Implex's Decreasing Monthly Draw

I recently updated my pharmacy revenue projections for May after this week's fantastic announcement of almost $1 million in April revenues. More recently, I provided my opinions on the pharmacy revenue recognition, cash receipts, and the timing of when Scrips receives its financing fee and 97% management fee. I will not rehash those discussions here. Admittedly, however, my projection for SCRC's May fees is possibly a bit high due to the pipeline issues I discussed. That said, I will stand firm on my pharmacy revenue projections and margins.

The purpose of this post is to give more thoughts on the Business Management Agreement, specifically insofar as it relates to the owner's draw. It is no mystery that Scrips has all of the responsibilities for operating and funding the pharmacy (sans the permits and license responsibilities). So it should come as no surprise to anyone that Scrips is entitled to virtually all of the pharmacy's cash receivables (minus the pharmacy's cash expenses and Implex's small monthly draw). Moreover, as discussed below, not only is Scrips entitled to virtually everything, the owner's monthly draw will drop from about 4% of pharmacy revenues to half-percent of those revenues during the first 3 years of the agreement. As an SCRC shareholder, I am proud of our CEO for negotiating such a sweet deal for us!

Implex, which is owned by the acting Scrips general counsel, will receive a monthly draw in connection with its ownership of the pharmacy. Based on the terms of the agreement and certain assumptions stated below, its total annual draw over the first three years of the agreement will be as follows: $842,136 in the first year, $239,588 in the second year, and $120,000 in the third year -- totaling over $1.2 million over the first three years of the agreement for 33,317 scripts. This is slightly over twice the amount of the $550,000 purchase price -- not too shabby of an investment.

Here is how I calculated Implex's draw over the next three years:

Year One (April 1, 2014 to March 1, 2015): $842,136 ($564,036 fixed draw + $278,100 per script draw based on 9,317 scripts)

Year Two (April 1, 2015 to March 1, 2016): $239,588 ($105,928 fixed draw + $133,660 per script draw on 12,000 total scripts - the draw per script decreases from $30 on the first 683 scripts to $10 per script for the remaining scripts for the life of the agreement pursuant to agreement that draw per script decreases to $10 after the pharmacy sells 10,000 scripts; 9,317 scripts from Year One + 683 scripts from Year Two = 10,000 total scripts)

Year Three (April 1, 2016 to March 1, 2017): $120,000 (based only on the per script draw on 12,000 scripts, no fixed draw after Year Two)

Assumptions: (1) $2,100 received per script based on industry DD; (2) monthly script increases by at least 15% each month (I am confident it will be much more); and (3) number of monthly scripts peak at 1,000. I understand from one of our core investors that one pharmacist can safely fill between 50 and 100 scripts each day. I fully expect the pharmacy to exceed 1,000 monthly scripts; I also expect the pharmacy to add pharmacist as Scrips' management team continues to build out this business.

It is interesting that the owner's draw actually decreases over the next three years, while the amount of monthly fees paid to Scrips increases over the same period . So this is great news for SCRC investors! Based on the current revenue growth and anticipated high margins, it is clear to me that Scrips received the much better end of the stick:

Year One - Pharmacy revenues about $19,559,400 (9,317 X $2,100 per script), Scrips annual fees about $9,779,700 (maybe slightly less due to previously-discussed pipeline issues), and Implex's annual draw $842,136 (4.3% of pharmacy revenues versus Scrips' 50%).

Year Two - Pharmacy revenues about $25,200,000, Scrips' annual fees increase 35% to about $13,202,548, and Implex's annual draw decreases about 72% to $239,588 (0.95% of pharmacy revenues). Notably, Implex's $602,548 lower monthly fee over Year One results in additional increase in Scrips' annual fees.

Year Three - Pharmacy revenues remain $25,200,000, Scrips' annual fees about $13,322,136, and Implex's annual draw is halved to $120,000 (0.5% of the pharmacy revenues). Per my assumptions conservatively capping the monthly scripts to 1,000, the slight annual increase in Scrips's fees is solely the result of Implex's $119,588 lower monthly fee over Year Two.

I realize the pharmacy revenues will be higher than the numbers expressed in my "Year Two" and "Year Three" examples, but the main point here is my focus on Implex's draw, the disparity between the cash it receives under the agreement compared to the amount Scrips receives, and how its impact on the pharmacy's margins become growingly insignificant (i.e., decrease in impact from 4.3% to about a half-percent in 3 years).

The above discussion, in my humble opinion, clearly demonstrates Scrips had significant leverage when negotiating this agreement. There are many sections within the agreement that weigh in favor of Scrips. For example, the term of the agreement is five years, a very long duration for a "management agreement" with a startup company in the red. Further, per the termination section, the only events that could lead to an early termination during those five years are in Scrips' exclusive control. To prevent termination, Scrips must only stay away from bankruptcy or some other form of default and not breach the agreement. Even so, they still would have 30 days after receiving notice of a termination event to fix the problem.

Moreover, so long as Scrips is not in default at the end of the five-year term, it has the sole and exclusive right to extend the term for another five years, thus creating a 10-year term! This is an airtight agreement, from which Implex has no legal termination rights other than what I have expressed. In a nutshell, while Scrips receives virtually all of the pharmacy's cash receivables, Implex will be on the hook for the next ten years (perhaps that it will more than double its original investment in the pharmacy in the first 3 years and receive at least $120K of "mailbox money" each year thereafter for the next 7 years, Implex is quite satisfied and believes this to be a win-win deal). With the early indications of parabolic growth, this alone should give all of the loyal and longterm shareholders over one million reasons to celebrate - executing this deal was a huge win for us!

Thoughts?

Bsav88atty (I was not paid for this post, nor have I ever been previously paid for any post that I have ever made on any stock message board for any stock, but of course I am long with a hefty amount of SCRC purchased with my hard-earned money)


For the language of the agreement relevant to my discussion, see the excerpts on Owner Draws, Term, and Termination pasted below.

OWNER’S DRAWS . (a) Implex shall be entitled to draw certain amounts, each month, commencing April 1, 2014 and continuing for the term of this Agreement, which amounts shall either be paid over to Implex or paid to such persons and/or entities as Implex may direct. Such amounts shall be an Allowable Deduction for purposes of calculating the Management Fee payable to Scrips pursuant to Paragraph 7 following.

(b) Commencing April 1, 2014 and continuing to, and including, March 1, 2015, Implex shall be entitled to a monthly draw calculated as the total of (i) $26,654.44, (ii) $7,160.64, (iii) $13,187.88 and (iv) a sum calculated as $30 per prescription processed by the Pharmacy during the preceding month, except that the payment for April 1, 2014 shall include all prescriptions processed since the First Closing by Implex.

(c) Commencing April 1, 2015 and continuing to, and including, March 1, 2016, Implex shall be entitled to a monthly draw calculated as the total of (i) $7,160.64, (ii) $ 1,666.66 and (iii), subject to sub-paragraph (e) following, a sum calculated as $30 per prescription processed by the Pharmacy during the preceding month.

(d) Commencing April 1, 2016 and continuing thereafter, Implex shall be entitled to a monthly draw calculated as $30 per prescription processed by the Pharmacy during the preceding month.

(e) At such time as the Pharmacy shall have processed 10,000 prescriptions, the sum to be paid shall be reduced, commencing with the 10,001st prescription, to $10 per prescription instead of $30.


TERM . (a) The initial term of this Agreement shall be from February 7, 2014 to January 31, 2019, unless sooner terminated pursuant to Paragraph 9 below.

(b) If, at September 30, 2018 this Agreement is still in effect, and Scrips is not in default under this Agreement, then Scrips shall have the option to continue this Agreement and relationship for a further term of five (5) years; i.e., from February 1, 2019 to January 31, 2024.


TERMINATION . This Agreement may be terminated by any of the parties as follows:

(a) Upon failure of the other party to cure a default under, or a breach of, this agreement within thirty (30) days after written notice is given as to such default or breach by the terminating party;

(b) Upon the bankruptcy or liquidation of the terminated party; whether voluntary or involuntary;

(c) Upon the terminated party taking the benefit of any insolvency law; and/or

(d) Upon the terminated party having, or applying to have, a receiver appointed for all or a substantial part of such party's assets or business.

Link to the "Business Management Agreement" here - http://www.sec.gov/Archives/edgar/data/152147...ex1024.htm