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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTER REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to ___________
Commission File Number 0-31014
HEALTHEXTRAS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2181356
- ------------------------------- ----------
(State or other Jurisdiction of (IRS Employer
incorporation) Identification No.)
2273 Research Boulevard, 2nd Floor, Rockville, Maryland 20850
-------------------------------------------------------------
(Address of principal executive offices)
(301) 548-2900
--------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
------------------------------------------------------------
(Former name or former address, if changed since last report.)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes X No
---
As of August 12, 2003, there were 32,449,250 shares outstanding of the
Registrant's $0.01 par value common stock.
HEALTHEXTRAS, INC.
Second Quarter 2003 Form 10-Q
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2002 and June 30,
2003 (Unaudited)......................................................1
Consolidated Statements of Operations for the Six
Months Ended June 30, 2002 and 2003 (Unaudited)....................2
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2002 and 2003 (Unaudited).................................3
Notes to Financial Statements...........................................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk...15
Item 4. Controls and Procedures......................................15
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................15
Item 2. Changes in Securities........................................15
Item 3. Defaults Upon Senior Securities..............................15
Item 4. Submission of Matters to a Vote of Security Holders..........15
Item 5. Other Information............................................15
Item 6. Exhibits and Reports on Form 8-K.............................16
SIGNATURES
PART I. FINANCIAL INFORMATION
ITEM I. Financial Statements
HEALTHEXTRAS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, June 30,
2002 2003
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 17,531,051 $ 26,162,251
Accounts receivable, net ................................................... 37,799,778 39,824,162
Income taxes receivable .................................................... 2,773,773 1,644,580
Deferred income taxes ...................................................... 1,286,313 1,286,313
Deferred charges ........................................................... 1,888,072 1,969,137
Other current assets ....................................................... 1,282,484 1,199,076
------------- ------------
Total current assets ................................................. 62,561,471 72,085,519
Fixed assets, net ............................................................ 4,056,130 3,398,537
Deferred income taxes ........................................................ 3,759,152 1,636,104
Intangible assets, net ....................................................... 14,185,751 13,777,773
Goodwill ..................................................................... 33,538,142 33,666,142
Other assets ................................................................. 1,901,490 1,840,909
------------- ------------
Total assets ......................................................... $ 120,002,136 $ 126,404,984
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 34,451,789 $ 40,943,439
Note payable ............................................................... 1,056,000 --
Accrued expenses and other current liabilities ............................. 2,156,165 2,231,203
Deferred revenue ........................................................... 4,813,555 5,227,282
------------- ------------
Total current liabilities ............................................ 42,477,509 48,401,924
Note payable ................................................................. 18,000,000 14,000,000
------------- ------------
Total liabilities .................................................... 60,477,509 62,401,924
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares authorized,
none issued ............................................................. -- --
Common stock, $0.01 par value, 100,000,000 shares authorized, 32,295,120
and 32,414,115 shares issued and outstanding at
December 31, 2002 and June 30, 2003, respectively ....................... 322,951 324,141
Additional paid-in capital ................................................. 70,460,184 70,810,251
Accumulated deficit ........................................................ (11,243,127) (7,131,332)
Deferred compensation ...................................................... (15,381) --
------------- ------------
Total stockholders' equity ........................................... 59,524,627 64,003,060
------------- ------------
Total liabilities and stockholders' equity ........................... $ 120,002,136 $ 126,404,984
============= =============
The accompanying notes are an integral part of these financial statements
1
HEALTHEXTRAS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended For the six months ended
June 30, June 30,
----------------------------- ------------------------------
2002 2003 2002 2003
------------- ------------- ------------- -------------
Revenue .................................................... $ 55,248,679 $ 94,114,780 $ 109,900,934 $ 185,849,641
------------- ------------- ------------- -------------
Direct expenses ............................................ 44,658,926 83,863,324 89,317,012 166,323,430
Selling, general and administrative expenses ............... 9,003,208 6,492,387 18,424,809 12,561,305
------------- ------------- ------------- -------------
Total operating expenses ........................... 53,662,134 90,355,711 107,741,821 178,884,735
------------- ------------- ------------- -------------
Operating income ................................... 1,586,545 3,759,069 2,159,113 6,964,906
Interest expense, net ...................................... 59,738 114,330 3,606 263,111
------------- ------------- ------------- -------------
Income before income taxes and minority interest ... 1,526,807 3,644,739 2,155,507 6,701,795
Minority interest .......................................... -- -- (44,992) --
------------- ------------- ------------- -------------
Income before income taxes ......................... 1,526,807 3,644,739 2,110,515 6,701,795
Provision for income taxes ................................. -- 1,407,000 -- 2,590,000
------------- ------------- ------------- -------------
Net income ......................................... $ 1,526,807 $ 2,237,739 $ 2,110,515 $ 4,111,795
============= ============= ============== =============
Earnings per share, basic .................................. $ 0.05 $ 0.07 0.07 $ 0.13
Earnings per share, diluted ................................ $ 0.05 $ 0.07 0.07 $ 0.13
Weighted average shares of common stock, basic
(in thousands) ........................................... 32,291 32,403 32,160 32,370
Weighted average shares of common stock outstanding, diluted
(in thousands) ........................................... 32,501 33,280 32,280 32,783
The accompanying notes are an integral part of these financial statements
2
HEALTHEXTRAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the six months ended
June 30,
----------------------------
2002 2003
------------ ------------
Cash flows from operating activities:
Net income ................................................. $ 2,110,515 $ 4,111,795
Depreciation expense ....................................... 655,938 775,461
Deferred income taxes ...................................... -- 2,590,000
Income taxes receivable .................................... -- 662,241
Noncash charges (credits) .................................. (950,070) 100,068
Loss on disposal of fixed asset ............................ 115,821 --
Amortization of intangibles and other assets ............... 194,139 407,978
Minority interest .......................................... 44,992 --
Changes in assets and liabilities:
Accounts receivable, net ................................ 1,000,637 (2,024,384)
Other assets ............................................ (419,949) 143,989
Deferred charges ........................................ (1,163,391) (81,065)
Accounts payable, accrued expenses, and other liabilities (8,278,342) 6,566,688
Deferred revenue ........................................ 223,940 413,727
------------ ------------
Net cash (used in) provided by operating activities .. (6,465,770) 13,666,498
------------ ------------
Cash flows from investing activities:
Capital expenditures ....................................... (632,367) (117,868)
Deposits, restricted cash and other ........................ 600,000 --
Purchase of intangible assets .............................. (300,000) --
Business acquisitions and related payments ................. (9,961,603) (1,056,000)
------------ ------------
Net cash used in investing activities ................ (10,293,970) (1,173,868)
------------ ------------
Cash flows from financing activities:
Proceeds received from exercise of stock options ........... 33,469 138,570
Borrowings (repayments) under line of credit, net .......... 8,000,000 (4,000,000)
------------ ------------
Net cash provided by (used in) financing activities .. 8,033,469 (3,861,430)
------------ ------------
Net (decrease) increase in cash and cash equivalents ......... (8,726,271) 8,631,200
Cash and cash equivalents at the beginning
of period .................................................. 33,009,143 17,531,051
------------ ------------
Cash and cash equivalents at the end of period ............... $ 24,282,872 $ 26,162,251
============ ============
The accompanying notes are an integral part of these financial statements
3
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
- -- ---------------------
The accompanying consolidated financial statements have been prepared
by HealthExtras, Inc. (the "Company") pursuant to the rules and regulations of
the Securities and Exchange Commission (the "SEC") for interim financial
reporting. These consolidated financial statements are unaudited and, in the
opinion of management, include all adjustments, consisting of normal recurring
adjustments and accruals, necessary for a fair presentation of the consolidated
balance sheets, statements of operations and statements of cash flows for the
periods presented. Operating results for the six months ended June 30, 2003, are
not necessarily indicative of the result that may be expected for the year
ending December 31, 2003. Certain information and footnote disclosures normally
included in the financial statements prepared in accordance with accounting
principles generally accepted in the United States have been omitted in
accordance with the rules and regulations of the SEC. These consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and accompanying notes, included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002, as filed with the SEC
on March 31, 2003. Certain prior period amounts have been reclassified to
conform to the current period presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
- -- --------------------------------
SFAS NO. 148
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("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
FASB statement 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 Company has included the proper
disclosures in Note 3 to these Notes To Financial Statements.
FIN NO. 45
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
June 30, 2003, there is no impact on the Company's financial statements as a
result of the issuance of FIN No. 45.
4
3. STOCK-BASED COMPENSATION
- -- ------------------------
At June 30, 2003, the Company has stock-based compensation plans for
employees and directors. Stock-based compensation is accounted for using the
intrinsic-value-based method in accordance with the Accounting Principles Board
Opinion ("APB") 25, "Accounting for Stock Issued to Employees," and related
Interpretations. No stock-based compensation expense is reflected in net income
as all options granted under these plans had an exercise price equal to the
market value of the underlying common stock on issue date of the grant. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of SFAS 123,
"Accounting for Stock-Based Compensation", to stock-based employee compensation:
Three months ended Six months ended
June 30, June 30,
2002 2003 2002 2003
----------- ----------- ----------- -----------
Net income, as reported .............................. $ 1,526,807 $ 2,237,739 $ 2,110,515 $ 4,111,795
Deduct: Total stock-based employee compensation
expense determined under fair value method for
all awards (net of related tax effect for the three
and six month periods ended June 30, 2003 of
$388,640 and $763,248, respectively) .............. 830,998 615,116 1,347,135 1,213,055
---------- ----------- ----------- ------------
Pro forma net income ................................. $ 695,809 $ 1,622,623 $ 763,380 $ 2,898,740
========== =========== =========== ============
Earnings per share:
Basic - as reported ............................... $ 0.05 $ 0.07 $ 0.07 $ 0.13
Basic - pro forma ................................. $ 0.02 $ 0.05 $ 0.02 $ 0.09
The fair value for these options was estimated at the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions for the three and six months ended June 30, 2002 and 2003:
Three months ended Six months ended
June 30, June 30,
2002 2003 2002 2003
---------- -------------- ------------ --------------
Expected term ......... 5 years 5 years 5 years 5 years
Volatility factor ..... 87% 83.26 - 83.67% 87% 83.26 - 87.31%
Risk free interest rate 4.41-5.11% 2.28 - 3.01% 4.41 - 5.11% 2.28 - 3.19%
Dividend yield ........ -- -- -- --
Fair value ............ $3.17 $4.34 $3.06 $3.61
4. BUSINESS COMBINATIONS
- -- ---------------------
ACQUISITION OF CATALYST
During the first quarter of 2002, the Company purchased the outstanding
20% minority interest in Catalyst Rx, and Catalyst Consultants ("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
$3.1 million was paid on the note in 2002, with the final installment of $1.1
million paid on March 1, 2003.
5
ACQUISITION OF PNNC
On December 1, 2002, the Company acquired 100% of the common stock of
Pharmacy Network National Corporation ("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 and borrowings under the credit
facility. The acquisition resulted in goodwill of approximately $10.6 million
and intangible assets of $8.0 million.
The following table sets forth certain unaudited proforma financial
data assuming that the acquisition of 100% of Catalyst and PNNC had each been
completed as of January 1, 2002, after giving effect to purchase accounting
adjustments. Amounts are in thousands, except for per share data.
Three months ended Six months ended
June 30, June 30,
--------------------- -----------------------
2002 2003 2002 2003
--------- ------- ---------- ----------
(proforma) (actual) (proforma) (actual)
Revenue ....................... $ 85,675 $ 94,115 $ 169,605 $ 185,850
Net income .................... $ 2,027 $ 2,238 $ 3,584 $ 4,112
Net income per share basic .... $ 0.06 $ 0.07 $ 0.11 $ 0.13
Net income per share diluted .. $ 0.06 $ 0.07 $ 0.11 $ 0.13
Weighted average shares basic . 32,291 32,403 32,264 32,370
Weighted average shares diluted 32,501 33,280 32,384 32,783
The proforma results of operations are not necessarily indicative of
the results that would have occurred had the Company owned 100% of Catalyst and
PNNC at January 1, 2002, nor are these results indicative of future operating
results.
5. GOODWILL
- -- --------
The Company adopted SFAS 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. In the first quarter of 2003, the Company increased goodwill by $128,000
due to additional acquisition costs incurred related to the PNNC acquisition.
There have been no impairments or write-downs to goodwill in the three and six
month periods ended June 30, 2003.
6. INTANGIBLE ASSETS
- -- -----------------
As of June 30, 2003, intangible assets consisted of the following:
Amortization Period
Catalyst customer contracts $ 5,700,000 20 years
PNNC customer contracts 8,000,000 20 years
Other PBM contracts 945,200 5 - 10 years
--------------
Total intangible assets 14,645,200
Accumulated amortization (867,427)
--------------
Total $ 13,777,773
==============
Catalyst and PNNC customer contracts represent the estimated fair value
of customer contracts held by Catalyst and PNNC at the dates of acquisition.
This estimated fair value and the weighted average useful-lives are based on
income-method valuation calculations, performed by an independent consulting
firm.
6
The estimated aggregate amortization expense of intangible assets
through 2007 is as follows:
2003 $ 816,000
2004 816,000
2005 816,000
2006 816,000
2007 776,000
------------
Total $ 4,040,000
============
Amortization expense for the three month periods ended June 30, 2003
and 2002 was approximately $204,000 and $85,000 respectively. Amortization
expense for the six month periods ended June 30, 2003 and 2002 was approximately
$408,000 and $151,000, respectively.
7. CREDIT FACILITY
- -- ---------------
In December 2002, the Company arranged an $18.0 million revolving
credit facility the term of which was extended through May 2005. Borrowings on
the credit facility are collateralized by substantially all of the Company's
trade receivables. The credit facility contains affirmative and negative
covenants related to indebtedness, other liabilities and consolidated net worth.
The facility bears interest at LIBOR plus 2.75%. The effective rate at June 30,
2003, was 3.79%. Interest is payable in arrears on the fifth day of each month.
The outstanding balance on the credit facility at June 30, 2003 was $14.0
million. All principal and accrued interest is due to the bank on May 31, 2005.
Interest expense related to notes payable for the three and six month periods
ended June 30, 2003 were approximately $161,000 and $345,000, respectively.
Subsequent to June 30, 2003, an additional $2.0 million was paid on the credit
facility. The outstanding balance on the credit facility on the date of filing
is $12.0 million.
8. SEGMENT REPORTING
- -- -----------------
The Company operates in two business segments, pharmacy benefit
management ("PBM") and supplemental benefits. The following table represents
financial data by segment for the three and six month periods ended June 30,
2003, and June 30, 2002.
For the three months ended June 30, 2003:
Supplemental
PBM Benefits Total
------------ ------------- ------------
Revenue .................. $ 80,526,505 $ 13,588,275 $ 94,114,780
Segment operating expenses 77,810,698 11,028,509 88,839,207
Segment operating income . 2,715,807 2,559,766 5,275,573
Total assets ............. 109,037,379 17,367,605 126,404,984
Accounts receivable ...... 39,635,462 188,700 39,824,162
Accounts payable ......... 40,638,873 304,566 40,943,439
Operating expenses of the segments exclude $1.5 million in corporate
overhead that was not allocated by management in assessing segment performance
for the three month period ended June 30, 2003.
7
For the three months ended June 30, 2002:
Supplemental
PBM Benefits Total
------------ ------------- ------------
Revenue .................. $ 37,572,648 $ 17,676,031 $ 55,248,679
Segment operating expenses 36,127,666 16,665,613 52,793,279
Segment operating income . 1,444,982 1,010,418 2,455,400
Total assets ............. 75,019,542 9,647,902 84,667,444
Accounts receivable ...... 19,745,173 1,665,158 21,410,331
Accounts payable ......... 16,739,209 165,610 16,904,819
Operating expenses of the segments exclude $869,000 in corporate
overhead that was not allocated by management in assessing segment performance
for the three month period ended June 30, 2002.
For the six months ended June 30, 2003:
Supplemental
PBM Benefits Total
------------ ------------- ------------
Revenue .................. $158,944,636 $ 26,905,005 $ 185,849,641
Segment operating expenses 153,744,728 22,179,716 175,924,444
Segment operating income . 5,199,908 4,725,289 9,925,197
Operating expenses of the segments exclude $3.0 million in corporate
overhead that was not allocated by management in assessing segment performance
for the six month period ended June 30, 2003.
For the six months ended June 30, 2002:
Supplemental
PBM Benefits Total
------------ ------------- -------------
Revenue .................. $ 72,085,598 $ 37,815,336 $ 109,900,934
Segment operating expenses 70,163,292 35,787,632 105,950,924
Segment operating income . 1,922,306 2,027,704 3,950,010
Operating expenses of the segments exclude $1.8 million in corporate
overhead that was not allocated by management in assessing segment performance
for the six month period ended June 30, 2002.
8
9. PROVISION FOR INCOME TAXES
- -- --------------------------
In the three and six month periods ended June 30, 2003, the Company
recorded a provision for income taxes of approximately $1.4 million and $2.6
million, respectively. The effective rate of the tax provision is 38.6%. For the
three and six month periods ended June 30, 2002, the Company recorded no
provision for income taxes, as the Company maintained a full valuation allowance
against the Company's deferred tax assets due to the uncertainty as to their
ultimate realization.
10. NET INCOME PER SHARE
- --- --------------------
Basic net income per share is based on the weighted average number of
shares outstanding during the period. Diluted income per share is computed based
on the weighted average number of shares and dilutive common stock equivalent
shares outstanding during the period.
For the three month period ended June 30, 2003, the dilutive effect
(877,000 shares determined using the treasury stock method) of stock options to
purchase 4.7 million shares of common stock was included in the computation of
diluted earnings per common share because the option exercise price was less
than the average market price of the common shares during the three month
period. The dilutive effect of 2.2 million outstanding common stock options and
warrants for the period ended June 30, 2003 has been excluded from the
computation of diluted net income per share as the effect would be antidilutive.
For the six month period ended June 30, 2003, the dilutive effect
(413,000 shares determined using the treasury stock method) of stock options to
purchase 2.5 million shares of common stock was included in the computation of
diluted earnings per common share because the option exercise price was less
than the average market price of the common shares during the six month period.
The dilutive effect of 4.3 million outstanding common stock options and warrants
for the six month period ended June 30, 2003, has been excluded from the
computation of diluted net income per share as the effect would be antidilutive.
For the three month period ended June 30, 2002, the dilutive effect
(210,000 shares determined using the treasury stock method) of stock options to
purchase 671,000 shares of common stock was included in the computation of
diluted earnings per common share because the option exercise price was less
than the average market price of the common shares during the three month
period. The dilutive effect of 3.9 million outstanding common stock options and
warrants from the period ended June 30, 2002, has been excluded from the
computation of diluted net income per share as the effect would be antidilutive.
For the six month period ended June 30, 2002, the dilutive effect
(209,000 shares determined using the treasury stock method) of stock options to
purchase 601,000 shares of common stock was included in the computation of
diluted earnings per common shares because the option exercise prices were less
than the average market price of the common shares during the six month period.
The dilutive effect of 3.9 million outstanding common stock options and warrants
for the six month period ended June 30, 2002, has been excluded from the
computation of diluted net income per share as the effect would be antidilutive.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- ------ ---------------------------------------------------------------
The following discussion should be read in conjunction with the interim
consolidated financial statements presented in Item 1. Certain statements
contained herein may constitute 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 the future. The
acquisitions of Catalyst and PNNC have contributed significantly to the growth
of our PBM business.
PHARMACY BENEFIT MANAGEMENT
We have established a nationwide network of over 53,000 retail
pharmacies. In general, clients 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. 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, remit the amounts owed to the retail pharmacies pursuant to our
negotiated rates and retain the difference, including claims processing fees.
Pharmacy benefit claim payments from our clients are recorded as
revenues and prescription costs to be paid to pharmacies are recorded as direct
expenses. Under our network contracts, we have an independent obligation to pay
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 processing fees as revenue. Rebates earned under arrangements
with manufacturers are recorded as a reduction of direct expenses. The portion
of manufacturer rebates due to clients is recorded as a reduction of revenue.
Member co-payments are not recorded as revenue. Under our pharmacy
agreements, the pharmacy is solely obligated to collect the co-payments from the
members. Under our client contracts, we do not assume liability for member
co-payments in retail pharmacy transactions. As such, we do not include member
co-payments to retail pharmacies in revenue or operating expenses.
Because the SEC is in the process of reviewing the topic of co-payments
and whether co-payments should or should not be included as a component of
revenues and operating expenses in PBM companies, we are providing certain
supplemental information in the tables below. This information may also assist
investors in comparing PBMs with differing accounting policies related to
co-payments. If the SEC should ultimately decide that co-payments should be
included in reported PBM revenues and operating expenses, it would result in an
increase in reported PBM revenue and operating expenses for the second quarters
of 2003 and 2002 of approximately $33.6 million and $15.9 million,
respectively, and in an increase in reported PBM revenue and operating expenses
for the six month periods ended June 30, 2003 and 2002 of approximately $67.5
million and $30.6 million. Our consolidated statements of operations, which
include operating and net income, and the consolidated balance sheets and
statements of cash flows, would not be affected.
10
The following tables illustrate the effects on the reported PBM revenue
and operating expenses (see Note 8 to these Notes To Financial Statements) if
the Company had included member co-payments:
Three months ended Six months ended
June 30, June 30,
--------------------------- ---------------------------
2002 2003 2002 2003
------------ ----------- ------------ ------------
Reported PBM revenue $ 37,572,648 $ 80,526,505 $ 72,085,598 $158,944,636
Member co-payments ............. 15,876,464 33,649,952 30,611,484 67,546,985
------------ ------------ ------------ ------------
Total ........................ $ 53,449,112 $114,176,457 $102,697,082 $226,491,621
============ ============ ============ ============
Three months ended Six months ended
June 30, June 30,
--------------------------- ---------------------------
Reported PBM
operating expenses ........... $ 36,127,666 $ 77,810,698 $ 70,163,292 $153,744,728
Member co-payments ............. 15,876,464 33,649,952 30,611,484 67,546,985
------------ ------------ ------------ ------------
Total ........................ $ 52,004,130 $111,460,650 $100,774,776 $221,291,713
============ ============ ============ ============
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 supplied by others, including the insurance
components. Payments from the distributors related to new member enrollments
were recorded as revenue to the extent of the related direct expenses through
September 30, 2002. These payments by distributors were discontinued at that
time under restructured marketing agreements.
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.
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 without any
related revenue. The Company believes that current enrollment trends will allow
the minimum future commitments at June 30, 2003, to be fully utilized by current
enrollment levels.
RESULTS OF OPERATIONS
- ---------------------
THREE MONTHS ENDED JUNE 30, 2003, COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
REVENUE. Revenue from operations for the second quarter of 2003, was
$94.1 million, consisting of $80.5 million in revenue associated with the PBM
segment and $13.6 million in revenue attributable to the supplemental benefits
11
segment. PBM segment revenue increased by $42.9 million, including $27.0 million
from PNNC, while the supplemental benefits segment revenue decreased by $4.1
million. Revenue for the second quarter of 2002 was $55.2 million, consisting of
approximately $37.5 million and $17.7 million attributable to the PBM and the
supplemental benefits segments, respectively.
DIRECT EXPENSES. Direct expenses for the three months ended June 30,
2003 were $83.9 million consisting of $73.8 million in direct expenses
associated with the PBM segment and $10.1 million in direct expenses
attributable to supplemental benefits segment. PBM segment direct expenses
increased by $39.0 million, including $24.8 million from PNNC, while the
supplemental benefits segment direct expenses increased by approximately
$300,000. Direct expenses for the second quarter of 2002 were $44.7 million
consisting of approximately $34.9 million and $9.8 million attributable to the
PBM and supplemental benefits segments, respectively. The direct expenses of
$83.9 million and $44.7 million for the three month periods ended June 30,
2003, and June 30, 2002, represented 92.8% and 83.2% of operating expenses for
the respective periods.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses for the three month period ended June 30, 2003 totaled
$6.5 million or 7.2% of operating expenses, $4.0 million of which was related
to the Company's PBM services segment, $970,000 of which was related to the
management of the supplemental benefits segment, while the remaining $1.5
million related to corporate overhead. These expenses include approximately
$454,000 for creative development, product endorsement and market research,
$2.6 million in compensation and benefits, $923,000 in professional fees,
insurance and taxes, $1.2 million in other expenses, $445,000 in facility
costs, $285,000 in travel expenses and $584,000 in depreciation and
amortization. The Company has no direct marketing expense in the second quarter
of 2003, as direct marketing expenses are now paid by the distributor.
Selling, general and administrative expenses for the three month period
ended June 30, 2002 were approximately $9.0 million or 16.8% of total operating
expenses, $1.2 million of which was related to the Company's PBM services
segment, $6.9 million of which related to the management of the supplemental
benefits segment, while the remaining $869,000 related to corporate overhead.
These expenses included approximately $1.1 million for creative development,
product endorsements and market research, $4.3 million in direct marketing, $1.7
million in compensation and benefits, $849,000 in professional fees, insurance
and taxes, $376,000 in facility costs, $196,000 in travel expenses, and $426,000
in depreciation and amortization.
INTEREST EXPENSE, NET. Interest expense, net for the second quarter
2003, was approximately $114,000, compared to approximately $59,700 of interest
expense net for the three month period ended June 30, 2002. This was
principally due to increased borrowings under the line of credit in the fourth
quarter 2002. Interest expense on borrowings for the second quarter of 2003 was
approximately $161,000.
PROVISION FOR INCOME TAXES. Through the third quarter of 2002, the
Company maintained a full valuation allowance against the Company's deferred
tax assets due to the uncertainty as to their ultimate realization. Due to the
recording of the full valuation allowance, no provision for income taxes was
recorded in the second quarter of 2002. As the Company released its valuation
allowance in the fourth quarter of 2002, the Company, using an effective tax
rate of 38.6%, recorded a provision for income taxes of $1.4 million in the
second quarter of 2003. See Note 9 to these Notes To Financial Statements for
further information.
NET INCOME. Net income for the three month period ended June 30, 2003
was $2.2 million compared to $1.5 million for the three month period ended June
30, 2002. The $2.2 net income for the second quarter of 2003 included a $1.4
million provision for income taxes as discussed above. As a percentage revenue,
pre-tax net income increased from 2.8% to 3.9%.
SIX MONTHS ENDED JUNE 30, 2003, COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
REVENUE. Revenue from operations for the six months ended June 30, 2003
was $185.8 million, consisting of $158.9 million in revenue associated with the
PBM segment and $26.9 million in revenue attributable to the supplemental
benefits segment. PBM segment revenue increased by $86.8 million, including
$53.1 million from PNNC, while the supplemental benefits segment revenue
decreased by $10.9 million. Revenue for the first six months of 2002 was $109.9
million consisting of approximately $72.1 million and $37.8 million
attributable to the PBM and the supplemental benefits segments, respectively.
12
DIRECT EXPENSES. Direct expenses for the six months ended June 30, 2003
were $166.3 million, consisting of $146.1 million in direct expenses associated
with the PBM segment and $20.2 million in direct expenses attributable to
supplemental benefits segment. PBM segment direct expenses increased by $79.0
million, including $49.4 million from PNNC, while the supplemental benefits
segment direct expenses decreased by $2.0 million. Direct expenses for the first
six months of 2002 were $89.3 million consisting of approximately $67.1 million
and $22.2 million attributable to the PBM and supplemental benefits segments,
respectively. The direct expenses of $166.3 million and $89.3 million for the
six month periods ended June 30, 2003, and June 30, 2002, represented 93.0% and
82.9% of operating expenses for the respective periods.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses for the six month period ended June 30, 2003, totaled
$12.6 million or 7.0% of operating expenses, $7.6 million of which was related
to the Company's PBM services segment, $2.0 million of which was related to the
management of the supplemental benefits segment, while the remaining $3.0
million related to corporate overhead. These expenses include approximately
$893,000 for creative development, product endorsement and market research, $5.2
million in compensation and benefits, $1.7 million in professional fees,
insurance and taxes, $2.2 million in other expenses, $850,000 in facility costs,
$545,000 in travel expenses and $1.2 million in depreciation and amortization.
The Company has no direct marketing expense in the second quarter of 2003, as
direct marketing expenses are now paid by the distributor.
Selling, general and administrative expenses for the six month period
ended June 30, 2002 were approximately $18.4 million or 17.1% of total operating
expenses, $3.1 million of which was related to the Company's PBM services
segment, $13.5 million of which related to the management of the supplemental
benefits segment, while the remaining $1.8 related to corporate overhead. These
expenses included approximately $2.5 million for creative development, product
endorsements and market research, $8.4 million in direct marketing, $3.8 million
in compensation and benefits, $1.8 million in professional fees, insurance and
taxes, $757,000 in facility costs, $319,000 in travel expenses, and $850,000 in
depreciation and amortization.
INTEREST EXPENSE, NET. Interest expense, net for the six month period
ended June 30, 2003 was approximately $263,000, compared to approximately
$3,600 of interest expense, net for the six month period ended June 30, 2002.
This was principally due to increased borrowings under the line of credit in
the fourth quarter 2002. Interest expense on borrowings for the six month
period ended June 30, 2003 was approximately $345,000.
PROVISION FOR INCOME TAXES. Through the third quarter of 2002, the
Company maintained a full valuation allowance against the Company's deferred
tax assets due to the uncertainty as to their ultimate realization. Due to the
recording of the full valuation allowance, no provision for income taxes was
recorded for six months ended June 30, 2002. As the Company released its
valuation allowance in the fourth quarter of 2002, the Company, using an
effective tax rate of 38.6%, recorded a provision for income taxes of $2.6
million in the first six months of 2003. See Note 9 to these Notes to Financial
Statements for further information.
MINORITY INTEREST. There was no minority interest charge for the six
month period ended June 30, 2003, while the Company recorded a minority interest
charge of approximately $45,000 for the six month period ended June 30, 2002.
The $45,000 change represents the net income attributable to the 20% minority
interest holder of Catalyst for the months of January and February 2002, as the
Company purchased the remaining minority interest on March 1, 2002.
NET INCOME. Net income for the six month period ended June 30, 2003,
was $4.1 million compared to $2.1 million for the six month period ended June
30, 2002. The $4.1 net income for the six months ended June 30, 2003 included a
$2.6 million provision for income taxes as discussed above. As a percentage
revenue, pre-tax net income increased from 1.9% to 3.6%.
13
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and cash equivalents at June 30, 2003, totaled $26.2 million
compared to $24.3 million at June 30, 2002. During the six month period ended
June 30, 2003, the Company generated $13.7 million in cash from operating
activities, paid approximately $118,000 in cash for capital expenditures, repaid
approximately $1.1 million in cash to satisfy the Catalyst acquisition
promissory note and repaid $4.0 million in cash on the revolving credit
facility.
NET CASH PROVIDED BY OPERATING ACTIVITIES. The Company's overall
operating activities generated $13.7 million of net cash from operations during
the first six months of 2003, a $20.1 million increase from the $6.5 million of
net cash utilized in the six month period ended June 30, 2002. The increase is
primarily due to a $4.6 million increase in income before income taxes and the
timing of payments to vendors included in accounts payable, offset somewhat by
the timing of payments from clients included in accounts receivable
NET CASH USED IN INVESTING ACTIVITIES. Net Cash used in investing
activities for the six months ended June 30, 2003, was $1.2 million compared to
$10.3 million for the six months ended June 30, 2002. The decrease is due to a
reduction in capital expenditures and repayments due on the promissory note
regarding the Catalyst acquisition in 2002. As of March 1, 2003, the promissory
note on the Catalyst acquisition was satisfied.
NET CASH FROM FINANCING ACTIVITIES. Net Cash used in financing
activities for the first six months of 2003 was $3.9 million compared to cash
provided by financing activities of $8.0 million in the first six months of
2002. In 2003, the Company made payments totaling $4.0 million on the Company's
outstanding revolving credit facility; while in 2002, the Company arranged for a
line of credit with a financial institution, of which $8.0 million was
outstanding at June 30, 2003.
The Company anticipates continuing to generate positive operating cash
flow, which combined with available cash resources, should be sufficient to meet
our planned working capital, capital expenditures and operating expenses.
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 assured that such financing will be available on
acceptable terms, if at all, or that such financing will not be dilutive to our
stockholders.
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------ ----------------------------------------------------------
(Included in Management's Discussion and Analysis of Financial
Condition and Results of Operations)
ITEM 4. CONTROLS AND PROCEDURES
- ------- -----------------------
GENERAL STATEMENT OF RESPONSIBILITY. The management of the Company is
responsible for the preparation, integrity and objectivity of the Consolidated
Financial Statements and the other information included in this report. The
financial statements have been prepared in conformity with accounting principles
generally accepted in the United States of America and accordingly include
certain amounts that represent management's best estimates and judgments. Actual
amounts could differ from those estimates. Management maintains internal control
systems to assist it in fulfilling its responsibility for financial reporting.
These systems include business, accounting and reporting policies and
procedures, selection of personnel, and segregation of duties.. While no system
can ensure elimination of all errors and irregularities, the Company's systems,
which are reviewed and modified in response to changing conditions, have been
designed to provide reasonable assurance that assets are safeguarded, policies
and procedures are followed, transactions are properly executed and reported and
appropriate disclosures are made. The concept of reasonable assurance is based
on the recognition that there are limitations in all systems of internal
controls and that the costs of such systems should not exceed their benefits.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. As of June 30, 2003,
the Company evaluated the effectiveness of the design and operations of its
disclosure controls and procedures pursuant to Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Based upon the
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
ensuring that information required to be disclosed in the Company's periodic
filings under the Exchange Act is accumulated and communicated to such officers
to allow timely decisions regarding required disclosures. There was no change in
the Company's internal control over financial reporting during the second
quarter of 2003 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- ------ -----------------
In the ordinary course of business, the Company may become subject to
legal proceedings and claims. The Company is not aware of any legal proceedings
or claims which, in the opinion of management, will have a material effect on
the financial condition or results of operations of the Company.
ITEM 2 CHANGES IN SECURITIES
- ------ ---------------------
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ------- -------------------------------
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None
ITEM 5. OTHER INFORMATION
- ------- -----------------
None
15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------ --------------------------------
1. The following exhibits are filed as part of this report unless noted
otherwise:
Exhibit No. Description
--------------------------------------------------------------------------
3.1(a) Certificate of Incorporation of HealthExtras, Inc( 1) 3.1(b)
Form of Amended and Restated Certificate of Incorporation
(1)
3.2 Bylaws of HealthExtras, Inc. (1)
4.1 Specimen Stock Certificate of HealthExtras, Inc. ( 1)
4.2 Form of Stockholders' Agreement (1)
11.1 Computation of Per Share Earnings (Incorporated by reference
in Part I, hereto)
31.0 Certifications pursuant to Rule 13a-14(a)/15d-14(a)
32.0 Certifications pursuant to 18 U.S.C. Section 1350, as Added
By Section 906 of the Sarbanes Oxley Act of 2002.
- --------------
(1) Incorporated herein by reference into this document from the Exhibits to
the Form S-1 Registration Statement, as amended, Registration No.
333-83761, initially filed on July 26, 1999. .
2. Reports on Form 8-K
On April 30, 2003 the Company furnished a Current Report on Form 8-K
announcing the Company's financial results for the quarter ended March 31, 2003.
16
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
HealthExtras, Inc.
Date: August 14, 2003 By: /s/ David T. Blair
-------------------------------
David T. Blair
Chief Executive Officer and Director
Date: August 14, 2003 By: /s/ Michael P. Donovan
-------------------------------
Michael P. Donovan
Chief Financial Officer and
Chief Accounting Officer
17