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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, 2002
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
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2273 Research Boulevard, 2nd Floor, Rockville, Maryland 20850
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(Address of principal executive offices, zip code)
(301) 548-2900
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(Registrant's phone number, including area code)
Not Applicable
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(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: ( __ )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the ACT) Yes X No ____
--
The market value of the voting and non-voting common equity held by
non-affiliates was $77,291,800 based upon the closing price of $5.07 as quoted
on the NASDAQ National Market as of June 28, 2002, the last business day of the
registrant's most recently completed second fiscal quarter. Solely for the
purposes of this calculation, directors and officers of the registrant are
deemed to be affiliates.
Documents incorporated by reference:
------------------------------------
The Company's Proxy Statement for its annual meeting of stockholders to be held
in June, 2003, a definitive copy of which will be filed within 120 days of
December 31, 2002, is incorporated by reference in Part III of this Report on
Form 10-K.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business.....................................................3
Item 2. Properties..................................................16
Item 3. Legal Proceedings...........................................16
Item 4. Submission of Matters for a Vote of Security Holders........16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................17
Item 6. Selected Financial Data.....................................18
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................19
Item 7A Quantitative and Qualitative Disclosures About Market
Risk......................................................33
Item 8. Financial Statements and Supplementary Data.................33
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................33
PART III
Item 10. Directors and Executive Officers of the Registrant..........33
Item 11. Executive Compensation......................................33
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................33
Item 13. Certain Relationships and Related Transactions..............34
Item 14. Controls and Procedures.....................................34
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K..................................................34
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.
CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
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PART 1
ITEM 1. BUSINESS
BUSINESS OVERVIEW
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HealthExtras, Inc. ("HealthExtras") is a provider of pharmacy benefit
management services ("PBM") and supplemental benefits. The Company's PBM
clients include managed-care organizations, self-insured employers, and third
party administrators ("payors"), who contract with HealthExtras to
cost-effectively administer the prescription drug component of their overall
health benefit programs. As a PBM, the Company provides access to a contracted
national network of over 50,000 pharmacies, maintains an electronic
point-of-sale system of eligibility verification and plan design while also
offering access to rebate arrangements for certain branded pharmaceuticals.
These services provide our clients' members with timely and accurate benefit
adjudication while controlling pharmacy spending trends through innovative plan
designs, physician orientation programs and member education.
Much of HealthExtras' competitive differentiation is attributable to a
strong local market presence in Nevada, New Mexico, Oklahoma, Texas and the
Carolinas. The Company's significant market share in each of these regions
allows it to offer attractive benefit pricing based on local pharmacy network
rates and formulary design. The Company maintains operational facilities in
Rockville, Maryland as well as Las Vegas, Nevada and Raleigh, North Carolina.
These offices provide account management, customer service and clinical support
programs including dedicated clinical pharmacists with expertise in plan
design, treatment protocols and various cost management initiatives. PBM
revenues have grown to more than $180 million or 73% of total revenue in 2002
from approximately $5 million or 11% of total revenue in 2000. The remainder of
the Company's revenues relate to the supplemental benefits segment of our
operations. HealthExtras has over 800 PBM clients and no single client
generated more than 8% of total revenue in 2002.
In 2002, the Company processed more than 4.5 million pharmacy claim
transactions and completed the year with an annualized claim rate in excess of
8 million transactions. The Company continues to develop its PBM service
offerings and has successfully integrated several strategic acquisitions over
the last three years. In each acquisition transaction the Company has executed
on its objectives by integrating operations, improving profitability and
growing the revenue base of the acquired businesses. In the most recent of
these transactions, HealthExtras acquired Pharmacy Network National Corporation
("PNNC"), a PBM company located in Raleigh, North Carolina, on December 1,
2002. The Company will continue to look for acquisition opportunities which
complement its existing operations and have the same or similar characteristics
as the previously acquired companies. These characteristics would include
geographic membership concentrations, opportunities to improve profitability
and a base from which to generate significant revenue growth.
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.
The Company's Internet website is www.healthextras.com. The Company
makes available free of charge on or through its website its annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after the Company electronically files such material with, or furnishes it to,
the Securities and Exchange Commission. This reference to the Company's website
is for the convenience of shareholders as required by the Securities and
Exchange Commission and shall not be deemed to incorporate any information on
the website into this report.
Pharmacy Benefit Management
---------------------------
The PBM industry has developed and grown in response to the increased
utilization of pharmaceuticals, increasing unit costs and broader application
of prescription drugs to various conditions. These factors have combined to
create a significant and recurring escalation in the cost of drug coverage
offered by managed-care organizations, self-insured employers and third party
administrators. In order to understand, manage and mitigate these trends, many
of these payor organizations have contracted for the specialized services
offered by PBMs.
3
According to 2003 survey data from national benefits consultants,
employer sponsored pharmacy benefit costs increased between 14.2% and 16.9%
annually in each of the four years ending in 2002. Current projections
generally anticipate that increases for 2003 will again be in excess of 15%. In
the context of overall employer-sponsored health care cost increases, pharmacy
costs have been escalating at a rate approximately 50% higher than that of
overall spending. The persistence of these trends has resulted in an increasing
willingness on the part of payors to embrace plan design changes and other
options to curb these levels of cost escalation.
The factors contributing to the increase in pharmacy spending include:
- The introduction of new and expensive drug therapies and greater
reliance on drug therapy by the physician community,
- Increased "preventative prescribing" to manage high cholesterol
levels and digestive disorders,
- Efforts by drug manufacturers to increase market share and extend
single-source brand use,
- The introduction of improvements over existing therapies, which
normally carry higher unit prices than existing formulations,
- Increased patient demand and education as a result of
direct-to-consumer advertising and other pharmaceutical marketing or
promotional efforts,
- An aging workforce,
- Increased obesity among all age groups, and
- Improved techniques and technology to detect and diagnose diseases.
Overall cost increases are a function of both the number of
pharmaceuticals dispensed and their unit cost. Each factor has contributed
approximately half of recent trend increases.
PBMs are responsible for implementing and administering benefit plans
that seek to lower overall prescription spending by encouraging generic
utilization, increasing the proportion of brand drugs dispensed from the
preferred category and encouraging, where appropriate, non-prescription therapy
and treatment alternatives. These objectives are accomplished through a
combination of administrative, educational and technology initiatives directed
towards pharmacies, physicians and members.
Over the past several years, plan design has increasingly focused on
the use of three-tier co-payment structures. Co-payments represent that portion
of the cost of a prescription paid for by the member at the time the drug is
dispensed. The purpose of these designs and the use of drug specific formulary
lists is to create financial incentives for members to utilize generic drugs
where available and to select the most cost-effective brand drugs indicated for
a specific diagnosis or condition. In general, these plans incorporate the
lowest member co-payments for generic drugs, with increases for preferred brand
drugs and reaching their highest level for non-preferred brands. Typically
these categories might require member co-payments of $10, $20 and $35
respectively. The use of these tiered plans has increased significantly over
the past several years and now applies to approximately 70% of
employer-sponsored members. As importantly, both the levels of member
co-payment and the differential between tiers has continued to increase.
While 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, HealthExtras has demonstrated its ability to serve a broad range
of clients from large managed-care organizations to employer groups with fewer
than a thousand members.
BUSINESS STRATEGY
-----------------
Our strategy is to capitalize on our competitive differentiation in
addressing the challenges confronting payors. The increasing focus on pharmacy
cost management should contribute to an attractive and dynamic market for cost
effective pharmacy benefit programs such as ours. HealthExtras provides its
clients the tools, information, and specialized expertise needed to offer the
best drug therapy to their membership, while simultaneously working to lower
the costs associated with a pharmacy benefit plan. We believe that growth will
be driven by demonstrating the effectiveness of these programs as alternatives
to the programs currently utilized by employer groups, managed-care
organizations, and third party administrators.
4
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 the management of client specific cost control initiatives.
Our PBM services include:
- Benefit plan design and consultation
- Formulary administration
- 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
- Contracted mail order pharmacy
- Prescription benefits and discount programs tailored for businesses
with a high percentage of low-wage or part-time employees
Because we are not affiliated with any pharmaceutical manufacturer, and
because we do not own a mail-order facility, the formulary and plan designs we
suggest to clients are free from exposure to certain potential conflicts of
interest. Our larger competitors are often subject to either or both conflicts
in that they may benefit from increasing the volume of drug utilization
generally or that of certain specific drugs. These conflicts arise where
revenues from pharmaceutical manufacturers may support the inclusion of certain
drugs on formulary where not otherwise indicated or may result from mail order
utilization serving as a visible and important profit center for the PBM. By
not actively pursuing pharmaceutical manufacturer revenue sources and by
outsourcing mail order as a cost center, we believe that our interests are more
fully aligned with the cost saving interests of our clients.
We Intend to Increase our PBM Client Base by Targeting Certain Market
Segments
- --------------------------------------------------------------------------
Our analysis of the market opportunity by segment is as follows:
- 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. 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 hundreds of 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, 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.
- MID-TIER MANAGED-CARE ORGANIZATIONS (MCOS): There are hundreds of MCOs
which cover under 200,000 lives. These MCOs represent over 20 million
lives and $8 billion in annual drug spending. 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 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.
- 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
5
utilization patterns, and the insights offered by the physicians
themselves to deliver better care at lower costs.
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 Texas, Nevada,
Virginia, New Mexico, Tennessee and Carolina regions and intends to
develop similar networks in other parts of the country.
- DATA ANALYSIS AND REPORTING TO IMPROVE COST EXPERIENCE AND QUALITY OF
CARE: HealthExtras performs 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
actively influence the drivers of prescription drug utilization; and to
monitor clinical formulary and disease management trends.
- EXTENSIVE USE OF INTERNET FACILITIES TO ENHANCE ACCOUNT MANAGEMENT
EFFECTIVENESS: 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, physician, 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.
We Offer Our Clients a Variety of Specialized Services Focused On Improving
Health Outcomes
- -------------------------------------------------------------------------------
Clinical and Other Services. Our clinical services teams work closely
with clients to design and administer pharmacy benefit plans that use
formularies and other techniques to promote clinically appropriate and
cost-effective drug usage. We are often able to influence physician prescribing
patterns by comparing individual behavior to physician peer groups and
encouraging change where practices differ from peer group norms and medical
best practices. Because we operate with significant geographic focus the
consultations between our clinical pharmacists and local physicians tend to
have high levels of effectiveness compared with less concentrated initiatives.
Similarly, our programs with retail pharmacies support therapeutic interchange
programs that encourage the evaluation of cost-effective drug alternatives
where appropriate. We also offer consulting services to assist clients in
designing education and communication programs designed to support
cost-effective prescription drug programs.
Disease Management. We assist clients in managing the cost and
treatment of specific chronic diseases to improve medical outcomes and lower
the overall cost of health care. These programs monitor the contracted
population and intervene when individuals demonstrate symptoms of a specific
disease or high risk indications.
Our disease management programs are the responsibility of a dedicated
team of clinicians and have been developed around three-key approaches:
- Data Analysis and Integration. We evaluate and identify medical,
laboratory, pharmacy and other relevant data within an identified
population.
- Case Identification. We identify patients who have the specific disease
and evaluate the appropriateness of targeted interventions.
6
- Clinical and Program interventions. We communicate with identified
patients and offer enhanced education about their condition and
effective management tools. We also integrate our recommendations with
physicians including treatment guidelines, patient profiles and patient
management tools. Case management intervention programs are coordinated
with other care-givers to monitor outcomes and improve overall care.
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 scale, 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,
specialized disease management companies and information service providers.
Supplemental Benefits
---------------------
Approximately 25% of our revenues are attributable to the Supplemental
Benefits segment. Supplemental benefits programs developed by HealthExtras are
offered to individuals and small businesses through various direct marketing
initiatives. The Company has distribution agreements with many of the nation's
largest financial institutions (the "distributors"), along with leading
affinity groups and associations. Additionally, HealthExtras has a relationship
with actor and advocate Christopher Reeve to promote these benefits programs.
The marketing expenditures for these programs are now funded entirely by the
distributors. Accordingly an increasing percentage of total program revenues
are retained by the distributors as compensation and accounted for as direct
expenses by us.
Insurance companies underwrite the insurance components of these
programs. As a result, we do not assume any insurance underwriting risk. The
financial responsibility for the payment of claims resulting from a qualifying
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 and the programs are marketed
through an independent, licensed and non-affiliated insurance agency.
Our agreements with the distributors 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. The significant majority of new enrollees in HealthExtras programs are
attributable to marketing initiatives funded entirely by the distributors.
Accordingly, the level of revenues from this segment will depend upon funding
levels for marketing campaigns that are not controlled by us.
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COMPETITION
-----------
We consider that our supplemental benefits 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
benefits markets are price, brand recognition, marketing expenditures and
customer service. Many of our current and potential competitors 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 distributors described above could seek to compete against
us in providing supplemental 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.
GOVERNMENT REGULATION
---------------------
Various aspects of our businesses are governed by federal and state
laws and regulations. Because 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 also cannot provide
any assurance that federal or state governments will not impose additional
restrictions or adopt interpretations of existing laws or regulations that
could have a material adverse effect on our business or financial position.
- PHARMACY BENEFIT MANAGEMENT FEDERAL REGULATION. Certain federal laws
and regulations affect or may affect aspects of our PBM business. Among
these are the following:
- ANTI-REMUNERATION/FRAUD AND ABUSE LAWS. The federal healthcare
anti-kickback statute (the "Statute") 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 in whole or in part under Medicare,
Medicaid, CHAMPUS or other federally funded health care programs.
Sanctions for violating these federal laws and regulations may
include imprisonment, criminal and civil fines, and exclusion from
participation in the Medicare and Medicaid programs.
The 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 Statute's broad
scope, federal regulations establish certain "safe harbors" from
liability. Safe harbors exist for certain properly disclosed and
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
8
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.
Additionally, it is a crime under the Federal Employees Health
Benefit Programs ("FEHBP") for any person to knowingly and willfully
include, directly or indirectly, the amount of any kickback in the
contract price charged by a subcontractor or prime contractor to the
United States. Violators of this law also may be subject to civil
monetary penalties.
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, drug reimbursing, and formulary
management programs, therapeutic intervention programs conducted by
independent PBMs, or the contractual relationships such as those we
have with certain of our clients. However:
- In mid-2002, it was reported publicly that the U.S. Attorney's
Office in Boston, Massachusetts had issued subpoenas to Express
Scripts, Inc. and Caremark Rx, Inc., both PBMs, and to WellPoint
Health Networks, Inc., and PacifiCare Health Systems, Inc., both
managed care companies, in connection with documents related to TAP
Pharmaceuticals ("TAP"). TAP, a pharmaceutical manufacturer,
reached a public settlement with the federal and state governments
in late 2001, in a case that included allegations of
anti-remuneration law violations. At this time, there is no
indication that the PBMs and managed-care organizations are targets
of this investigation.
- In October 2002, the OIG published a "Draft OIG Compliance Program
Guidance for Pharmaceutical Manufacturers" (the "Compliance
Guidance"). The Compliance Guidance is voluntary and is directly
aimed at the compliance efforts of pharmaceutical manufacturers.
Moreover, the Compliance Guidance is in draft and has not yet been
finalized. However, the Compliance Guidance highlights several
compliance "risk areas" that include certain potentially prohibited
remuneration in connection with pharmaceutical manufacturer
financial relationships with other entities that might include
PBMs.
- In late 1999, it was reported publicly that the U.S. Attorney's
Office in Philadelphia, Pennsylvania had issued subpoenas to Medco
Managed Care, LLC (now Medco Health Solutions, Inc., "Medco") and
PCS (now "AdvancePCS"), both PBMs, and Schering-Plough Corp., a
pharmaceutical manufacturer. The investigation is reported to
involve, among other things, practices under certain
anti-remuneration statutes.
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.
- In late 2002, it was reported publicly that Medco, was preparing to
settle a class action suit, which suit alleged that Medco violated
"fiduciary" obligations under ERISA in steering clients towards
Merck products through a variety of means. Under the proposed
settlement, Medco reportedly will not admit any liability under
ERISA or otherwise.
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- Additionally, other PBMs, including Caremark and AdvancePCS, have
disclosed publicly that they are defending private litigant
lawsuits alleging that they are ERISA fiduciaries.
We believe that the conduct of our business generally is not 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, or a private litigant 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 Statute. Like the health care anti-remuneration laws, the
corresponding provisions of ERISA are written broadly and their
application to particular cases is often uncertain. The Company has
implemented policies, which include disclosure to health plan
sponsors with respect to any commissions paid by or to 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 and
potential private litigants to meet the requirements of the statute.
- 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
has taken no further action on the Notice and Draft Guidance.
However, there can be no assurance that the FDA will not attempt
again 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.
- PHARMACY BENEFIT MANAGEMENT STATE REGULATION. Certain state laws and
regulations affect or may affect aspects of our PBM business.
Accordingly, compliance with state laws and regulations remains a
significant operational requirement for us. These state laws are
described below. Some of the state laws described below 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. We also provide services to certain
clients, such as governmental entities, that are not subject to the
preemption provisions of ERISA. Other state laws described below 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.
- ANTI-REMUNERATION/FRAUD AND ABUSE LAWS. Several states have laws
and/or regulations similar to those federal anti-remuneration and
fraud and abuse laws described above. Such state laws are not
necessarily limited to services or items for which federally funded
programs such as Medicare payment may be made. Sanctions for
violating these state anti-remuneration laws may include injunction,
imprisonment, criminal and civil fines, and exclusion from
participation in the state Medicaid programs. 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 the Company.
- CONSUMER PROTECTION LAWS. Most states have consumer protection laws
that generally prohibit payments and other broad categories of
conduct deemed harmful to consumers. These statutes may be enforced
by the states and, in fact, have been the basis for state
investigations and at least one multi-state settlement relating to
financial incentives provided by drug manufacturers to retail
pharmacies in connection with drug switching programs.
10
- In January 2003, it was reported publicly that New York's Attorney
General is investigating Medco, in connection with therapeutic
interchange programs that may have been improper under state consumer
protection laws.
- In November 2002, it was reported publicly that West Virginia's
Attorney General sued Medco, for consumer protection violations,
allegedly in connection with misrepresentations and nondisclosures
regarding potential savings to the state public employees' drug
benefit plan.
- In 2002, it was reported publicly that Florida's Attorney General
initiated investigations into two separate drug discount card
companies, Medplan, Inc. and the "People's Prescription Plan",
regarding possible consumer protection violations.
- Pursuant to a settlement agreement entered into with seventeen states
on October 25, 1995, Medco, agreed to have pharmacists affiliated
with Medco mail service pharmacies disclose to physicians and
patients the financial relationships between pharmaceutical
manufacturer Merck (Medco's parent company), Medco and the mail
service pharmacy when such pharmacists contact physicians seeking to
change a prescription from one drug to another.
We do not believe that we have contractual relationships with drug
manufacturers and retail pharmacies that include the features that have
been identified as problematic in these settlement agreements and
investigations. However, no assurance can be given that we will not be
subject to scrutiny or challenge under one or more of these laws.
In addition to enforcement by state regulators, many of these state
consumer protection laws allow for enforcement by private litigants.
For example:
- In March 2003, the American Federation of State County and Municipal
Employees, a public employee union, and the Prescription Access
Litigation project, a nationwide coalition of consumer groups filed
suit in California state court against AdvancePCS, Caremark Rx,
Express Scripts, and Medco. The suit alleges that a variety of PBM
practices in connection with accepting various forms of payments from
pharmaceutical manufacturers violate the California Unfair
Competition Law. Some of the PBMs involved have asserted publicly
that the allegations are without merit.
No assurance can be given that we will not be subject to scrutiny or
challenge under similar consumer protection theories.
- COMPREHENSIVE PBM REGULATION. States continue to introduce
legislation to regulate PBM activities in a comprehensive manner. 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. Many states have licensure or registration laws governing
certain types of ancillary health care organizations, including PPOs,
TPAs, companies that provide utilization review services, and
companies that engage in the practices of a pharmacy. 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 believe that we are in substantial
compliance with all such laws and requirements where required, and
continue to monitor legislative and regulatory developments. There
can be no assurance, however, regarding the future interpretation of
these laws and their applicability to the activities of our PBM
business. Future legislation or regulation, or interpretations by
11
regulatory authorities of existing laws and regulations could
materially affect the cost and nature of the business as currently
conducted.
- 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 OR BENEFIT 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.
- 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. We do not believe that our PBM
business currently accepts financial risk of the type subject to such
regulation.
- DISCOUNT DRUG CARD REGULATION. Several states recently have enacted
laws and/or promulgated or proposed regulations regulating the
selling, marketing, promoting, advertising or distributing of
discount drug cards for cash purchases. Such laws and regulations
provide generally that any person may bring an action for damages or
injunction for violations. While we offer a very limited discount
drug card program which we do not consider material to our business,
there can be no assurance that the existence of such laws will not
materially impact our ability to offer certain new products and/or
services in the future.
- PHARMACY BENEFIT MANAGEMENT State and Federal Regulation. Certain
aspects of our PBM business are or may be affected by bodies of law
that exist at both the federal and state levels. Among these are the
following:
- PRIVACY AND CONFIDENTIALITY LEGISLATION. Our activities 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. Many states' laws restrict
the use and disclosure of confidential medical information, and new
legislative and regulatory initiatives are underway in several
states. To date, no such laws adversely impact 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.
12
As of April 14, 2003, the final privacy regulations (the "Privacy
Rule") issued by the Department of Health and Human Services,
pursuant to the Health Insurance Portability and Accountability Act
of 1996 ("HIPAA"), become effective, and impose extensive
restrictions on the use and disclosure of individually identifiable
health information by certain entities known under the Privacy Rule
as "covered entities". While PBMs, in general, are not considered
covered entities, our clients are covered entities, and are
required to enter into "business associate agreements" with vendors,
such as PBMs, that perform a function or activity for the covered
entity that involves the use or disclosure of individually
identifiable health information. The business associate agreements
mandated by the Privacy Rule create a contractual obligation for the
PBM to perform its duties for the covered entity in compliance with
the Privacy Rule. As of October 16, 2002 (October 16, 2003 for those
who filed for an extension) the final transactions and code sets
regulation (the "Transactions Rule") promulgated under HIPAA became
effective. That regulation requires that all covered entities engaged
in electronic transactions use standardized formats and code sets. It
is incumbent upon PBMs to conduct all such transactions in accordance
with the Transaction Rule to satisfy the obligations of their covered
entity clients. We have made the necessary arrangements to offer
compliant electronic transactions to our clients. While
implementation of the Privacy Rule and the Transactions Rule (the
"HIPAA Regulations") is just beginning, and future regulatory
interpretations could alter our assessment, we currently believe that
compliance with the HIPAA Regulations should not have a material
adverse impact on our business operations. Also, pursuant to HIPAA,
state laws that are more protective of medical information are not
pre-empted by HIPAA. Therefore, to the extent states enact more
protective legislation, we could be required to make significant
changes to our business operations.
Independent of any regulatory restrictions, individual health plan
sponsor clients could increase limitations on our use of medical
information, which could prevent us from offering certain services.
- LEGISLATION AFFECTING DRUG PRICES. Various federal and state Medicaid
agencies, as well as legislators and private litigants have raised
the issue of how average wholesale price ("AWP") is determined. AWP
is a standard pricing unit published by third party data sources and
used throughout the industry as the basis for determining drug
pricing under contracts with clients, pharmacies and pharmaceutical
manufacturers. Changes to how AWP is determined and reported, as well
as the extent to which it is used in pricing, have been suggested at
both the state and federal levels and could alter the calculation of
drug prices for federal and/or state 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.
Additionally, 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.
- VOLUNTARY INDUSTRY ETHICAL GUIDELINES. In June 2002, the
Pharmaceutical Research and Manufacturers of America published a
voluntary ethical code for its members governing their interactions
with healthcare professionals. Although it does not have the force of
law, this code provides guidance relating to several facets of
pharmaceutical manufacturers' marketing practices, particularly with
respect to payments to providers. We believe that these ethical
guidelines will not have a material adverse effect on our financial
operations.
- REGULATION OF SUPPLEMENTAL 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
13
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
- regulate the solicitation of insurance and license insurance
companies, agents and brokers who solicit insurance.
State insurance laws and regulations, including their application to
use of the Internet, 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 the distributors are otherwise not in compliance
with applicable regulations could result in fines, additional licensing
requirements or inability to market the 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.
One of the means by which distributors market the programs is
telemarketing, which the distributors may out source 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.
On January 29, 2003, the FTC published a final rule on telemarketing
sales that, among other things, provides for a national "do-not-call"
registry. While the registry will require additional federal funding to
become effective, and additional time to be implemented, it is
anticipated that as of October 2003 it will be illegal for most
telemarketers to call anyone who has elected to be listed on the
registry. Implementation of the registry could have an adverse effect
on the sale of the Company's programs. In addition, 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. While compliance with these
regulations is generally the responsibility of the distributors and
subcontractors, there can be no assurance that the Company would have
no exposure to liability.
- 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.
14
EMPLOYEES
---------
As of December 31, 2002, we had 105 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.
15
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 25,400 square feet under three
leases that expire in March 2003, February 2006, and October 2011. 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 government regulators alleging that we may have violated certain
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, 2002.
16
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
------- ------
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............... $ 6.61 $ 2.69
Second quarter.............. $ 5.49 $ 2.40
Third quarter............... $ 5.45 $ 3.31
Fourth quarter............. $ 4.46 $ 3.80
2003
First quarter (through March 21, 2003)..... $ 4.30 $ 3.40
On March 21, 2003, the last closing sale price of the common stock, as
reported by the Nasdaq National Market was $3.99 per share. As of March 21,
2003, the Company had approximately 546 stockholders of record. The Company did
not pay any cash dividends in 2002 and has no plans to do so in the foreseeable
future.
17
ITEM 6. SELECTED FINANCIAL 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,
--------------------------------
(In thousands except per share data)
1998 1999 2000 2001 2002
--------- --------- -------- --------- ---------
Statement of Operations Data
Revenues .................................... $ -- $ 5,327 $ 43,924 $ 118,226 $ 248,408
Direct expenses.............................. -- 3,096 24,049 87,543 209,523
Selling, general and administrative ......... 6,534 13,327 39,669 38,454 35,485
--------- --------- -------- --------- ---------
Operating income (loss) ..................... (6,534) (11,096) (19,794) (7,771) 3,400
Interest income (expense), net .............. (110) (351) 2,069 1,092 (82)
Other income (expense), net ................. -- (73) 499 -- --
--------- --------- -------- --------- ---------
Income (loss) before income taxes
and minority interest .................. (6,644) (11,520) (17,226) (6,679) 3,318
Income tax benefit .......................... -- -- -- -- 10,205
Minority interest ........................... -- -- -- (96) (45)
--------- --------- -------- --------- ---------
Net income (loss) .......................... $ (6,644) $ (11,520) $ (17,226) $ (6,775) $ 13,478
========== ========= ========= ========= ========
Basic and diluted net income (loss) per share -- $ (0.56) $ (0.62) $ (0.23) $ 0.42
Weighted average shares of
common stock outstanding, basic ........ -- 20,588 28,010 29,731 32,234
Weighted average shares of
common stock outstanding, diluted ...... -- 20,588 28,010 29,731 32,420
Pro forma basic and diluted net loss
per share (1) .......................... $ (0.38) $ -- $ -- $ -- $ --
Pro forma weighted average shares of
common stock outstanding (1) ........... 17,680 -- -- -- --
Balance Sheet Data:
Cash and cash equivalents ................... 219 46,971 28,921 33,009 17,531
Total assets ................................ 4,608 53,662 52,044 88,153 120,002
Total liabilities ........................... 5,531 6,298 15,806 42,372 60,478
Total stockholders' (members') equity
(deficit) .............................. (923) 47,364 36,238 45,237 59,524
- --------------
(1) Reflects the formation of HealthExtras, Inc. 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.
18
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
HealthExtras is a provider of PBM services and supplemental benefits.
The Company's clients include managed-care organizations, self-insured
employers, third party administrators, as well as individual customers. The PBM
segment now generates the significant majority of our revenues and is expected
to be the primary source of growth and profit potential in years ahead. The
acquisitions of International Pharmacy Management, Inc. ("IPM"), Catalyst Rx
("Catalyst") and PNNC have contributed significantly to the growth of our PBM
business.
PHARMACY BENEFIT MANAGEMENT
---------------------------
Our primary PBM services consist of the automated online processing of
prescription claims on behalf of our clients. When a member of one of our
clients 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-payment to the retail pharmacy and the pharmacist fills the
prescription. On behalf of our clients, we electronically aggregate pharmacy
benefit claims, which include prescription costs plus our claims processing
fees for consolidated billing and payment. We receive payments from clients 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 benefit from 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 clients. When the Company administers pharmacy
reimbursement contracts and does not assume a credit risk, the Company records
only its administrative or dispensing fees as revenue. Pharmacy benefit claim
payments from our clients are recorded as revenues, and prescription costs to
be paid to pharmacies are recorded as direct expenses. Member co-payments are
not recorded as revenue. Rebates earned under arrangements with manufacturers
are recorded as a reduction of direct expenses. The portion of manufacturer
rebates due to plan sponsors is recorded as a reduction of revenue.
Acquisitions
------------
The Company has supported the growth of its PBM segment through three
acquisitions. The revenues from this business segment are larger than those of
the supplemental benefits segment and are continuing to grow at a higher rate.
On December 1, 2002, the Company acquired 100% of the common stock of
PNNC. Total consideration for PNNC stock was $20.2 million. Total acquisition
cost included transaction costs of approximately $1.4 million. Funding for the
$21.6 million cash transaction was derived from the Company's working capital.
The acquisition of PNNC was accounted for using the purchase method of
accounting. The acquisition resulted in goodwill of approximately $10.6
million.
19
On November 14, 2001, the Company acquired 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 $9.1 million excess
of the purchase price paid over the net fair value of identifiable assets and
liabilities of Catalyst was recorded as goodwill.
During the first quarter of 2002, the Company purchased the outstanding
20% minority interest in Catalyst for 319,033 shares of the Company's stock
valued at $1.1 million and notes payable of $4.2 million. The stock was
transferred to the seller on April 1, 2002, and the $3.1 million in cash was
paid in 2002, with the final installment of $1.1 million paid on March 1, 2003.
Effective November 1, 2000, the Company 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 common stock. The acquisition of IPM was accounted for using the
purchase method of accounting. Goodwill recorded at acquisition was $9.2
million.
Integration of Acquisitions
---------------------------
HealthExtras has successfully integrated IPM and Catalyst into the
Company's financial, organizational, management and technology structure. Our
acquisitions have provided the Company with a more diverse and complete set of
products and services to sell to a larger customer base. For example,
Catalyst's previously developed demand management, generic substitution and
other clinical programs have significantly enhanced the Company's ability to
serve larger and more sophisticated customers. The acquisitions have also
allowed us to better capture efficiencies in corporate overhead and information
technology investments. The Company has achieved cost savings from the
consolidation of certain corporate activities and the elimination of certain
duplicated components of the Company's corporate operations.
The Company has completed the initial steps of integrating PNNC that
are necessary for HealthExtras 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, employees and suppliers have access to
a consistent and reliable organizational infrastructure. Over the next several
quarters the Company expects to complete additional integration steps around
data processing platforms and other technology systems.
SUPPLEMENTAL BENEFITS PROGRAMS
------------------------------
The Company's supplemental benefits segment generates revenue from the
sale of membership programs which provide insurance and other benefits. The
Company has distribution agreements with many of the nation's largest financial
institutions (the "distributors"), along with leading affinity groups and
associations. Additionally, HealthExtras has a relationship with actor and
advocate Christopher Reeve to promote these benefits programs.
Revenue is generated by payments for program benefits and payments from
certain distributors. 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 distributor 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 the distributors related to
new member enrollments are recorded as revenue to the extent of the related
direct expenses, which to date have exceeded payments from the distributors.
Direct expenses consist principally of the cost of benefits provided to
program members, distributors' compensation, and transaction processing fees.
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.
20
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. 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 the Company
with out any related revenue. The Company believes that current enrollment
trends will allow the minimum future commitments at December 31, 2002, to be
fully utilized by current enrollment levels.
RESULTS OF OPERATIONS
- ---------------------
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUE. Revenue from operations for the year ended December 31, 2002, was
$248.4 million, compared to $118.2 million for the year ended December 31,
2001. The PBM segment contributed $135.4 million of this revenue increase,
while the supplemental benefits segment decreased by $5.2 million. Total
revenue for the year ended increased 289% and decreased 7.3% in the PBM segment
and the supplemental benefits segment, respectively. The PBM increase was
principally due to the Catalyst acquisition on November 14, 2001, which
increased revenues by $115.2 million from 2001 to 2002. Of the $115.2 million,
$49.8 million is attributed to new business for Catalyst in 2002. Due to the
Company's adoption of Emerging Issues Task Force Issue No. 01-9, "Accounting
for Consideration Given by a Vendor to a Customer or a Reseller of the Vendors
Products" ("EITF 01-9"), revenues and direct expenses for 2001 have been
retroactively reduced by $6.2 million in the comparative financial statements.
For more information about the adoption of EITF 01-9, see Note 2 of the Notes
to Consolidated Financial Statements.
DIRECT EXPENSES. Direct expense for the year ended December 31, 2002 of
$209.5 million consisted of $168.0 million in direct costs associated with the
PBM segment and $41.5 million attributable to benefit costs and compensation to
our distributors for supplemental benefits products. Direct expenses for the
year ended 2001 were $87.5 million, consisting of approximately $43.6 million
and $43.9 million attributable to the pharmacy benefit management services and
supplemental benefits segments, respectively. The PBM increase is principally
due to the Catalyst acquisition, which increased direct expenses by $106.6
million from 2001 to 2002. Of the $106.6 million, $45.6 million is attributed
to new business for Catalyst in 2002. The direct expenses of $209.5 million and
$87.5 million for the years ended 2002 and 2001, represent 85.5% and 69.5% of
operating expenses for the respective periods.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the year ended December 31, 2002, totaled $35.5 million or 14.5%
of operating expenses, $7.0 million of which was related to the Company's PBM
segment, while the remaining $28.5 million related to the management of the
supplemental benefits segment. These expenses include $4.1 million for creative
development, product endorsement and market research, $12.6 million in direct
marketing, $8.2 million in compensation and benefits, $1.3 in professional
fees, insurance and taxes, $2.8 million in other expenses, $1.4 million in
facility costs, $826,000 in travel expenses and $1.7 million in depreciation
and amortization and $2.7 million related to the impairment of and write-off of
fixed assets.
Selling and general administrative expenses for the year ended 2001, were
approximately $38.5 million or 30.5% of total operating expenses, $3.7 million
which related to the Company's PBM segment, while the remaining $34.8 million
related to the supplemental benefits segment. These expenses included $5.8
million for creative development, product endorsements and market research,
$21.4 million in direct marketing, $6.1 million in compensation and benefits,
$1.1 million in professional fees, insurance and taxes, $1.0 million in other
expenses, $843,000 in facility costs, $466,000 in travel expenses, and $1.8
million in depreciation and amortization.
INTEREST INCOME (EXPENSE) NET. Interest expense, net for the year ended
December 31, 2002, was approximately $(82,000) compared to interest income, net
of $1.1 million for the year ended December 31, 2001. This was principally due
to lower invested balances, interest rates and interest on borrowings initiated
in 2002. Interest expense on borrowings for 2002 was $319,000.
21
INCOME TAX BENEFIT. Through 2001, the Company maintained a full valuation
allowance against the Company's deferred tax assets due to the uncertainly as
to their ultimate realization. In the fourth quarter of 2002, as a result of
the Company's current and projected profitability, the Company recognized
approximately a $10.2 million tax benefit principally resulting from the
Company releasing the valuation allowance for its deferred tax asset. See Note
7 to the Notes to Consolidated Financial Statements for further information.
MINORITY INTEREST. The minority interest charge for the years ended December
31, 2002 and 2001, was approximately $45,000 and $96,000, respectively. The
charges represent the net income attributable to the 20% minority interest
holder of Catalyst for the months of January and February 2002, and November
and December 2001, respectively. As the Company purchased the remaining
minority interest on March 1, 2002, no additional minority interest charge for
Catalyst will appear on the Company's future financial statements.
NET INCOME (LOSS). Net income for the year ended December 31, 2002, was
$13.5 million compared to a $(6.8) million net loss in 2001. As a percentage of
revenue, net income increased from (5.6)% to 5.4%.
December 31, 2002
Supplemental
PBM Benefits Total
------------- ------------- --------------
Revenue ............... $ 182,275,943 $ 66,131,523 $ 248,407,466
Operating expenses.... 174,993,333 58,162,480 233,155,813
Operating income ..... 7,282,610 7,969,043 15,251,653
Total assets ......... 103,174,621 16,827,515 120,002,136
Accounts receivable... 37,527,001 272,777 37,799,778
Accounts payable ..... 33,863,566 588,223 34,451,789
December 31, 2001
Supplemental
PBM Benefits Total
------------- ------------- --------------
Revenue ............... $ 46,893,749 $ 71,332,170 $ 118,225,919
Operating expenses .... 46,233,164 77,326,609 123,559,773
Operating income (loss) 660,585 (5,994,439) (5,333,854)
Total assets .......... 67,526,792 20,626,543 88,153,335
Accounts receivable ... 19,652,601 2,758,367 22,410,968
Accounts payable ...... 22,580,269 2,014,000 24,594,269
Operating expenses of the segments exclude $11.9 million and $2.4 million in
corporate overhead that was not allocated by management in assessing segment
performance for the years ended December 31, 2002 and 2001, respectively.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
REVENUE. Revenue from operations for the year ended December 31, 2001 was
$118.2 million, compared to $43.9 million for the year ended December 31, 2000.
PBM segment revenue was $46.9 million, while revenue for the supplemental
benefits segment was $71.3 million. As the Company had increased its strategic
focus on pharmacy services during 2001, the majority of its revenue and revenue
growth were derived from such services at the end of 2001. Much of the growth
in the PBM segment was attributable to the acquisitions IPM and Catalyst during
the fourth quarters of 2000 and 2001, respectively. The 2001 increase in
revenue due to the IPM acquisition was approximately $28.9 million. Catalyst
revenue accounted for $13.0 million in 2001. Due to the Company's adoption of
EITF 01-9, revenue of previously reported 2001 and 2000 revenue has been
reduced by $6.2 million and $255,000,
22
respectively, in the comparative financial statements. For more information
about the adoption of EITF 01-9, see Note 2 of the Notes to Consolidated
Financial Statements.
DIRECT EXPENSES. Direct expense for the year ended December 31, 2001 of
$87.5 million consisted of $43.6 million in direct costs associated with the
PBM segment and $43.9 million attributable to benefit costs and compensation to
our distributors for supplemental benefits products. Direct expenses for the
year ended 2000 were $24.0 million, consisting of approximately $4.5 million
and $19.5 million attributable to the pharmacy benefit management services and
supplemental benefits segments, respectively. Much of the growth in the PBM
segment was attributable to the acquisitions of IPM and Catalyst during the
fourth quarters of 2000 and 2001, respectively. The 2001 increase in direct
expenses due to the IPM acquisition was approximately $22.7 million. Catalyst
direct expenses accounted for $12.2 million in 2001. The direct expenses of
$87.5 million and $24.0 million for the years ended 2001 and 2000, represent
69.5% and 37.7% of operating expenses for the respective periods. Due to the
Company's adoption of EITF 01-9, revenue of previously reported 2001 and 2000
direct expenses have been reduced by $6.2 million and $255,000, respectively,
in the comparative financial statements. For more information about the
adoption of EITF 01-9, see Note 2 of the Notes to Consolidated Financial
Statements.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the year ended December 31, 2001, totaled $38.5 million of 30.5%
of operating expenses, $3.7 million of which was related to the Company's PBM
segment, while the remaining $34.8 million related to the management of
supplemental benefits segment. These expenses include $5.8 million for creative
development, product endorsements, and market research, $21.4 million in direct
marketing, $6.1 million in compensation and benefits, $1.1 million in
professional fees, insurance and taxes, $1.0 million in other fees, $843,000
million in facility costs, $466,000 in travel expenses and $1.8 million in
depreciation and amortization.
Selling and general administrative expenses for the year ended 2000, were
approximately $39.7 million or 62.3% of total operating expenses, $448,000
which related to the Company's PBM segment, which $39.2 million related to the
supplemental benefits segment. These expenses included $5.1 million for
creative development, product endorsements and market research, $26.1 million
in direct marketing, $4.6 million in compensation and benefits, $2.5 million in
other fees and insurance and taxes, $467,000 in facility costs, $274,000 in
travel expenses, and $702,000 in depreciation and amortization.
INTEREST INCOME (EXPENSE) NET. Interest income, net for the year ended
December 31, 2001, was $1.1 million compared to interest income of $2.1 million
for the year ended December 31, 2000, a decrease of 48% principally due to
lower invested balances, interest rates and interest on borrowings initiated in
2001.
MINORITY INTEREST. The minority interest charge for the year ended December
31, 2001 was approximately $96,000. There was no minority interest charge for
the year ended December 31, 2000. The 2001 charge represents the net income
attributable due to the 20% minority interest holder of Catalyst for the months
November and December 2001.
23
NET LOSS. Net loss for the year ended December 31, 2001, was $6.8 million
compared to a $17.4 million net loss in 2000. As a percentage of revenue, net
loss decreased from 39.2% in 2000 to 5.6% in 2001.
December 31, 2001
Supplemental
PBM Benefits Total
------------- ------------- --------------
Revenue ............... $ 46,893,749 $ 71,332,170 $ 118,225,919
Operating expenses .... 46,233,164 77,326,609 123,559,773
Operating income (loss) 660,585 (5,994,439) (5,333,854)
Total assets .......... 67,526,792 20,626,543 88,153,335
Accounts receivable ... 19,652,601 2,758,367 22,410,968
Accounts payable ...... 22,580,269 2,014,000 24,594,269
December 31, 2000
Supplemental
PBM Benefits Total
------------- ------------- --------------
Revenue ............... $ 4,877,149 $ 39,046,762 $ 43,923,911
Operating expenses .... 4,988,403 51,031,389 56,019,792
Operating loss ........ (111,254) (11,984,627) (12,095,881)
Total assets .......... 32,356,816 19,687,290 52,044,106
Accounts receivable ... 101,944 3,697,326 3,799,270
Operating expenses of the segments exclude $2.4 million and $7.7 million in
corporate overhead that was not allocated by management in assessing segment
performance for the years ended December 31, 2001 and 2000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and cash equivalents at December 31, 2002, totaled $17.5 million
compared to $33.0 million at December 31, 2001. During 2002, the Company
received $30.5 million in cash from borrowings, repaid $12.5 million on
borrowings, paid $31.6 million for business acquisitions and related costs,
paid $2.0 million in capital expenditures, and used $6.9 million of the
borrowed funds and $1.4 million of the Company's cash to reduce outstanding
payables and accrued expenses in order to negotiate more favorable rates with
specific vendors.
CASH USED IN OPERATING ACTIVITIES. Cash used for operating activities during
2002 was $22,000 compared to $2.0 million during 2001. The variance is
primarily due to a $10 million increase in income before taxes offset by a
large reduction in accounts payable and, accrued expenses, and an increase in
deferred charges.
CASH USED IN INVESTING ACTIVITIES. Cash used in investing activities for
2002 was $33.5 million compared to approximately $589,000 during 2001. The
increase is primarily attributed to the $19.6 million paid in cash for the PNNC
acquisition and related costs and the $12.1 million paid to satisfy the
Catalyst acquisition promissory notes.
CASH FROM FINANCING ACTIVITIES. Cash provided by financing activities for
2002 was approximately $18.0 million compared to $6.7 million at December 31,
2001. In January 2002, the Company arranged for a line of credit for $5.0
million to support the working capital requirements of the Company's
acquisition of Catalyst. In March 31, 2002, the Company arranged an $8.0
million revolving credit facility. In April 2002, the Company repaid the
outstanding principal of $4.5 million on the credit facility previously
arranged in January 2002. The Company repaid the remaining outstanding
principal of $8.0 million in the fourth quarter of 2002. In December 2002, the
24
Company arranged to an $18.0 million revolving credit facility. At December 31,
2002, the outstanding balance on the credit facility was $18.0 million. All
principal and accrued interest is due to the bank on May 31, 2004.
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 combined with available cash resources will be
sufficient to met our planned working capital, capital expenditures and
business expense 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 be assume that such
financing will be available on acceptable terms, if at all, of that such
financing will not be dilutive to our stockholders.
The Company has no off balance sheet transactions. The following table
reflects our current contractual commitments as of December 31, 2002.
Payments Due by Period
---------------------------------------------------------------------------------------
Total < 1 year 1-3 years 4-5 years After 5 years
---------------------------------------------------------------------------------------
Operating leases $ 4,409,494 $ 1,208,945 $ 1,656,248 $ 327,739 $ 1,216,562
Unconditional purchase
obligations 1,900,000 1,900,000 -- -- --
Other long-term obligations 2,000,000 1,000,000 1,000,000 -- --
------------------------------------------------------------------------------------
$ 8,309,494 $ 4,108,945 $ 2,656,248 $ 327,739 $ 1,216,562
====================================================================================
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
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
In 2000 and 2001, the Company recorded as direct expense the fair
market value of common stock warrants earned, or expected to be earned by a
distributor. The Company estimated the value of the warrants at each balance
sheet date using an equity-pricing model with assumptions consistent with those
used in preparing the Company's fair value stock option compensation
disclosures. Direct expense was 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 distributor. Effective January 1, 2002,
the Company adopted EITF 01-9, which was issued in November 2001. The Company's
adoption of EITF 01-9 resulted in changing the way the Company recognizes the
cost of consideration provided to a distributor under a warrant agreement.
Effective January 1, 2002, the charge for this consideration was recorded as a
reduction to revenue from the distributor rather than as a charge to direct
expense, as reflected in prior periods. To comply with EITF 01-9, the non-cash
warrant expenses of $6.2 million and $255,000 for 2001 and 2000, respectively
from prior years have been reclassified as a reduction to revenue from the
distributor.
PHARMACY BENEFIT MANAGEMENT REBATE REVENUES
Rebates earned under arrangements with manufacturers are recorded as a
reduction of direct expenses. The portion of such rebates due to plan sponsors
is recorded as a reduction of revenue. Manufacturers rebates are based on
estimates, which are subject to final settlement with the contracted party.
Member co-payments are not recorded as revenue.
25
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 benefits, substantially all revenues are collected in advance via
credit card and as such generate no accounts receivable exposure.
INTANGIBLE ASSETS
Intangible assets related to the acquisitions of Catalyst, and PNNC
were recognized under the provisions of FASB Statement No. 141 ("FAS 141").
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. The remaining useful life of intangible assets will be evaluated
periodically and adjusted as necessary to match the period that the assets are
expected to provide economic benefits.
GOODWILL
The Company adopted Statement of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets ("FAS No. 142"), and discontinued the
amortization of goodwill and indefinite-lived intangible assets effective
January 1, 2002. The Company completed its initial adoption impairment testing
of goodwill and concluded that no impairment of goodwill exists. The Company
performed a similar test as of December 31, 2002, and concluded that no
impairment of goodwill exists.
INCOME TAXES
The Company records deferred tax assets and liabilities based on
temporary differences between the financial statement and the tax bases of
assets and liabilities using enacted tax rates in effect in the year in which
the differences are expected to reverse. In 2000 and 2001, the Company
maintained a full valuation allowance against the Company's deferred tax assets
due to the uncertainty as to their ultimate realization. In the fourth quarter
of 2002, as a result of the Company's current and projected profitability, the
Company recognized approximately $10.2 million in tax benefits principally
resulting from the Company releasing the full valuation allowance for its
deferred tax asset.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"; however, it
retains many of the fundamental provisions of that Statement. SFAS No. 144 also
supersedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations--Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of a segment of a business. However,
it retains the requirement in APB No. 30 to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. By broadening the presentation of discontinued
operations to include more disposal transactions, the FASB has enhanced
management's ability to provide information that helps financial statement
users to assess the effects of a disposal transaction on the ongoing operations
of an entity. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. Early
application is encouraged. The provisions of SFAS No. 144 generally are to be
applied prospectively. The Company recognized an impairment loss on fixed
assets of $2.6 million for the year ended December 31, 2002. See footnote
financial statement disclosure for additional detail.
26
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123", to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
application of the transition provisions of SFAS No. 148 is effective for
fiscal years ending after December 15, 2002. The application of the disclosure
requirements is effective for financial reports for interim periods beginning
after December 15, 2002. We are currently evaluating the impact of SFAS No.
148 on our financial position, results of operations and liquidity.
In November 2002, the FASB issued FASB Interpretation (FIN) No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees Including
Indirect Guarantees of Indebtedness of Others", which elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of FIN No. 45 are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002, irrespective of the guarantor's
fiscal year end. The disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. As of
December 31, 2002, there is no impact on the Company's financial statements as
a result of the issuance of FIN 45.
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
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 maintain
profitability
- -----------------------------------------------------------------------------
Our growth strategy, if successful, will result in further expansion of
our PBM operations. We can maintain 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 PNNC, 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.
27
If we do not effectively manage and integrate our acquisition of PNNC our
business prospects could be damaged
- ----------------------------------------------------------------------------
Our recent acquisition of PNNC 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.
Our pharmacy benefit management business relies on real-time management
information systems
- -----------------------------------------------------------------------------
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 distribution relationships, our access to
potential customers would decline and sales and revenues would su