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SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004
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 000-25769
ACCREDO HEALTH, INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE | 62-1642871 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1640 CENTURY CENTER PKWY, SUITE 101, MEMPHIS, TN 38134
(Address of principal executive offices)
(Zip Code)
(901) 385-3688
(Registrant’s telephone number, including area code)
NO CHANGE
(Former name, former address and former fiscal year,
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 [ ]
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APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
CLASS | OUTSTANDING AT October 29, 2004 | |||
COMMON STOCK, $0.01 PAR VALUE | 48,882,186 | |||
TOTAL COMMON STOCK | 48,882,186 | |||
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ACCREDO HEALTH, INCORPORATED
INDEX
Note: Items 1, 2, 3, 4 and 5 of Part II are omitted because they are not applicable.
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PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ACCREDO HEALTH, INCORPORATED
Three | ||||||||
Months Ended September 30, | ||||||||
2004 | 2003 | |||||||
Net patient revenue | $ | 410,464 | $ | 326,039 | ||||
Other revenue | 8,665 | 8,397 | ||||||
Equity in net income of joint ventures | 605 | 548 | ||||||
Total revenues | 419,734 | 334,984 | ||||||
Cost of sales | 342,491 | 258,897 | ||||||
Gross profit | 77,243 | 76,087 | ||||||
General & administrative | 35,983 | 34,552 | ||||||
Bad debts | 5,600 | 7,174 | ||||||
Depreciation and amortization | 3,839 | 2,955 | ||||||
Income from operations | 31,821 | 31,406 | ||||||
Interest expense, net | (7,281 | ) | (2,276 | ) | ||||
Minority interest in income of consolidated joint venture | (207 | ) | (482 | ) | ||||
Income before income taxes | 24,333 | 28,648 | ||||||
Provision for income taxes | 9,296 | 11,140 | ||||||
Net income | $ | 15,037 | $ | 17,508 | ||||
Cash dividends declared on common stock | $ | — | $ | — | ||||
Net income per common share: | ||||||||
Basic | $ | 0.31 | $ | 0.37 | ||||
Diluted | $ | 0.31 | $ | 0.36 | ||||
Weighted average shares outstanding: | ||||||||
Basic | 48,653,474 | 47,848,126 | ||||||
Diluted | 49,093,243 | 48,554,127 |
See accompanying notes to condensed consolidated financial statements.
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ACCREDO HEALTH, INCORPORATED
(Unaudited) | ||||||||
September 30, | June 30, | |||||||
2004 | 2004 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 81,596 | $ | 42,743 | ||||
Patient accounts receivable, less allowance for doubtful accounts of $83,167 at September 30, 2004 and $81,051 at June 30, 2004 | 346,084 | 325,642 | ||||||
Due from affiliates | 3,616 | 4,191 | ||||||
Other accounts receivable | 26,053 | 28,584 | ||||||
Inventories | 145,542 | 128,323 | ||||||
Prepaids and other current assets | 6,441 | 5,084 | ||||||
Income taxes receivable | — | 382 | ||||||
Deferred income taxes | 13,829 | 14,129 | ||||||
Total current assets | 623,161 | 549,078 | ||||||
Property and equipment, net | 42,535 | 41,283 | ||||||
Other assets: | ||||||||
Joint venture investments | 7,688 | 7,713 | ||||||
Goodwill, net | 550,289 | 382,628 | ||||||
Other intangible assets, net | 20,522 | 17,480 | ||||||
Total assets | $ | 1,244,195 | $ | 998,182 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 198,005 | $ | 164,780 | ||||
Accrued expenses | 17,874 | 22,625 | ||||||
Due to affiliates | 546 | 654 | ||||||
Income taxes payable | 3,552 | — | ||||||
Current portion of long-term debt | 4,453 | 4,445 | ||||||
Total current liabilities | 224,430 | 192,504 | ||||||
Long-term debt | 370,312 | 174,866 | ||||||
Deferred income taxes | 25,801 | 25,112 | ||||||
Minority interest in consolidated joint venture | 3,364 | 3,757 | ||||||
Commitments | — | — | ||||||
Stockholders’ equity: | ||||||||
Undesignated preferred stock, 5,000,000 shares authorized, no shares issued | — | — | ||||||
Common stock, $.01 par value; 100,000,000 shares authorized; 48,878,169 and 48,603,341 shares issued and outstanding at September 30, 2004 and June 30, 2004, respectively | 489 | 486 | ||||||
Additional paid-in capital | 439,334 | 436,021 | ||||||
Accumulated other comprehensive income | — | 8 | ||||||
Retained earnings | 180,465 | 165,428 | ||||||
Total stockholders’ equity | 620,288 | 601,943 | ||||||
Total liabilities and stockholders’ equity | $ | 1,244,195 | $ | 998,182 | ||||
See accompanying notes to condensed consolidated financial statements.
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ACCREDO HEALTH, INCORPORATED
Three Months Ended | ||||||||
September 30, | ||||||||
2004 | 2003 | |||||||
OPERATING ACTIVITIES: | ||||||||
Net income | $ | 15,037 | $ | 17,508 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 4,575 | 3,869 | ||||||
Write-off of unamortized debt issuance costs | 4,422 | — | ||||||
Provision for losses on accounts receivable | 5,600 | 7,174 | ||||||
Deferred income taxes | 1,006 | 3,720 | ||||||
Tax benefit of exercise of stock options | 480 | 148 | ||||||
Undistributed earnings of joint ventures | 26 | (368 | ) | |||||
Minority interest in income of consolidated joint venture | 207 | 482 | ||||||
Changes in operating assets and liabilities, net of effect from business acquisitions: | ||||||||
Patient receivables and other | (7,913 | ) | (9,717 | ) | ||||
Due from affiliates | 466 | (375 | ) | |||||
Inventories | (7,550 | ) | (4,315 | ) | ||||
Prepaids and other current assets | (1,101 | ) | (559 | ) | ||||
Accounts payable and accrued expenses | 16,270 | (17,366 | ) | |||||
Income taxes payable | 5,793 | 7,255 | ||||||
Net cash provided by operating activities | 37,318 | 7,456 | ||||||
INVESTING ACTIVITIES: | ||||||||
Purchases of property and equipment | (3,942 | ) | (1,850 | ) | ||||
Business acquisitions and joint venture investments | (187,158 | ) | (44 | ) | ||||
Net cash used in investing activities | (191,100 | ) | (1,894 | ) | ||||
FINANCING ACTIVITIES: | ||||||||
Proceeds from notes payable | 375,000 | — | ||||||
Principal payments on notes payable | (179,546 | ) | (4,062 | ) | ||||
Payment of debt issuance costs | (5,055 | ) | — | |||||
Issuance of common stock | 2,836 | 415 | ||||||
Distributions to minority interest partner | (600 | ) | (800 | ) | ||||
Net cash provided by (used in) financing activities | 192,635 | (4,447 | ) | |||||
Increase in cash and cash equivalents | 38,853 | 1,115 | ||||||
Cash and cash equivalents at beginning of period | 42,743 | 48,006 | ||||||
Cash and cash equivalents at end of period | $ | 81,596 | $ | 49,121 | ||||
See accompanying notes to condensed consolidated financial statements.
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ACCREDO HEALTH, INCORPORATED
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the condensed consolidated financial position, results of operations and cash flows of Accredo Health, Incorporated ( the “Company” or “Accredo” ) have been included. Operating results for the three-month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 2005.
The balance sheet at June 30, 2004, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2004.
2. STOCKHOLDERS’ EQUITY
During the quarter, employees and directors exercised stock options to acquire 274,828 shares of Accredo common stock at a weighted average exercise price of $10.32 per share.
3. PRO FORMA NET INCOME EFFECT OF COMPANY STOCK OPTION PLANS
The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Pro forma information regarding net income is required by Statement of Financial Accounting Standards No. 123 (“Statement 123”) and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. Significant assumptions used by the Company in the Black-Scholes option pricing model computations are as follows for the quarters ended September 30:
2004 | 2003 | |||||||
Weighted avg. risk-free interest rate | 3.22 | % | 2.91 | % | ||||
Dividend yield | 0 | % | 0 | % | ||||
Volatility factor | .635 | .660 | ||||||
Weighted-average expected life | 4.0 years | 4.0 years | ||||||
Estimated turnover | 8 | % | 8 | % |
The Black-Scholes option model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
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For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the three-month periods ended September 30 is as follows (in thousands, except share data):
Three Months Ended | ||||||||
September 30, | ||||||||
2004 | 2003 | |||||||
Net income, as reported | $ | 15,037 | $ | 17,508 | ||||
Less stock-based employee compensation cost, net of related tax effects, applying the fair value method to all awards | (2,839 | ) | (2,208 | ) | ||||
Pro forma net income | $ | 12,198 | $ | 15,300 | ||||
Earnings per share: | ||||||||
Basic – as reported | $ | 0.31 | $ | 0.37 | ||||
Basic – pro forma | $ | 0.25 | $ | 0.32 | ||||
Diluted – as reported | $ | 0.31 | $ | 0.36 | ||||
Diluted – pro forma | $ | 0.25 | $ | 0.32 |
4. COMPREHENSIVE INCOME
Comprehensive income includes changes in the fair value of certain derivative financial instruments that qualify for hedge accounting. Comprehensive income for all periods presented is as follows:
Three Months Ended | ||||||||
September 30, | ||||||||
2004 | 2003 | |||||||
Reported net income | $ | 15,037 | $ | 17,508 | ||||
Unrealized income (loss) on interest rate swap contracts, net of tax benefit | (8 | ) | 68 | |||||
Comprehensive income | $ | 15,029 | $ | 17,576 | ||||
The adjustments made in computing comprehensive income are reflected as a component of stockholders equity under the heading “accumulated other comprehensive income”.
5. ACQUISITIONS
On July 21, 2004, the Company acquired all of the outstanding stock of HRA Holding Corporation and its wholly owned subsidiary, Hemophilia Resources of America, Inc (HRA). HRA specializes in providing pharmaceuticals, therapeutic supplies and disease management services for people with hemophilia and related bleeding disorders. The acquisition of HRA increased the Company’s market leading position in the distribution of hemophilia related products. The aggregate purchase price paid for this acquisition, inclusive of transaction costs and related expenses, was approximately $165.8 million and was funded by the Company’s increased credit facility. This transaction was accounted for using the purchase method of accounting. Total assets acquired and liabilities assumed were $24.0 million and $6.6 million, respectively. The excess of the purchase price, including acquisition costs of approximately $0.3 million, over the fair value of the net assets acquired of $17.4 million was allocated as follows: $145.1 million to goodwill and $2.5 million related to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The Company also paid $0.8 million as consideration for an agreement with a selling shareholder not to compete with the Company for a period of ten years. The transition and integration of HRA business activities commenced during the September 2004 quarter and will continue throughout the remainder of fiscal 2005. The results of HRA have been included in the consolidated financial statements since July 21, 2004.
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On July 1, 2004, the Company acquired all of the outstanding stock of Home Health Care Resources, Inc. (HHCR). HHCR specializes in providing pharmaceuticals, therapeutic supplies and disease management services for people with autoimmune disorders and hemophilia. The aggregate purchase price paid for this acquisition, inclusive of transaction costs and related expenses, was approximately $26.8 million. In addition, HHCR may be paid additional consideration amounting to $3 million related to an earn-out payment based on the achievement of certain financial results for the six months ended December 31, 2004. This transaction was accounted for using the purchase method of accounting. Total assets acquired and liabilities assumed were $4.3 million and $0.8 million, respectively. The excess of the purchase price over the fair value of the net assets acquired of $3.5 million was allocated as follows: $22.7 million to goodwill and $0.3 million related to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The Company also paid $0.3 million as consideration for an agreement with the selling shareholders not to compete with the Company for a period of ten years. The results of HHCR have been included in the consolidated financial statements since July 1, 2004.
6. CONTINGENCIES
The Company, David D. Stevens and Joel R. Kimbrough are named as defendants in a putative class action lawsuit filed in the United States District Court for the Western District of Tennessee, Memphis Division. A Consolidated Amended Complaint was filed on September 15, 2004. Defendants filed a Motion to Dismiss the Consolidated Amended Complaint on November 1, 2004. The lawsuit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)(5) promulgated thereunder, and Section 20 of the Securities Exchange Act of 1934. The putative class representatives seek to represent a class of individuals and entities that purchased Company stock during the period June 16, 2002 through April 7, 2003 and who supposedly suffered damages from the alleged violations of the securities laws. The Company believes that the claims asserted in the putative class action lawsuits are without merit.
In addition, two purported derivative lawsuits were filed in the Circuit Court of Shelby County, Tennessee for the Thirtieth Judicial District at Memphis. These actions were consolidated and a Consolidated Derivative Complaint was filed on July 28, 2003. The derivative action names certain current and former Company officers and directors (David D. Stevens, John R. Grow, Kyle J. Callahan, Kevin L. Roberg, Kenneth R. Masterson, Kenneth J. Melkus, Dick R. Gourley, Nancy-Ann Deparle, Joel R. Kimbrough, Thomas W. Bell, Jr., and Patrick J. Welsh) as defendants. The derivative lawsuit alleges that the defendants breached fiduciary duties owed to the Company by engaging in the same alleged conduct that is the basis of the putative class action lawsuits. On behalf of the Company, the derivative complaint seeks compensatory damages from the defendants and the disgorgement of profits, benefits and other compensation received by the defendants. The Company has filed a motion to dismiss the Consolidated Derivative Complaint and the parties are awaiting the Court’s ruling on this motion. The Company believes that the claims asserted in the derivative lawsuit are without merit.
The Company and the Company’s 80% owned joint venture in California provided contract pharmacy and related billing services to a local California pharmacy currently under audit by the California Department of Health Services concerning its MediCal billing for clotting factor supplied to the pharmacy by the Company or the Company’s joint venture. Although the joint venture is not currently involved with the audits, the contract pharmacy relationship is implicated and the pharmacy is seeking indemnification from the joint venture. Pending completion of the audit, the state agency has temporarily withheld MediCal payments from the pharmacy and has alleged, among other things, overbilling and false claims. Although the Company believes these allegations are without merit and expects the pharmacy and the joint venture to vigorously defend against these allegations through judicial proceedings if necessary, the Company also expects the California state agency to pursue a refund of some or all of the payments made by MediCal to the pharmacy. If state or federal false claim statutes are implicated, the pharmacy could also be assessed fines and penalties. At this time, the Company does not believe that it will incur any such fines or penalties. Due to the uncertainty about the issues involved in this matter, based on the facts and circumstances known to date, the Company believes some amount of monetary loss is reasonably possible in the range of zero to $20 million, absent any finding of false claims and incurrence of related fines and penalties.
The Company and the Company’s 80% owned joint venture in California also provided contract pharmacy and related billing services to a second local California pharmacy. The California Department of Health Services is also auditing this pharmacy. The Company has recently received a letter from the Department asking for information in connection with the audit. The Company anticipates that this audit will involve issues that are the same as or similar to those involved in the audit described in the preceding paragraph. The Company is in the process of gathering information responsive to the Department’s letter and cannot determine at this time whether it will incur any liability associated with this audit.
Also, from time to time, the Company is involved in lawsuits, claims, audits, and investigations arising in the normal course of business. In the Company’s opinion, in the aggregate these lawsuits, claims, audits and investigations should not have a material adverse effect on the Company’s business, financial condition, or results of operations. In addition, the business that the Company acquired from Gentiva Health Services, Inc. has several lawsuits and claims related to its historical operations by
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Gentiva, which are being controlled by Gentiva and for which the Company is entitled to indemnification from liability by Gentiva.
7. EARNINGS PER SHARE
The Company presents earnings per share in accordance with SFAS No. 128,Earnings Per Share. All per share amounts have been calculated using the weighted average number of shares outstanding during each period. Diluted earnings per share are adjusted for the impact of common stock equivalents using the treasury stock method when the effect is dilutive. A reconciliation of the basic and diluted weighted average shares outstanding is as follows at September 30:
2004 | 2003 | |||||||
Weighted average number of common shares outstanding used as the denominator in the basic earnings per share calculation | 48,653,474 | 47,848,126 | ||||||
Additional shares assuming exercise of dilutive stock options | 439,769 | 706,001 | ||||||
Weighted average number of common and equivalent shares used as the denominator in the diluted earnings per share calculation | 49,093,243 | 48,554,127 | ||||||
8. SUBSEQUENT EVENT
In an announcement dated October 29, 2004, CMS retroactively adjusted the reimbursement rate for Remodulin® in a manner that increases the Company’s reimbursement for Remodulin® sales January 1, 2004 and thereafter. Since January 1, 2004, the Company recorded revenues associated with sales of certain Remodulin ® vial sizes at Medicare’s reduced level of reimbursement. As a result of the retroactive price adjustment from CMS, the Company recorded the cumulative effect of this adjustment in the quarter ended September 30, 2004. This adjustment resulted in additional net patient revenue of approximately $3.6 million during the quarter ended September 30, 2004. Of the $3.6 million in cumulative additional net patient revenue recorded in the September 2004 quarter, approximately $2.3 million related to Remodulin® dispensed during the six month period ended June 30, 2004.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
FORWARD LOOKING STATEMENTS
Some of the information in this quarterly report contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “intend,” “estimate” and “continue” or similar words. You should read statements that contain these words carefully for the following reasons:
• | the statements discuss our future expectations; | |||
• | the statements contain projections of our future earnings or of our financial condition; and | |||
• | the statements state other “forward-looking” information. |
Specifically, this report contains, among others, forward-looking statements about:
• | our expectations regarding our product mix for periods following September 30, 2004; | |||
• | our expectations regarding our payor mix for periods following September 30, 2004; | |||
• | our expectations regarding the transfer of patients to us pursuant to our strategic alliance with Medco Health Solutions, Inc. following September 30, 2004; | |||
• | our expectations regarding the scope and cost of our capital expenditures following September 30, 2004; | |||
• | our sources and availability of funds to satisfy our working capital needs; | |||
• | the implementation or interpretation of current or future regulations and legislation relating to the industry in which we operate; | |||
• | our critical accounting policies; and | |||
• | our expectations regarding the percentage of our revenues attributable to federal and state programs. |
The forward-looking statements contained in this report reflect our current views about future events, are based on assumptions, and are subject to known and unknown risks and uncertainties. Many important factors could cause our actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict. Important factors that could cause actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements include, among other things, the factors discussed in Part I, Item 2 of this report under the sub-heading “Risk Factors.”
You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we currently expect or anticipate. You should be aware that the occurrence of any of the events described in the risk factors discussed elsewhere in this quarterly report and other events that we have not predicted or assessed could have a material adverse effect on our earnings, financial condition and business. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.
The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.
We qualify all of our forward-looking statements by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
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OVERVIEW
For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this report. This management’s discussion and analysis should also be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Form 10-K for the fiscal year ended June 30, 2004.
We provide specialty retail pharmacy services for the treatment of patients with costly, chronic diseases. We derive revenues primarily from the retail sale of drugs to patients. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The following table presents the percentage of our total revenues generated from sales with respect to the diseases that we primarily serve:
Three Months Ended September 30, | ||||||||
2004 | 2003 | |||||||
Hemophilia, Autoimmune Disorders and Primary Immunodeficiency Diseases (PID) | 38 | % | 40 | % | ||||
Pulmonary Arterial Hypertension (PAH) | 17 | % | 17 | % | ||||
Multiple Sclerosis | 17 | % | 15 | % | ||||
Growth Hormone-Related Disorders | 10 | % | 8 | % | ||||
Gaucher Disease | 7 | % | 10 | % | ||||
Respiratory Syncytial Virus (RSV) | — | % | — | % |
We anticipate that our revenue mix for the second and third quarters of our fiscal year 2005 will change as a result of revenues from the seasonal drug Synagis® for the treatment of RSV. In addition, we anticipate an increase in revenues associated with multiple sclerosis and growth hormone-related disorders in our fiscal year ended June 30, 2005, as compared to our fiscal year ended June 30, 2004, due to our expanded relationship with Medco Health Solutions, Inc. (Medco).
Reimbursement for the products we sell comes from governmental payors, Medicare and Medicaid, and non-governmental payors. The following table presents the percentage of our total revenues reimbursed by these payors:
Year Ended | Year Ended | Three Months Ended | ||||||||||
June 30, 2003 | June 30, 2004 | September 30, 2004 | ||||||||||
Non-governmental | 73 | % | 72 | % | 72 | % | ||||||
Governmental: | ||||||||||||
Medicaid | 20 | % | 21 | % | 20 | % | ||||||
Medicare | 7 | % | 7 | % | 8 | % |
We anticipate that our payor mix for the remainder of our fiscal year 2005 will be similar to the payor mix achieved in fiscal 2004 and the three months ended September 30, 2004. The increase in the percentage of revenues from Medicare in the three months ended September 30, 2004, resulted from the retroactive rate increase for Remodulin® that was recorded on a cumulative basis during that period.
ACQUISITIONS
On July 21, 2004, we acquired all of the outstanding stock of HRA Holding Corporation and its wholly owned subsidiary, Hemophilia Resources of America, Inc (HRA). HRA specializes in providing pharmaceuticals, therapeutic supplies and disease management services for people with hemophilia and related bleeding disorders. The acquisition of HRA increased our market leading position in the distribution of hemophilia related products. The aggregate purchase price paid for this acquisition, inclusive of transaction costs and related expenses, was approximately $165.8 million and was funded by the Company’s increased credit facility. This transaction was accounted for using the purchase method of accounting. Total assets acquired and liabilities assumed were $24.0 million and $6.6 million, respectively. The excess of the purchase price, including acquisition costs of approximately $0.3 million, over the fair value of the net assets acquired of $17.4 million was allocated as follows: $145.1 million to goodwill and $2.5 million related to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The Company also paid $0.8 million as consideration for an agreement with a selling shareholder not to compete with the Company for a period of ten years. The transition and integration of HRA business activities commenced during the September 2004 quarter and will continue throughout the remainder of fiscal 2005. The results of HRA have been included in the consolidated financial statements since July 21, 2004.
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On July 1, 2004, the Company acquired all of the outstanding stock of Home Health Care Resources, Inc. (HHCR). HHCR specializes in providing pharmaceuticals, therapeutic supplies and disease management services for people with autoimmune disorders and hemophilia. The aggregate purchase price paid for this acquisition, inclusive of transaction costs and related expenses, was approximately $26.8 million. In addition, HHCR may be paid additional consideration amounting to $3 million related to an earn-out payment based on the achievement of certain financial results for the six months ended December 31, 2004. This transaction was accounted for using the purchase method of accounting. Total assets acquired and liabilities assumed were $4.3 million and $0.8 million, respectively. The excess of the purchase price over the fair value of the net assets acquired of $3.5 million was allocated as follows: $22.7 million to goodwill and $0.3 million related to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The Company also paid $0.3 million as consideration for an agreement with the selling shareholders not to compete with the Company for a period of ten years. The results of HHCR have been included in the consolidated financial statements since July 1, 2004.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003
Revenues.Total revenues increased 25% from $335.0 million to $419.7 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. Net patient revenues increased 26% from $326.0 million to $410.5 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. The increase is primarily due to volume growth in our products for the treatment of hemophilia, multiple sclerosis, growth hormone disorders, pulmonary arterial hypertension and autoimmune disorders. This growth resulted from the addition of new patients and additional sales of product to existing patients, our expanded relationship with Medco and the acquisitions that occurred during the September 2004 quarter. The initial transfer of patients from Medco began in May 2004 and was substantially complete as of September 30, 2004. In addition, the Company experienced significant revenue growth quarter over quarter from its new product lines that launched at various times since April 2003. We also benefited from the addition of new and expanded contracts with managed care organizations.
In an announcement dated October 29, 2004 CMS retroactively adjusted the reimbursement rate for Remodulin® in a manner that increases the Company’s reimbursement for Remodulin® sales January 1, 2004 and thereafter. Since January 1, 2004, we recorded revenues associated with certain vial concentration sizes of Remodulin® at Medicare’s reduced level of reimbursement. As a result of the retroactive price adjustment from CMS and in accordance with generally accepted accounting principles, we recorded the cumulative effect of this adjustment in the quarter ended September 30, 2004. This adjustment resulted in additional net patient revenue of approximately $3.6 million during the quarter ended September 30, 2004. Of the $3.6 million in cumulative additional net patient revenue recorded in the September 2004 quarter, approximately $2.3 million related to Remodulin® dispensed during the six month period ended June 30, 2004.
Cost of Services.Cost of services increased 32% from $258.9 million to $342.5 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. As a percentage of revenues, cost of services increased from 77.3% to 81.6% from the three months ended September 30, 2003 to the three months ended September 30, 2004, resulting in gross margins of 22.7% and 18.4% for the three months ended September 30, 2003 and 2004, respectively. The decrease in gross profit margins resulted from the expected decrease in government and commercial payor reimbursement levels, primarily in the PAH and IVIG product lines. In addition, the full-quarter impact of the reduced reimbursement levels for hemophilia products from MediCal was experienced in the September 2004 quarter. The MediCal changes were effective June 1, 2004. The Company’s margin profile also changed in the September 2004 quarter as a result of a change in product mix, resulting in part from the expanded relationship from Medco. The primary change in product mix was an increase in the percentage of total revenues from products for the treatment of multiple sclerosis and growth hormone deficiencies, and a decrease in the percentage of total revenues from products for the treatment of hemophilia, Gaucher’s disease and autoimmune disorders.
General and Administrative.General and administrative expenses increased from $34.6 million to $36.0 million, or 4%, from the three months ended September 30, 2003 to the three months ended September 30, 2004. As a percentage of revenues, general and administrative expenses decreased from 10.3% to 8.6% from the three months ended September 30, 2003 to the three months ended September 30, 2004. The increase on an absolute value basis is primarily due to start up costs related to the upcoming Synagis® season and increases in other general and administrative items such as rent, marketing and information technology costs. In addition, we experienced increased salaries and benefits and related costs associated with the expansion of our reimbursement, sales and marketing, administrative and support staffs. These increases were partially offset by decreases in professional fees (principally audit fees) and insurance costs.
Bad Debts.Bad debts decreased from $7.2 million to $5.6 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. As a percentage of revenues, bad debt expense was 2.1% for three months
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ended September 30, 2003 and 1.3% for the three months ended September 30, 2004. The decrease is primarily related to an increase in the mix of products that were reimbursed by third-party payors pursuant to prescription drug benefits as compared to major medical benefits in the September 2004 quarter as compared to the September 2003 quarter. In addition, all of the claims associated with the expanded relationship with Medco are pre-adjudicated by Medco. Therefore, the revenue stream associated with these claims has little, if any, bad debt expense associated with it.
Depreciation and Amortization.Depreciation expense increased from $1.8 million to $2.6 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. This increase resulted from the purchase of property and equipment, and principally included information technology assets associated with improving our infrastructure and sustaining our revenue growth. In addition, the increase resulted from additional leasehold improvements related to expanded space needs associated with our revenue growth. Amortization expense was $1.1 million in the three months ended September 30, 2003 and $1.2 million in the three months ended September 30, 2004. The increase is primarily attributable to the amortization of certain intangible assets associated with the acquisition of HRA in the September 2004 quarter.
Interest Income/Expense, Net.Interest expense, net increased from $2.3 million to $7.3 million from the three months ended September 30, 2003 to the three months ended September 30, 2004. Current quarter interest expense (net) includes the write-off of approximately $4.4 million in unamortized debt issuance costs associated with the replacement and expansion of our senior credit facility. Upon the closing of the expanded facility (now at $550 million capacity), the Company increased its borrowings to $375.0 million. The borrowings were primarily used to fund the acquisition of HRA that occurred during the September 2004 quarter. Amounts borrowed under the previous senior credit facility were approximately $178.4 million at June 30, 2004. Interest rates on outstanding borrowings were 3.36% as of September 30, 2004, as compared to a weighted average rate of 3.70% as of September 30, 2003.
Income Tax Expense.Our effective tax rate decreased from 38.9% to 38.2% from the three months ended September 30, 2003 to the three months ended September 30, 2004. The decrease in the effective tax rate for the period is primarily due to a larger percentage of our income being derived from subsidiaries that are not taxable in certain states. The difference between the recognized effective tax rate and the statutory rate is primarily attributed to state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2004, working capital was $398.7 million, cash and cash equivalents were $81.6 million and the current ratio was 2.8 to 1.0.
Net cash provided by operating activities was $37.3 million for the three months ended September 30, 2004. During the three months ended September 30, 2004, accounts receivable increased $2.3 million, inventories increased $7.6 million and accounts payable, accrued expenses and income taxes payable increased $22.1 million. These changes are due primarily to our revenue growth and the timing of the collection of receivables (including a favorable impact resulting from the expanded Medco relationship), inventory purchases and payments of accounts payable, accrued expenses, and tax obligations.
Net cash used in investing activities was $191.1 million for the three months ended September 30, 2004. Cash used in investing activities consisted primarily of the acquisitions of HRA and HHCR during the September 2004 quarter. In addition, we purchased $3.9 million of property and equipment during the three months ended September 30, 2004.
Net cash provided by financing activities was $192.6 million for the three months ended September 30, 2004. This consisted of $375.0 million in proceeds from the Term B portion of the Company’s expanded senior credit facility which closed during the September 2004 quarter. Principal repayments on the Company’s previous senior credit facility and other borrowings were $179.5 million. In addition, we paid approximately $5.1 million in debt issuance costs associated with our new credit facility. For the three months ended September 30, 2004, net proceeds from stock option exercises amounted to $2.8 million and distributions to our minority interest partner were $0.6 million.
Historically, we have funded our operations and continued internal growth through cash provided by operations. Capital expenditures amounted to $19.7 million in fiscal year 2004 and $16.0 million in fiscal year 2003. We anticipate that our capital expenditures for the fiscal year ending June 30, 2005 will consist primarily of additional computer hardware, including installation of a second data center, enhancements to our fully integrated pharmacy and reimbursement software system and costs to build out and furnish additional space needed to meet our anticipated growth. We expect the cost of our capital expenditures in fiscal year 2005 to be approximately $20.0 million, exclusive of any acquisitions of businesses. We expect to fund these expenditures through cash provided by operating activities and/or borrowings under the revolving credit facility with our bank.
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As of June 30, 2004, our $325 million revolving credit facility with Bank of America, N.A. and other participating banks (collectively the “Lenders”) consisted of a $125 million revolving commitment expiring June 2007, a $75 million term loan (Tranche A Term Loan) due in periodic principal payments through March 2007, and a $125 million term loan (Prior Tranche B Term Loan) due in periodic principal payments through March 2009. On November 18, 2003, we amended our credit facility to lower the margin on the Prior Tranche B Term Loan to 2.25% for London Inter-Bank Offered Rate (LIBOR) based loans and 0.75% for prime rate based loans effectively reducing the margin by 50 basis points through May 2004 and 25 basis points for the remaining term of the loan. We paid Bank of America, N.A. $175,000 in administrative fees to obtain the amendment. During the quarter ended September 30, 2004, we replaced our credit facility to increase the size of the credit facility to $550 million, consisting of a $175 million revolving commitment expiring July 2009 and a $375 million term loan (Tranche B Term Loan) due in periodic principal payments through June 2011.
Amounts outstanding under the credit facility bear interest at varying rates based upon a LIBOR or prime rate of interest (as selected by us), plus a variable margin rate based upon our leverage ratio as defined by the credit agreement. The combination of a variable rate margin and LIBOR base rate resulted in an effective borrowing rate of 3.39% and 3.36% at June 30, 2004, and September 30, 2004, respectively. Our obligations under the credit facility are secured by a lien on substantially all of our assets, including a pledge of all of the common stock or partnership interest of each of our domestic subsidiaries. The Lenders’ security interest in a portion of our inventory is subordinate to the liens on that inventory under the terms of a security agreement between one of our vendors and us. The same vendor has a security interest in certain accounts receivable, which is subordinate to the rights of the Lenders.
The credit facility documentation contains financial covenants, including requirements to maintain certain ratios with respect to leverage, fixed charge coverage, net worth and asset coverage, each as defined in the credit agreement. The credit facility documentation also includes customary affirmative and negative covenants, including covenants relating to transactions with affiliates, uses of proceeds, restrictions on subsidiaries, limitations on indebtedness, limitations on mergers, acquisitions and asset dispositions, limitations on investments, limitations on payment of dividends and stock repurchases, and other distributions. The credit facility documentation also contains customary events of default, including events relating to changes in control of the Company.
On June 4, 2003, we entered into an interest rate swap agreement effectively converting for a period of one year beginning July 21, 2003, $120 million of floating-rate borrowings to fixed-rate borrowings with a fixed rate of 1.14%, plus the applicable margin rate as determined by the credit agreement. The interest rate swap agreement expired on July 21, 2004.
On February 6, 2003, the Securities and Exchange Commission (SEC) declared effective our shelf registration statement on Form S-3 providing for the offer, from time to time, of various securities, up to an aggregate of $500 million. The shelf registration statement may enable us to more efficiently raise funds from the offering of securities covered by the shelf registration statement, subject to market conditions and our capital needs.
Our liquidity needs currently arise primarily from working capital requirements, capital expenditures, commitments related to financing obtained through the issuance of long-term debt and inventory purchase obligations. We believe that our cash from operations, cash available under the recently increased revolving credit facility and the proceeds from any offering of debt or equity securities allowed by the shelf registration statement will be sufficient to meet our internal operating and working capital requirements and growth plans for at least the next 12 months.
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Commitments and Contractual Obligations
The following table sets forth a summary of our contractual cash obligations as of September 30, 2004. Excluding long-term debt, this table does not include amounts already recorded on our balance sheet.
Payments Due Under Contractual Obligations by Fiscal Year | ||||||||||||||||||||||||||||
2005 (1) | 2006 | 2007 | 2008 | 2009 | Thereafter | Total | ||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||
Long-Term Debt | $ | 3,337 | $ | 3,928 | $ | 3,750 | $ | 3,750 | $ | 3,750 | $ | 356,250 | $ | 374,765 | ||||||||||||||
Operating Leases | 6,073 | 5,652 | 4,138 | 2,633 | 1,906 | 1,020 | 21,422 | |||||||||||||||||||||
Purchase Obligations | 224,994 | 161,361 | 30,126 | — | — | — | 416,481 | |||||||||||||||||||||
Capital Leases | — | — | — | — | — | — | — | |||||||||||||||||||||
Other Long-Term Liabilities | — | — | — | — | — | — | — | |||||||||||||||||||||
$ | 234,404 | $ | 170,941 | $ | 38,014 | $ | 6,383 | $ | 5,656 | $ | 357,270 | $ | 812,668 | |||||||||||||||
(1) | Cash obligations for the remainder of fiscal 2005. |
The long-term debt obligations in the table reflect the maturities pursuant to revised and expanded credit facility amendments that occurred during the quarter ended September 30, 2004.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. We evaluate our estimates and judgments on an ongoing basis. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates, and different assumptions or conditions may yield different estimates.
Information regarding our “Critical Accounting Policies and Estimates” can be found in our Annual Report on Form 10-K for our most recent fiscal year ended June 30, 2004, filed with the SEC on September 13, 2004. The four critical accounting policies that we believe are either the most judgmental, or involve the selection or application of alternative accounting policies, and are material to our financial statements are those relating to revenue recognition, allowance for doubtful accounts, allowance for contractual discounts and medical claims reserve. In addition, Note 1 to the financial statements in our Annual Report contains a summary of our significant accounting policies.
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RISK FACTORS
You should carefully consider the risks and uncertainties we describe below before investing in Accredo Health, Incorporated. The risks and uncertainties described below arenotthe only risks and uncertainties that could develop. Other risks and uncertainties that we have not predicted or evaluated could also affect our company.
If any of the following risks occur, our earnings, financial condition or business could be materially harmed, and the trading price of our common stock could decline, resulting in the loss of all or part of your investment
We are highly dependent on our relationships with a limited number of biopharmaceutical suppliers and the loss of any of these relationships could significantly impact our ability to sustain or grow our revenues.
Approximately 38% of our revenue for the quarter ended September 30, 2004 was derived from the sale of IVIG and blood clotting factor product. The majority of our IVIG and blood clotting factor products were purchased from Baxter Healthcare Corporation. We also derive a substantial percentage of our revenue and profitability from our relationships with Biogen Idec, Inc., Genzyme Corporation, GlaxoSmithKline, Inc. and MedImmune, Inc. Our revenue derived from these relationships represented approximately 32% of our revenue during the quarter ended September 30, 2004.
Our agreements with these suppliers are short-term and cancelable by either party without cause on 60 to 365 days prior notice. These agreements also generally limit our ability to handle competing drugs during and, in some cases, after the term of the agreement, but allow the supplier to distribute through channels other than us. Further, these agreements provide that pricing and other terms of these relationships be periodically adjusted for changing market conditions or required service levels. Any termination or modification to any of these relationships could have a material adverse effect on a significant portion of our business, financial condition and results of operations.
Our ability to grow could be limited if we do not expand our existing base of drugs or if we lose patients.
We primarily sell 21 product lines. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The drugs that we sell with respect to the following core disease markets accounted for approximately 89% of our revenues for the quarter ended September 30, 2004, with the drugs for hemophilia, autoimmune disorders and PID constituting approximately 38% of our revenue for the same period:
• | Hemophilia, Autoimmune Disorders and PID; | |||
• | Pulmonary Arterial Hypertension; | |||
• | Multiple Sclerosis; | |||
• | Gaucher Disease; | |||
• | Growth Hormone-Related Disorders; and | |||
• | Respiratory Syncytial Virus, or RSV. |
Due to the small patient populations that use the drugs we handle, our future growth is highly dependent on expanding our base of drugs. Further, a loss of patient base or reduction in demand for any reason of the drugs we currently handle could have a material adverse effect on a significant portion of our business, financial condition and results of operations.
Our business would be harmed if demand for our products and services is reduced.
Reduced demand for our products and services could be caused by a number of circumstances, including:
• | patient shifts to treatment regimens other than those we offer; | |||
• | new treatments or methods of delivery of existing drugs that do not require our specialty products and services; | |||
• | a recall of a drug; | |||
• | adverse reactions caused by a drug; |
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• | the expiration or challenge of a drug patent; | |||
• | competing treatment from a new drug or a new use of an existing drug; | |||
• | the loss of a managed care or other payor relationship; | |||
• | the expansion of product-only service models; | |||
• | changes in sites of service; | |||
• | the cure of a disease we service; or | |||
• | the death of a high-revenue patient. |
There is substantial competition in our industry, and we may not be able to compete successfully.
The specialty pharmacy industry is highly competitive and is continuing to become more competitive. Most of the drugs, supplies and services that we provide are also available from our competitors. Our current and potential competitors include:
• | other specialty pharmacy distributors; | |||
• | specialty pharmacy divisions of wholesale drug distributors; | |||
• | payors or pharmacy benefit management companies (PBMs); | |||
• | hospital-based pharmacies; | |||
• | retail pharmacies; | |||
• | home infusion therapy companies; | |||
• | manufacturers that sell their products both to distributors and directly to users; | |||
• | comprehensive hemophilia treatment centers; | |||
• | patient support groups and payors entering the specialty pharmacy distribution business; and | |||
• | other alternative site health care providers. |
Many of our competitors have substantially greater resources and more established operations and infrastructure than we have. We are particularly at risk from any of our suppliers or payors deciding to pursue their own distribution and services instead of outsourcing these needs to companies like us. A significant factor in effective competition will be our ability to maintain and expand relationships with managed care companies, PBMs and other payors who can effectively determine the pharmacy source for their enrollees.
Entry by PBMs into the specialty pharmacy market, our strategic alliance with Medco Health Solutions, changes in Medco’s business and consolidation in the industry could affect our ability to serve patients.
Caremark Rx, Inc. and AdvancePCS recently combined to form the nation’s second largest pharmacy benefit manager, processing drug claims for about 95 million individuals with about 600 million prescriptions filled per year. Express Scripts, Inc., which provides PBM services to over 50 million members, acquired Curascripts on January 30, 2004. All of these firms are our customers and competitors. On February 9, 2004, we entered into a 10-year strategic alliance with Medco Health Solutions, Inc. where we became the preferred retail and home delivery pharmacy provider to Medco’s members for our specialty pharmacy products. Because of the amount of revenue that we generate from our relationship with Medco, we could be adversely impacted if Medco is not able to retain the customer base that we service or is not able to attract new customers and expand their customer base.
As a result of our new relationship with Medco, other PBMs may be reluctant to do business with us. As PBMs acquire specialty pharmacy capability, it is likely that they will attempt to cancel their relationships with entities, including us, that compete with the PBM specialty pharmacy operations, and to cause the PBM patients to obtain their drugs from the PBM’s
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own specialty pharmacy. We also expect there will be further consolidation among specialty pharmacy providers, such as the recently proposed merger of Chronimed and MIM Corporation. Such events could materially and adversely affect our financial condition and results of operations.
Our business could be harmed by changes in Medicare or Medicaid.
Changes in Medicare, Medicaid or similar government health benefit programs or the amounts paid by those programs for our services may adversely affect our earnings. Such programs are highly regulated and subject to substantial changes and cost containment measures. In recent years, changes in these programs have modified payments to providers both positively and negatively. The Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA, is having a significant impact on the U.S. drug delivery system and, correspondingly, on our business. The MMA expands drug benefits for Medicare beneficiaries. The MMA changes drug pricing methodologies resulting in both increases and decreases in drug payments. The MMA changes Medicare’s payment methodology over the next three years from a system based on average wholesale price, or AWP, to one based on average sales price, or ASP, and provided for Medicare rate reductions that were effective January 1, 2004. In November 2004, the reimbursement levels for Remodulin® were retroactively increased from the rates initially established under the MMA. The amount of Medicare reimbursement that we receive for blood clotting factor will also be changed effective January 1, 2005 to an ASP methodology. Although the MMA impacted the Company in 2004, we expect potentially significant impact in 2005, 2006 and thereafter, but the effect of which is not readily ascertainable at this time. We expect that the effect of the MMA will be to reduce prices and margins on some of the drugs that we distribute.
At least one Medicaid program has adopted, and we expect other Medicaid programs, some states and some commercial payors, to adopt those aspects of the MMA that either result in or appear to result in price reductions for drugs covered by such programs. Adoption of ASP as the measure for determining reimbursement by state Medicaid programs for the drugs we sell could materially reduce our revenue and gross margins.
In order to deal with budget shortfalls, some states are attempting to create state administered prescription drug discount plans, to limit the number of prescriptions per person that are covered, to raise Medicaid co-pays and deductibles, and are proposing more restrictive formularies and reductions in pharmacy reimbursement rates. For example, California’s Medicaid program, MediCal, recently adopted a plan that shifted away from use of acquisition cost plus 1% and instead uses ASP plus 20% for blood clotting factor products. Prior to adoption of the ASP methodology, the State of California adopted a 5% reimbursement rate reduction paid to providers of the state’s MediCal program, which was scheduled to take effect on January 1, 2004. On December 23, 2003, the United States District Court for the Eastern District of California issued an injunction enjoining the State from implementing the 5% rate reduction. The subsequent change in the law, adopting the new ASP methodology, caused the 5% rate reduction to expire June 30, 2004. This reduction and any further reductions in the reimbursement from MediCal could adversely impact revenues and profitability from the sale of drugs by us or by our two partnerships in California to patients covered by MediCal. Any reductions in amounts reimbursable by other government programs for our services or changes in regulations governing such reimbursements could materially and adversely affect our business, financial condition and results of operations.
Changes in average wholesale prices could reduce our pricing and margins.
Many government payors, including Medicare and Medicaid, have paid, or continue to pay, us directly or indirectly at a percentage off a drug’s AWP. We have also contracted with a number of private payors to sell drugs at AWP or at a percentage off AWP. AWP for most drugs is compiled and published by several private companies, including First DataBank, Inc. Several states have filed lawsuits against pharmaceutical manufacturers for allegedly inflating reported AWP for prescription drugs. In addition, class action lawsuits have been brought by consumers against pharmaceutical manufacturers alleging overstatement of AWP. We are not responsible for such calculations, reports or payments; however, there can be no assurance that our ability to negotiate discounts from drug manufacturers will not be materially adversely affected by such investigations or lawsuits, in the future.
The Federal Government has also entered into settlement agreements with several drug manufacturers relating to the calculation and reporting of AWP pursuant to which the drug manufacturers, among other things, have agreed to report new pricing information, the “average sales price”, to government healthcare programs. The average sales price is calculated differently than AWP.
The recently enacted MMA changes the way the federal government pays for certain Part B drugs. While the majority of our revenue is reimbursed by private payors, as CMS implements the ASP methodology of reimbursement, it may affect our current AWP based reimbursement structure with our private payors. If private payors adopt the ASP methodology, it could have a material effect on reimbursement rates that we are able to negotiate with these payors.
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While we cannot predict the eventual results of these law changes, government proposals, investigations, or lawsuits, the effect of the MMA has been and will be to reduce prices and margins on some of the drugs that we distribute. If government payors or private payors revise their pricing based on new methods of calculating the AWP for drugs we handle or implement reimbursement methodology based on some value other than AWP, this could have a material adverse effect on our business, financial condition and results of operation, including reducing the pricing and margins on certain of our products.
Our business will suffer if we lose relationships with payors.
We are highly dependent on reimbursement from non-governmental payors. For the fiscal years ended June 30, 2002, 2003 and 2004, and the quarter ended September 30, 2004, we derived approximately 79%, 73%, 72% and 72% respectively of our gross patient revenue from non-governmental payors (including self-pay), which included 3%, 1%, 1% and 1%, respectively for those periods, from sales to private physician practices whose ultimate payor is typically Medicare.
Many payors seek to limit the number of providers that supply drugs to their enrollees. For example, we were selected by Aetna, Inc. as one of three providers of injectable medications. We received approximately 10% of our total revenues from Aetna in the fiscal year ended June 30, 2004, and approximately 6% in the quarter ended September 30, 2004. Aetna has recently indicated that during 2005, it will be transferring patients and therapies from us to a new joint venture between Aetna and one of our competitors. Our relationship with Medco was responsible for approximately 14% of our total revenue in the quarter ended September 30, 2004. This revenue was generated from patients that we serviced on a retail basis prior to our expanded relationship with Medco that commenced in February 2004 and also from patients that were referred to us through the expanded relationship. From time to time, payors with whom we have relationships require that we and our competitors bid to keep their business, and there can be no assurance that we will be retained or that our margins will not be adversely affected when that happens. Further, significant consolidation has occurred among non-government payors, and we expect there will be further consolidation in the future. If payors with whom we have relationships are part of this consolidation, our relationships with those payors could be terminated. The loss of a payor relationship, for example, our relationship with Aetna, Inc. and affiliates (which is terminable on 90 days notice), or an adverse change in the financial condition of a payor, could result in the loss of a significant number of patients and have a material adverse effect on our business, financial condition and results of operations.
Our business could be harmed if payors decrease or delay their payments to us or seek to recoup payments already made.
Our profitability depends on payment from governmental and non-governmental payors, and we could be materially and adversely affected by cost containment trends in the health care industry or by financial difficulties suffered by non-governmental payors. Cost containment measures affect pricing, purchasing and usage patterns in health care. Payors also influence decisions regarding the use of a particular drug treatment and focus on product cost in light of how the product may impact the overall cost of treatment. Recently, a number of payors have contracted with specialty drug management services or network managers that focus on controlling the cost of specialty drugs. These entities, similar to PBMs, are retained by payors to help control the drugs that are provided to patients and to minimize the cost of these drugs where appropriate. Certain employers and other private payors have also joined group purchasing arrangements in an effort to control costs.
Some payors, including large managed care organizations and some private physician practices, have recently experienced financial trouble. The timing of payments and our ability to collect from payors also affects our revenue and profitability. Payors also have contractual rights to audit our books and records to determine if they have overpaid us. We had a contractual relationship through a joint venture with two pharmacies currently involved in ongoing reimbursement audits by the California agency that administers MediCal. If the audits find that the pharmacies received overpayments from MediCal, we could be required, under the terms of our prior contractual relationship, to reimburse the pharmacies for a portion of any amounts recouped by the State of California. Subject to the outcome of the audits, we could be required to make a significant payment in order to satisfy our alleged contractual obligations. If we are unable to collect from payors or if payors fail to pay us in a timely manner, or if payors seek to recoup payments already made to us, it could have a material adverse effect on our business and financial condition.
If any of our relationships with medical centers are disrupted or canceled, our business could be harmed.
We have joint venture relationships with four medical centers that provide services primarily related to hemophilia, growth hormone-related disorders and RSV. For the fiscal years ended June 30, 2002, 2003 and 2004, we derived approximately 4%, 4% and 2%, respectively, of our income before income taxes from equity in the net income of unconsolidated joint ventures. We derived approximately 2% of our income before income taxes from equity in the net income of unconsolidated joint ventures during the quarter ended September 30, 2004.
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We own 80% of one of our joint ventures with Children’s Home Care, Inc. and the financial results of this joint venture are included in our consolidated financial results. This consolidated joint venture represented approximately 10% of our income before income taxes for the fiscal year ended June 30, 2002, 17% of our income before income taxes for the fiscal year ended June 30, 2003, 7% of our income before income taxes in the fiscal year ended June 30, 2004, and 3% of our income before income taxes in the quarter ended September 30, 2004.
Recently, the OIG issued a Special Advisory Bulletin focused on complex contractual joint ventures that could potentially violate the anti-kickback statute. In this bulletin, the OIG discussed the characteristics that potentially indicate a prohibited arrangement. Some of these characteristics are present in our existing joint ventures. As a result, our joint ventures will be restructured.
Further, the Department of Health and Human Services, or DHHS, published a set of “safe harbor” regulations and continues to publish clarifications to the safe harbors under the federal anti-kickback statute. Arrangements that fully comply with a safe harbor are deemed not to violate the anti-kickback statute. We have several business arrangements (for example, our joint venture and management arrangements with medical centers, service arrangements with physicians and product pricing arrangements with suppliers) that do not satisfy all of the requirements necessary to fall within the safe harbors. Failure to satisfy a safe harbor does not mean that an arrangement is necessarily illegal. We believe our business arrangements comply with the anti-kickback statute, the Health Insurance Portability and Accountability Act, or HIPPA, the federal Stark Law and similar state laws. However, if we are found to violate any of these laws, we could suffer penalties, fines or possible exclusion, which could adversely affect our revenues and earnings.
In addition to joint venture relationships, we also provide pharmacy management services to several medical centers. Our agreements with medical centers have terms of between one and five years, and may be cancelled by either party without cause upon notice of between one and twelve months. Adverse changes in our relationships with those medical centers could be caused, for example, by:
• | changes caused by consolidation within the hospital industry; | |||
• | changes caused by regulatory uncertainties inherent in the structure of the relationships; or | |||
• | restrictive changes to regulatory requirements. |
Any termination or adverse change of these relationships could have a material adverse effect on our business, financial condition and results of operations.
If additional providers obtain access to favorable pricing from the Health Resources and Services Administration, Office of Pharmacy Affairs drug discount program (the “PHS program”) for drugs we handle, our business could be harmed.
The federal pricing program of the Public Health Service, commonly known as PHS, allows qualified hospitals and hemophilia treatment centers to obtain discounts on blood clotting factor products. While we are able to access PHS pricing through our contracts to provide contract pharmacy services to hemophilia treatment centers, we are not eligible to participate directly in these programs. Increased competition from hospitals and hemophilia treatment centers that have the right to participate directly in these discount programs may reduce our profit margins.
Our acquisition and joint venture strategy may not be successful, which could cause our business and future growth prospects to suffer.
As part of our growth strategy, we continue to evaluate acquisition and joint venture opportunities, but we cannot predict or provide assurance that we will complete any future acquisitions or joint ventures. Acquisitions and joint ventures involve many risks, including:
• | difficulty in identifying suitable candidates and negotiating and consummating acquisitions on attractive terms; | |||
• | difficulty in assimilating the new operations; | |||
• | increased transaction costs; | |||
• | diversion of our management’s attention from existing operations; |
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• | dilutive issuances of equity securities that may negatively impact the market price of our stock; | |||
• | increased debt; and | |||
• | increased amortization expense related to intangible assets that would decrease our earnings. |
We could also be exposed to unknown or contingent liabilities resulting from the pre-acquisition operations of the entities we acquire, such as liability for failure to comply with health care or reimbursement laws, including an obligation to recoup reimbursement payments previously received by the companies we acquire. We also face exposure if any seller of an entity which we acquire, is not able to fulfill its indemnification obligations under the terms of the purchase agreement. We may suffer impairment of assets or have to bear a liability for which we are entitled to indemnification but are unable to collect.
Our debt incurred from recent acquisitions may limit our future financial flexibility.
The current level of our debt will have several important effects on our future operations, including, among others:
• | A portion of our cash flow from operations will be dedicated to the payment of principal on the debt and will not be available for other purposes; | |||
• | Our debt covenants will require us to meet financial tests, and may impose other limitations that may limit our flexibility in planning for and reacting to changes in our business, including possible acquisition opportunities; | |||
• | Our ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate and other purposes may be limited; | |||
• | Failure to meet our debt covenants could result in foreclosure by our lenders or an increase in the interest rate or administrative fees associated with our debt; | |||
• | We may be at a competitive disadvantage to similar companies that have less debt; and | |||
• | Our vulnerability to adverse economic and industry conditions may increase. |
Fluctuations in our quarterly financial results may cause our stock price to decline.
Our results of operations may fluctuate on a quarterly basis, which could adversely affect the market price of our common stock. Our results may fluctuate as a result of:
• | lower prices paid by Medicare or Medicaid for the drugs that we sell, including lower prices resulting from the MMA and other state and federal legislation and revisions in pricing methods, or the method of establishing AWP or ASP; | |||
• | below-expected sales or delayed launch of a new drug; | |||
• | price and term adjustments with our drug suppliers; | |||
• | increases in our operating expenses in anticipation of the launch of a new drug; | |||
• | product shortages or an oversupply of product; | |||
• | inaccuracies in our estimates of the costs of ongoing programs; | |||
• | the timing and integration of our acquisitions; | |||
• | changes in our estimates used to prepare our financial statements; | |||
• | effectiveness of our sales force; | |||
• | changes in governmental regulations; | |||
• | the annual renewal of deductibles and co-payment requirements that affect patient ordering patterns; |
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• | our provision of drugs to treat seasonal illnesses, such as RSV; | |||
• | physician prescribing patterns; | |||
• | general political and economic conditions; | |||
• | interest rate fluctuations; and | |||
• | adverse experience in collection of accounts receivable. |
Our business would be harmed if the biopharmaceutical industry reduces research, development and production of the types of drugs that are compatible with the services we provide.
Our business is highly dependent on continued research, development, manufacturing and marketing expenditures of biopharmaceutical companies, and the ability of those companies to develop, supply and generate demand for drugs that are compatible with the services we provide. Our business would be materially and adversely affected if those companies stopped outsourcing the services we provide or failed to support existing drugs or develop new drugs. Our business could also be harmed if the biopharmaceutical industry undergoes any of the following developments:
• | supply shortages; | |||
• | adverse drug reactions; | |||
• | drug recalls; | |||
• | increased competition among biopharmaceutical companies; | |||
• | an inability of drug companies to finance product development because of capital shortages; | |||
• | a decline in product research, development or marketing; | |||
• | a reduction in the retail price of drugs from governmental or private market initiatives; | |||
• | changes in the FDA approval process; or | |||
• | governmental or private initiatives that would alter how drug manufacturers, health care providers or pharmacies promote or sell products and services. |
Our business could be harmed if the supply of any of the products that we distribute becomes scarce.
The biopharmaceutical industry is susceptible to product shortages. Some of the products that we distribute, such as some of our hemophilia products, IVIG and some other blood-related products, are collected and processed from human donors. Accordingly, the supply of these products is highly dependent on human donors and their availability has been constrained from time to time. Our suppliers of IVIG have announced initiatives that could result in decreases in the future supply of IVIG, which, in addition to other factors, may cause the pricing of IVIG to rise. There was also an industry wide recombinant factor VIII product shortage that existed for some time, as a result of the manufacturers being unable to increase production to meet rising global demand. Supply of this drug has only recently returned to normal levels. If these products, or any of the other drugs that we distribute, are in short supply for long periods of time and we are unable to acquire an amount of the drug sufficient to service our patients, our business could be harmed.
Our industry is subject to extensive government regulation and noncompliance by us, physicians who prescribe our products and services or our suppliers could harm our business.
The marketing, sale and purchase of drugs and medical supplies is extensively regulated by federal and state governments, and if we fail or are accused of failing to comply with laws and regulations, we could suffer a material adverse effect on our business, financial condition and results of operations. Our business could also be materially and adversely affected if the suppliers or others we work with are accused of violating laws or regulations. The applicable regulatory framework is complex, and the laws are very broad in scope. Many of these laws remain open to interpretation, and have not been addressed by substantive court decisions.
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The health care laws and regulations that especially apply to our activities include:
• | The federal “Anti-Kickback Law” prohibits the offer or solicitation of compensation in return for the referral of patients covered by almost all governmental programs and billing for services rendered pursuant to such referrals, or the arrangement or recommendation of the purchase of any item, facility or service covered by those programs. The Health Insurance Portability and Accountability Act (HIPAA) created new violations for fraudulent activity applicable to both public and private health care benefit programs and prohibits inducements to Medicare or Medicaid eligible patients. The potential sanctions for violations of these laws range from significant fines, to exclusion from participation in the Medicare and Medicaid programs, to criminal sanctions. Although some “safe harbor” regulations attempt to clarify when an arrangement will not violate the Anti-Kickback Law, our business arrangements and the services we provide may not fit within these safe harbors. Failure to satisfy a safe harbor requires analysis of whether the parties intended to violate the Anti-Kickback Law. Allegations, investigations, or findings of a violation of the Anti-Kickback Law or similar state laws could have a material adverse effect on our business. | |||
• | The Department of Health and Human Services (DHHS) has issued regulations implementing the Administrative Simplification provisions of HIPAA concerning the maintenance of privacy and security of individually identifiable health information. These new regulations require the development and implementation of measures to maintain the privacy and security of health information and require that certain health claims transactions be conducted in accordance with uniform standards. These regulations govern health care providers, health plans and health clearinghouses. Failure to comply with these regulations, or wrongful disclosure of confidential patient information could result in the imposition of administrative or criminal sanctions, including exclusion from the Medicare and state Medicaid programs. In addition, if we choose to distribute drugs through new distribution channels such as the Internet, we will have to comply with government regulations that apply to those distribution channels, which could have a material adverse effect on our business. | |||
• | The Ethics in Patient Referrals Act of 1989, as amended, commonly referred to as the “Stark Law,” prohibits physician referrals to entities with which the physician or their immediate family members have a “financial relationship.” Many states have adopted laws similar to the Stark law. A violation of the Stark Law or similar state laws is punishable by civil sanctions, including significant fines and exclusion from participation in Medicare and Medicaid. | |||
• | State laws prohibit the practice of medicine, pharmacy and nursing without a license. To the extent that we assist patients and providers with prescribed treatment programs, a state could consider our activities to constitute the practice of medicine. If we are found to have violated those laws, we could face civil and criminal penalties and be required to reduce, restructure, or even cease our business in that state. | |||
• | Pharmacies and pharmacists must obtain state licenses to operate and dispense drugs. Pharmacies must also obtain licenses in some states to operate and provide goods and services to residents of those states. Our entities that provide nursing for our patients and our nurses must obtain licenses in certain states to conduct our business. If we are unable to maintain our licenses or if states place burdensome restrictions or limitations on non-resident pharmacies or nurses, this could limit or affect our ability to operate in some states which could adversely impact our business and results of operations. | |||
• | Federal and state investigations and enforcement actions continue to focus on the health care industry, scrutinizing a wide range of items such as joint venture arrangements, referral and billing practices, product discount arrangements, home health care services, dissemination of confidential patient information, clinical drug research trials and gifts for patients. Recently, the OIG issued a Special Advisory Bulletin focused on complex contractual joint ventures that could potentially violate the anti- kickback statute. In this bulletin, the OIG discussed the characteristics that potentially indicate a prohibited arrangement. Some of these characteristics are present in our existing joint ventures. Accordingly, some of our existing joint ventures have been restructured and others may be restructured in the future. | |||
• | The False Claims Act encourages private individuals to file suits on behalf of the government against health care providers such as us. Such suits could result in significant financial sanctions or exclusion from participation in the Medicare and Medicaid programs. |
If some of the drugs that we provide lose their “orphan drug” status, we could face more competition.
Our business could be adversely affected by the expiration or challenge to the orphan drug status that has been granted by the FDA to some of the drugs that we handle. When the FDA grants orphan drug status, it will not approve a second drug for the same treatment for a period of seven years unless the new drug is chemically different or clinically superior. Not all of the
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drugs that we sell which are related to our core disease states have orphan drug status. The loss of orphan drug status, the approval of new drugs notwithstanding orphan drug status or the development of drugs that are superior to the drugs we sell could result in additional competitive drugs entering the market, which could harm our business.
We rely heavily on a single shipping provider, and our business would be harmed if our rates are increased or our provider is unavailable.
Almost all of our revenues result from the sale of drugs we deliver to our patients and a single carrier, FedEx, ships principally all of our products. We depend heavily on these outsourced shipping services for efficient, cost effective delivery of our product. The risks associated with this dependence include:
• | any significant increase in shipping rates, including rate increases resulting from higher fuel prices; | |||
• | strikes or other service interruptions by our primary carrier, FedEx, or by another carrier that could affect FedEx; or | |||
• | spoilage of high cost drugs during shipment, since our drugs often require special handling, such as refrigeration. |
Disruptions in commercial activities such as those following the September 2001 terrorist attacks on the U.S. or as a result of a natural disaster may adversely impact our results of operations, our ability to raise capital or our future growth.
Our operations have been and could again be harmed by terrorist attacks on the U.S. For example, transportation systems and couriers that we rely upon to deliver our drugs have been and could again be disrupted, thereby causing a decrease in our revenues. In addition, we may experience a rise in operating costs, such as costs for transportation, courier services, insurance and security. We also may experience delays in payments from payors, which would harm our cash flow. The U.S. economy in general may be adversely affected by terrorist attacks or by any related outbreak of hostilities. Any such economic downturn could adversely impact our results of operations, impair our cost of or ability to raise debt or equity capital or impede our ability to continue growing our business.
We have a centralized data center located in Memphis, Tennessee and we are in the process of building a second data center in another city that we expect to be operational in calendar year 2005. Until the second data center is operational, acts by terrorists or a natural disaster that causes damage to the data center could cause us to be unable to operate our business for a period of time.
If we are unable to manage our growth effectively, our business will be harmed.
Our rapid growth over the past several years has placed a strain on our resources, and if we cannot effectively manage our growth, our business, financial condition and results of operations could be materially and adversely affected. We have experienced a large increase in the number of our employees, the size of our programs and the scope of our operations. Our ability to manage this growth and be successful in the future will depend partly on our ability to retain skilled employees, which has become more difficult due to the national health care professional shortage. Our ability to manage our growth is also dependent upon our ability to enhance our management team and improve our management information and financial control systems.
We could be adversely affected by an impairment of the significant amount of goodwill and other intangibles on our financial statements.
Our formation and our acquisitions have resulted in the recording of a significant amount of goodwill on our financial statements. The goodwill was recorded because the fair value of the tangible net assets acquired was less than the purchase price. There can be no assurance that we will realize the full value of this goodwill. We evaluate on an on-going basis whether events and circumstances indicate that all or some of the carrying value of goodwill is no longer recoverable, in which case we would write off the unrecoverable goodwill as a charge to our earnings. As of September 30, 2004, we had goodwill, net of accumulated amortization, of approximately $550.3 million, or 44% of total assets and 89% of stockholders’ equity.
Since our growth strategy may involve the acquisition of other companies, we may record additional goodwill in the future. The possible write-off of this goodwill could negatively impact our future earnings. We will also be required to allocate a portion of the purchase price of any acquisition to the value of non-competition agreements, patient base and contracts that are acquired. The amount allocated to these items could be amortized over a fairly short period. As a result, our earnings and the market price of our common stock could be negatively impacted.
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We rely on a few key employees whose absence or loss could adversely affect our business.
We depend on a few key executives, and the loss of their services could cause a material adverse effect to our company. We do not maintain “key person” life insurance policies on any of those executives. As a result, we are not insured against the losses resulting from the death of our key executives. Further, we must be able to attract and retain other qualified, essential employees for our technical operating and professional staff, such as pharmacists and nurses. If we are unable to attract and retain these essential employees, our business could be harmed.
We have been named in several shareholder class action lawsuits and a shareholders’ derivative lawsuit asserting claims under the securities laws.
The uncertainty associated with these unresolved lawsuits could harm our business and financial condition. The defense of these lawsuits also could result in litigation fees and costs, as well as the diversion of resources. Negative developments with respect to the lawsuits could cause our stock price to decline significantly. The indemnification provisions contained in our Certificate of Incorporation and Bylaws require us to indemnify our current and former officers and directors who are named as defendants against the allegations contained in these suits. Even though we maintain directors and officers insurance applicable to the lawsuits, there can be no guarantee that the proceeds of such insurance will be available for defense fees and costs, or payment of any settlement or judgment in the lawsuits or, if available, will be sufficient to cover the fees and costs and any settlement or judgment imposed against us.
The ultimate cost and effect of these lawsuits on our financial condition, results of operations, customer relations and management is unknown at this time.
In addition to the securities litigation currently pending against us and our officers and directors, we may also in the future be the target of similar litigation. Additional securities litigation could result in substantial costs and divert our attention and resources.
We may need additional capital to finance our growth and capital requirements, which could prevent us from fully pursuing our growth strategy.
In order to implement our growth strategy, we will need substantial capital resources and will incur, from time to time, short- and long-term indebtedness, the terms of which will depend on market and other conditions. We cannot be certain that existing or additional financing will be available to us on acceptable terms, if at all. As a result, we could be unable to fully pursue our growth strategy. Further, additional financing may involve the issuance of equity or debt securities that would reduce the percentage ownership of our then current stockholders.
The market price of our common stock may experience substantial fluctuations for reasons over which we have little control.
Our common stock is traded on the Nasdaq National Market System. The market price of our common stock could fluctuate substantially based on a variety of factors, including the following:
• | future announcements concerning us, our competitors, the drug manufacturers with whom we have relationships or the health care market; | |||
• | changes in government regulations; | |||
• | overall volatility of the stock market; | |||
• | changes in the financial estimates we provide to the market; | |||
• | changes in estimates by analysts; | |||
• | changes in operating results from quarter to quarter; and | |||
• | loss of key executives. |
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Furthermore, stock prices for many companies fluctuate widely for reasons that may be unrelated to their operating results. These fluctuations, coupled with changes in our results of operations and general economic, political and market conditions, may adversely affect the market price of our common stock.
Some provisions of our charter documents and the Stockholder Protection Rights Plan may have anti-takeover effects that could discourage a change in control, even if an acquisition would be beneficial to our stockholders.
Our certificate of incorporation, our bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. In addition, our Board of Directors has adopted a Stockholder Protection Rights Plan, sometimes referred to as a poison pill, which would substantially dilute the interest sought by an acquirer.
In the event we are unable to satisfy regulatory requirements relating to internal controls, or if these internal controls over financial reporting are not effective, our business and our stock price could suffer.
Section 404 of Sarbanes-Oxley requires companies to do a comprehensive and costly evaluation of their internal controls. As a result, during our fiscal year ending June 30, 2005, we will be required to perform an evaluation of our internal controls over financial reporting and have our auditor publicly attest to such evaluation. We have prepared an internal plan of action for compliance, which includes a timeline and scheduled activities with respect to preparation of such evaluation. Our efforts to comply with Section 404 and related regulations regarding our management’s required assessment of internal control over financial reporting and our independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. If we fail to timely complete this evaluation, or if our auditors cannot timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls, which could have an adverse effect on our business and our stock price.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to the impact of financial market risk is significant. Our primary financial market risk exposure consists of interest rate risk related to interest that we are obligated to pay on our variable-rate debt.
We sometimes use derivative financial instruments to manage our exposure to rising interest rates on our variable-rate debt, primarily by entering into variable-to-fixed interest rate swaps. We had fixed the interest rate through July 21, 2004 on $120 million of our variable-rate debt through the use of a variable-to-fixed interest rate swap. As a result, we did not benefit from any decrease in interest rates nor were we subjected to any detriment from rising interest rates on this portion of our debt during the period of the swap agreement.
We have not yet hedged against our interest rate risk exposure after July 21, 2004. As a result, we will benefit from decreasing interest rates, but rising interest rates on our debt will also harm us. Accordingly, if we maintain our current level of total debt, a 100 basis point decrease in interest rates along the entire yield curve would result in an increase in pre-tax income of approximately $3.74 million over the next twelve months. However, a 100 basis point increase in interest rates would result in a decrease in pre-tax income of $3.74 million for the same period.
Actual changes in rates may differ from the hypothetical assumptions used in computing the exposures in the examples cited above.
ITEM 4. CONTROLS AND PROCEDURES
The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report the Company maintains disclosure controls and procedures that provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
There have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II — OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 10.1 | Second Amended and Restated Credit Agreement dated as of July 21, 2004 among Accredo Health, Incorporated as Borrower, Certain Subsidiaries of the Borrower as Guarantors and The Lenders Named Therein and Bank of America, N.A. as Agent (as amended by Amendment No. 1 dated August 5, 2004) | |
Exhibit 10.2 | Amended and Restated Pledge Agreement dated as of July 21, 2004 by and among the parties identified as “Pledgors” and Bank of America, N.A. as collateral agent | |
Exhibit 10.3 | Amended and Restated Security Agreement dated as of July 21, 2004 by and among the parties identified as “Grantors” and Bank of America, N.A. as collateral agent | |
Exhibit 10.4 | Form of Incentive Stock Option Agreement under the Accredo Health, Incorporated 2002 Long-Term Incentive Plan | |
Exhibit 10.5 | Form of Incentive Stock Option Agreement under the Accredo Health, Incorporated 1999 Long-Term Incentive Plan | |
Exhibit 10.6 | Form of outside Director’s Non-Qualified Stock Option Agreement under the Accredo Health, Incorporated 2002 Long-Term Incentive Plan | |
Exhibit 10.7 | Form of Incentive Stock Option Agreement under the Accredo Health, Inc. and Subsidiaries Amended and Restated Stock Option and Restricted Stock Purchase Plan | |
Exhibit 31.1 | Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 31.2 | Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
*Exhibit 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
*Exhibit 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
(b) Reports on Form 8-K
We filed a report on Form 8-K on July 22, 2004 to report the acquisition of HRA Holding Corp and to furnish as exhibits the acquisition (merger) agreements.
We filed a report on Form 8-K on August 30, 2004 to furnish as an exhibit the press release reporting our financial results for the quarter and year ended June 30, 2004.
We filed a report on Form 8-K/A on September 20, 2004 to amend the Company’s Current Report on Form 8-K filed on July 22, 2004 regarding the acquisition of HRA Holding Corp. The Form 8-K/A was filed in order to report that the Company had determined that it was not required to file historical audited financial statements for HRA Holding Corp. or file pro forma financial information related to the acquisition of HRA Holding Corp. as was indicated in the Company’s initial report on Form 8-K.
* | In accordance with Release No. 34-47986, this exhibit is hereby furnished to the SEC as an accompanying document and is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933. |
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Signature
Pursuant to the requirements 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.
November 9, 2004 | Accredo Health, Incorporated | |||
BY: | /s/ David D. Stevens | |||
David D. Stevens | ||||
Chairman of the Board and | ||||
Chief Executive Officer | ||||
/s/ Joel R. Kimbrough | ||||
Joel R. Kimbrough | ||||
Senior Vice President, Chief | ||||
Financial Officer and Treasurer |
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Exhibit Index
Exhibit | ||
Number | Description of Exhibits | |
10.1 | Second Amended and Restated Credit Agreement dated as of July 21, 2004 among Accredo Health, Incorporated as Borrower, Certain Subsidiaries of the Borrower as Guarantors and The Lenders Named Therein and Bank of America, N.A. as Agent (as amended by Amendment No. 1 dated August 5, 2004) | |
10.2 | Amended and Restated Pledge Agreement dated as of July 21, 2004 by and among the parties identified as “Pledgors” and Bank of America, N.A. as collateral agent | |
10.3 | Amended and Restated Security Agreement dated as of July 21, 2004 by and among the parties identified as “Grantors” and Bank of America, N.A. as collateral agent | |
10.4 | Form of Incentive Stock Option Agreement under the Accredo Health, Incorporated 2002 Long-Term Incentive Plan | |
10.5 | Form of Incentive Stock Option Agreement under the Accredo Health, Incorporated 1999 Long-Term Incentive Plan | |
10.6 | Form of outside Director’s Non-Qualified Stock Option Agreement under the Accredo Health, Incorporated 2002 Long-Term Incentive Plan | |
10.7 | Form of Incentive Stock Option Agreement under the Accredo Health, Inc. and Subsidiaries Amended and Restated Stock Option and Restricted Stock Purchase Plan | |
31.1 | Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
*32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
*32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | In accordance with Release No. 34-47986, this exhibit is hereby furnished to the SEC as an accompanying document and is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933. |
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