating expenses, $1.2
million of which was for the continuing creative development of promotional
sales materials, $4.9 million for media production, including television, radio,
Internet and print advertisements, $21.2 million for media distribution, $1.1
million in product endorsement costs, and $2.8 million in market research,
product development, and other marketing-related expenses. General and
administrative expenses for the year totaled $8.5 million or 13% of total
operating expenses, $8.0 million of which was attributable to the Company's
supplemental health operations and approximately $448,000 was associated with
IPM operations. These expenses included $4.2 million in compensation and
benefits, $653,000 in professional fees, $467,000 in facility costs, $308,000 in
telephone and software costs, $380,000 in other personnel costs, $274,000 in
travel expenses, and $702,000 in depreciation and amortization. Interest income
for the period was approximately $2.1 million.
Total operating expenses for the year ended December 31, 1999, totaled
$16.4 million. Direct expenses of $3.1 million consisted of the cost of
obtaining the benefits included in our programs, and marketing and other fees
payable to our distribution partners. These direct expenses represented 19% of
operating expenses for the year. For the year ended December 31, 1999,
HealthExtras incurred $10.3 million in product development and marketing
expenses, or 63% of total operating expense, $4.3 million of which was incurred
for the continuing creative development of promotional and sales materials,
including television and print advertisements, and $1.1 million of which was
product endorsement costs. Media production expenses totaled $5.1 million for
print and Internet advertisement production and distribution. General and
administrative expenses for the year totaled $3.0 million or 18% of total
operating expenses. These expenses included $1.7 million in compensation and
benefits and $205,000 in professional services. Interest expense totaled
$350,000. The increase in operating expenses was attributable to the net growth
in our membership as well as expanded product development and marketing for the
year ended December 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, we had $33.0 million in cash and cash
equivalents, $24.6 million in operating working capital and short-term debt of
$8.9 million related to the acquisition of Catalyst. As the Company has
increased its PBM operations, its accounts receivable and accounts payable
balances have grown significantly. In order to remain in compliance with its
contractual arrangements with network pharmacies, the Company generally must
reimburse claims within approximately thirty days. The Company expects to reduce
its claims payable balance by between $8 and $10 million in the first quarter of
2002. In order to meet these obligations, the Company may borrow against its
accounts receivable as necessary. The Company intends to manage its cash flow
cycle by reducing its days outstanding on accounts receivable to as close to
thirty days as is commercially practical.
By managing accounts receivable to conform more closely to our payment
obligations to suppliers, the Company should be able to generate positive
operating cash flow, which when combined with available cash resources will be
sufficient to meet our planned working capital, capital expenditures and
business expansion requirements. However there can be no assurance that we will
not require additional capital. Even if such funds are not required, we may seek
additional equity or debt financing. We cannot assure you that such financing
will be available on acceptable terms, if at all, or that such financing will
not be dilutive to our stockholders.
21
The Company has no off balance sheet transactions. The following table
reflects our current contractual commitments as of December 31, 2001:
Payments Due by Period
--------------------------------------------------------------------
Total (1 Year 1 - 3 Years 4 - 5 Years) 5 Years
--------------------------------------------------------------------
Operating leases $ 1,847 $ 830 $ 1,017 $ -- $ --
Unconditional purchase
obligations $ 1,300 $ 1,300 $ -- $ -- $ --
Other long-term obligations $ 3,000 $ 1,000 $ 2,000 $ -- $ --
-------------------------------------------------------------------
Total contractual cash
obligations $ 6,147 $ 3,130 $ 3,017 $ -- $ --
====================================================================
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of the Financial Condition and
Results of Operations discusses the Company's consolidated financial statements.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
most significant accounting estimates made by the Company in preparing its
financial statements include the following:
Common Stock Warrants
The Company records direct expense for the fair market value of common
stock warrants earned or expected to be earned by a marketing partner. The
Company estimates the value of the warrants at each balance sheet date using an
appropriate equity-pricing model with assumptions consistent with those used in
preparing the Company's fair value stock option compensation disclosures. Direct
expense is based on the number of warrants expected to be issued, which is
determined based on an estimate of annualized revenues as defined under the
agreement with the marketing partner.
Pharmacy Benefit Management Rebate Revenues
Rebate revenues earned under arrangements with manufacturers are
recognized as they are earned in accordance with contractual agreements and
recorded as a reduction of direct expenses and a reduction of revenue if the
Company has agreed to share a portion of the manufacturers rebates with the plan
sponsors. Manufacturers rebates are based on estimates, which are subject to
final settlement with the contracted party.
22
Allowance for Bad Debts
The Company estimates reserves for doubtful PBM accounts receivable as
of each balance sheet date. The Company has historically had very limited
exposure to bad debts due to the nature of the employee benefits involved, the
necessity of maintaining benefit continuity for its customers employees, and the
general financial strength of its customer base. With respect to supplemental
health benefits, almost all revenues are collected in advance via credit card
and as such generate no accounts receivable exposure.
Goodwill
The Company carries the value of goodwill on its books at historical
values. In the future, the Company will subject these historical values to the
impairment testing required under FASB Statement No. 142 (described below). The
Company intends to complete its initial impairment test no later than June 30,
2002.
Intangible Assets
Intangible assets related to the November 2001 acquisition of Catalyst
were recognized under the provisions of FASB Statement No. 141 (FAS 141)
(described below). Accordingly, a portion of the excess purchase price was
assigned to intangible assets that were recognizable apart from goodwill. This
estimated fair value and the weighted average useful-life of the intangible
assets are based on income-method valuation calculations, performed by an
independent consulting firm. These calculations are in the process of being
finalized; thus the allocation of the purchase price to intangible assets is
subject to refinement. The remaining useful life of intangible assets will be
evaluated periodically and adjusted as necessary to match expected period that
the assets are expected to provide economic benefits.
RECENT ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 141 (FAS 141), Business Combinations, and FASB
Statement No. 142 (FAS 142), Goodwill and Other Intangible Assets were issued
July 20, 2001.
FAS 141 changes the accounting principles for Business combinations.
Some significant changes from the previous principles are: a) the purchase
method of accounting must be used for all business combinations initiated after
June 30, 2001; and b) specific criteria are provided for recognizing intangible
assets apart from goodwill. FAS 141 is effective for all business combinations
occurring after June 30, 2001.
FAS 142 establishes the accounting principles for goodwill and
intangible assets subsequent to their initial recognition. Some significant
changes from the previous principles are: a) goodwill and indefinite-lived
intangible assets are no longer amortized; and b) goodwill and intangible assets
deemed to have an indefinite life are tested for impairment at least annually.
The provisions of FAS 142 are not effective for the Company until
January 1, 2002; however, certain provisions of FAS 142 apply to goodwill and
intangible assets acquired after June 30, 2001. Those provisions have been
applied to the Catalyst acquisition and other purchases of intangible assets
that occurred after June 30, 2001. Upon adoption of FAS 142, the Company will be
required to perform an impairment analysis on the goodwill from the IPM
acquisition. The Company will perform the required analysis by June 30, 2002.
Emerging Issues Task Force Issue No. 01-9, "Accounting for
Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's
Products" ("EITF 01-9") will be effective for the Company in 2002. EITF 01-9
will change the way the Company recognizes the cost of consideration provided to
a marketing partner under a warrant agreement. This consideration is currently
recognized as a direct expense in the consolidated statements of operations and
comprehensive loss. Effective January 1, 2002, the Company will begin to
recognize the cost of this consideration as a reduction of revenue from the
marketing partner. Financial statements from prior periods presented for
comparative purposes must be reclassified to comply with these provisions.
On October 3, 2001 the FASB issued FASB Statement No. 144 (FAS 144),
Accounting for the Impairment or Disposal of Long-Lived Assets. The objectives
of FAS 144 are to address significant issues relating to the implementation of
FASB Statement No. 121 (FAS 121), Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and to develop a single
accounting model, based on the framework established in FAS 121, for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired. FAS 144 supersedes FAS 121, however it retains the fundamental
provision of FAS 121 for (1) the recognition and measurement of the impairment
of long-lived assets to be held and used and (2) the measurement of long-lived
assets to be disposed of by sale. FAS 144 will be effective for the Company in
2002. Implementation of FAS 144 is not expected to have any effect on the
Company's financial statements.
23
INTEREST RATE AND EQUITY PRICE SENSITIVITY
We are subject to interest rate risk on our short-term investments. We
have determined that a 10% move in the current weighted average interest rate of
our short-term investments would not have a material effect in our financial
position, results of operations and cash flows in the next year.
CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Factors Related to Our Business
Because we have a limited operating history, our business prospects are
subject to a great deal of uncertainty
- ----------------------------------------------------------------------------
The limited history of operating our business means that our business
prospects are subject to a great deal of uncertainty and risks. Our changing
strategic emphasis creates additional industry and competitive uncertainty.
We have not been consistently profitable and may not be profitable in
the future
- ---------------------------------------------------------------------------
We have incurred operating losses since our inception. Even if we
achieve profitability, we may not be able to maintain profitability in the
future. In addition, as our business model evolves, we expect to introduce a
number of new products and services that may or may not be profitable for us.
Our pharmacy benefit management operations face significant competition
-----------------------------------------------------------------------
The pharmacy benefit management industry is relatively consolidated and
dominated by large companies with significant resources. Many of the large
pharmacy benefit management companies are owned by large companies, including
pharmaceutical manufacturers, which can provide them with significant purchasing
power and other advantages, which we do not have. Competitors in this industry
include other pharmacy benefit management companies, drug retailers, physician
practice management companies, and insurance companies/health maintenance
organizations. We may also experience competition from other sources in the
future. Pharmacy benefit management companies compete primarily on the basis of
price, service, reporting capabilities and clinical services. In most cases, the
competitors referenced above are large, profitable and well-established
companies with substantially greater financial and marketing resources than our
resources. The significant majority of our PBM revenues are generated by our
twenty largest plan sponsors. The loss of any of these significant customers
could have an adverse affect on our revenues and profitability.
If we do not manage our growth effectively, we may not be able to operate
profitably
- -----------------------------------------------------------------------------
Our growth strategy, if successful, will result in further expansion of
our PBM operations. We can achieve profitable operations, however, only if we
are able to manage our growth effectively. Our growth in operations has placed
significant demands on our management and other resources, which is likely to
continue. Under these conditions, it is important for us to retain our existing
management, including those from Catalyst, and to attract, hire and retain
additional highly skilled and motivated officers, managers and employees.
We may not be successful in managing or expanding our operations or
maintaining adequate management, financial and operating systems and controls.
If we do not effectively manage and integrate our acquistion of Catalyst our
business prospects could be damaged
- --------------------------------------------------------------------------------
Our recent acquistion of Catalyst is important to achieving the scale
and operating leverage necessary to compete in this segment. Should we fail to
integrate these operations and realize the expected opportunities our prospects
could be damaged.
24
Our pharmacy benefit management business relies on real-time management
information systems
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Our pharmacy operations utilizes an electronic network connecting
approximately 50,000 retail pharmacies to process third-party claims. The
systems we utilize are provided by a third-party. Because claims are adjudicated
in real time, systems availability and reliability are key to meeting customers'
service expectations. Any interruption in real time service, either through
systems availability or telecommunications disruptions can significantly damage
the quality of service we provide. Our pharmacy benefit management services
depend on third-party proprietary software to perform automated transaction
processing. While our pharmacy benefit management services have not experienced
significant or detrimental service interruptions, and have significant back-up
database capability, there can be no assurance that the business will not be
harmed by these service interruptions.
If we lose one or more of our marketing relationships, our access to
potential customers would decline and sales and revenues would suffer
- -------------------------------------------------------------------------
A significant majority of all of our supplemental health program sales
is attributable to two marketing partner relationships. The relationships with
JCPenney and American Express provide us with access to customer leads resulting
in sales to individual consumers. These relationships directly or indirectly
were responsible for 62% and 17% of our supplemental health and disability
segment revenues for 2001. If we lose one or more of these marketing
relationships and are unable to replace them with other marketing outlets, our
access to potential customers would decline and sales and revenue would suffer.
Our supplemental health membership growth is increasingly dependent on
telemarketing
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A significant percentage of our membership growth during 2001 was
attributable to telemarketing sales. These sales involve a much higher
percentage of monthly rather than annual sales than was our previous experience.
The combination of these has resulted in higher initial cancellation rates and
reduced enrollment persistency.
The loss of our relationship with Christopher Reeve to promote our programs
could significantly impair our brand recognition and, thus, our ability to sell
our programs
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Our agreement for Christopher Reeve to promote our programs currently
expires in July 2005. The loss of the Christopher Reeve identification with our
programs, upon termination of our contract or otherwise, could significantly
reduce our ability to sell our programs.
If we lose our relationships with our benefit providers, we could have
difficulty meeting demand for the products and services included in the programs
we sell
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We are dependent on the providers of benefits included in our programs.
These benefits are provided pursuant to arrangements with Unum Life Insurance
Company of America, The Chubb Group of Insurance Companies, Zurich American
Insurance Company and others that may be terminated on relatively short notice.
If we lose these relationships and are unable to replace them quickly and cost
effectively, we would not be able to satisfy consumer demand for our programs.
If the providers of the benefits included in our programs fail to provide
those benefits, we could become subject to liability claims by our program
members
- -----------------------------------------------------------------------------
We arrange for the provision by others of the benefits included in our
member programs. If the firms with which we have contracted to provide those
benefits fail to provide them as required, or are negligent or otherwise
culpable in providing them, we could become involved in any resulting claim or
litigation.
We may experience significant fluctuations in our quarterly results of
operations, which will make it difficult for investors to make reliable
period-to-period comparisons and may contribute to volatility in our stock price
- --------------------------------------------------------------------------------
Our quarterly expenses have fluctuated significantly in the past, and
we expect our quarterly revenues and expenses to continue to fluctuate
significantly in the future. The causes for fluctuations could include, among
other factors:
25
* levels of pharmacy claims expenditures, seasonal fluctuations in
demand and enrollment levels;
* changing business mix between brand and generic prescription;
* changes in acceptance levels for our supplemental benefit program by
consumers;
* our levels of marketing expenditures;
* renewal rate experience for our benefit programs;
We believe that quarter-to-quarter comparisons of our operating results
are not necessarily meaningful and not good indicators of our future
performance. Due to the above-mentioned and other factors, it is possible that
in one or more future quarters our operating results will fall below the
expectations of securities analysts and investors. If this happens, the trading
price of our common stock would likely decrease.
FACTORS RELATED TO REGULATION
If we fail to comply with all of the various and complex laws and
regulations governing our products and marketing techniques, we could be subject
to fines, additional licensing requirements or the inability to market in
particular jurisdictions
- -------------------------------------------------------------------------------
Complex laws, rules and regulations of each of the 50 states and the
District of Columbia pertaining to insurance impose strict and substantial
requirements on insurance coverage sold to consumers and businesses. Compliance
with these laws, rules and regulations can be arduous and imposes significant
costs. The underwriter of the insurance benefits included in HealthExtras
programs is responsible for obtaining and maintaining regulatory approvals for
those benefits. If the appropriate regulatory approvals for the insurance
benefits included in our programs are not maintained, we would have to stop
including those benefits. An independent licensed insurance agency is
responsible for the solicitation of insurance benefits involved in HealthExtras
programs.
One of the means by which the Company markets its programs is
telemarketing, which it generally outsourced to third parties. Telemarketing has
become subject to an increasing amount of Federal and state regulation as well
as general public scrutiny in the past several years. For example such
regulation limits the hours during which telemarketers may call consumers and
prohibits the use of automated telephone dialing equipment to call certain
telephone numbers. The Federal Telemarketing and Consumer Fraud and Abuse
Prevention Act of 1994 and FTC regulations prohibit deceptive, unfair or abusive
practices in telemarketing sales. Both the FTC and state attorneys general have
authority to prevent certain telemarketing activities deemed by them to violate
consumer protection. Some states have enacted laws and others are considering
enacting laws targeted directly at regulating telemarketing practices, and there
can be no assurance that any such laws, if enacted, will not adversely affect or
limit the Company's current or future operations. Compliance with these
regulations is generally the shared responsibility of the Company, its
sub-contractors and its marketing partners. The Company maintains operational
controls to ensure that its marketing practices conform with applicable state
and federal regulations.
Regulation of the sale of insurance over the Internet and of electronic
commerce generally is unsettled, and future laws, regulations and
interpretations could hinder our ability to offer programs over the Internet
- ----------------------------------------------------------------------------
The distribution of our programs including an insurance component over
the Internet subjects us to additional risk as most insurance laws and
regulations have not been modified to clarify or amend their application to
Internet transactions. Currently, many state insurance regulators and
legislators are exploring the need for specific regulation of insurance sales
over the Internet. Such regulation could dampen the growth of the Internet as a
means of providing insurance services. Moreover, the application of laws
governing general commerce on the Internet remains largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws such as those governing insurance,
intellectual property, privacy and taxation apply to the Internet. In addition,
the growth and development of the market for electronic commerce may prompt
calls for more stringent consumer protection laws and regulations that may
impose additional burdens on companies conducting business over the Internet.
26
Any new laws or regulations or new interpretations of existing laws or
regulations relating to the Internet could hinder our ability to offer programs
over the Internet.
We could be subject to legal liability based upon the information on our
website
- ----------------------------------------------------------------------------
Our members may rely upon the information published on our website
regarding insurance coverage, exclusions, limitations and ratings, and the other
benefits included in our programs. To the extent that the information we provide
is not accurate, we could be liable for damages. These types of claims could be
time-consuming and expensive to defend, divert management's attention, and could
cause consumers to lose confidence in our service. As a result, these types of
claims, whether or not successful, could harm our business.
Our pharmacy benefit management business must comply with a range of State
and Federal regulatory requirements
- ------------------------------------------------------------------------------
Various forms of legislation and government regulations affect or could
affect providers of pharmacy benefit management services. Among the most
prominent forms of such regulation are the following:
Open Network Legislation. Numerous states have adopted "any willing
provider" legislation, which requires pharmacy network sponsors to admit for
network participation any retail pharmacy willing to meet a healthcare plan's
price and other terms.
Anti-Remuneration Legislation. "Anti-kickback" statutes at the federal
and state level prohibit an entity from paying or receiving any compensation to
induce the referral of healthcare plan beneficiaries or the purchase of items or
services for which payment may be made under such healthcare plans.
Additionally, state and federal regulations have been the basis for
investigations and multi-state settlements relating to financial incentives
provided by pharmaceutical manufacturers to retail pharmacies in connection with
pharmaceutical switching programs. To our knowledge, these laws have not been
applied to prohibit pharmacy benefit management companies from receiving amounts
from pharmaceutical manufacturers in connection with pharmaceutical purchasing
and formulary management programs, to prohibit therapeutic substitution programs
conducted by independent pharmacy benefit management companies, or to prohibit
contractual relationships such as we have regarding these types of programs.
Patient Choice. Some states have enacted legislation that prohibits the
plan sponsor from implementing certain restrictive design features, and many
states have introduced legislation to regulate various aspects of managed care
plans, including provisions relating to the pharmacy benefit. Legislation has
been introduced in some states to prohibit or restrict therapeutic substitution,
or to require coverage of all FDA approved drugs. Other states mandate coverage
of certain benefits or conditions. Such legislation does not generally apply to
us, but it may apply to certain of our customers, such as HMOs and health
insurers. If such legislation were to become widespread and broad in scope, it
could have the effect of limiting the economic benefits achievable through
pharmacy benefit management and consequently make our services less attractive.
Consumer Protection Legislation. Most states have consumer protection
laws that have been the basis for investigations and multi-state settlements
relating to financial incentives provided by drug manufacturers to retail
pharmacies in connection with drug switching programs. We believe that our
contractual relationships with drug manufacturers and retail pharmacies do not
include the features that were viewed adversely by enforcement authorities.
However, no assurance can be given that we will not be subject to scrutiny or
challenge under one or more of these laws.
Licensure. Many states have licensure or registration laws governing
certain types of ancillary healthcare organizations, including preferred
provider organizations, third party administrators and utilization review
organizations. These laws differ significantly from state to state, and the
application of such laws to the activities of pharmacy benefit managers is often
unclear. We have registered under such laws in those states in which we have
concluded such registration is required.
27
Confidential Information. Most of our activit