UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2006
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 0-17821
ALLION HEALTHCARE, INC.
(Exact Name of registrant as specified in its charter)
| Delaware | 11-2962027 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1660 Walt Whitman Road, Suite 105, Melville, NY 11747
(Address of principal executive offices)
Registrant’s telephone number: (631) 547-6520
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. x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨ | Accelerated Filer x | Non-accelerated filer ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
As of May 5, 2006 there were 16,202,666 shares of the Registrant’s common stock, $.001 par value, outstanding.
| 3 | ||
PART I. FINANCIAL INFORMATION | ||
| 4 | ||
| 5 | ||
| 6 | ||
Notes to Condensed Consolidated Financial Statements (Unaudited and Restated) | 7 | |
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations | 20 | |
Item 3: Quantitative and Qualitative Disclosures about Market Risk | 29 | |
| 29 | ||
PART II. OTHER INFORMATION | ||
| 31 | ||
| 31 | ||
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds | 32 | |
| 32 | ||
| 32 | ||
| 32 | ||
| 32 | ||
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Pursuant to Rule 12b-15 of the Securities Exchange Act of 1934, as amended, Allion Healthcare, Inc. hereby amends its Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 in response to certain comments of the Staff of the Securities and Exchange Commission (the “Commission”) in connection with its review of our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 and filed on April 19, 2006, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 and filed on May 10, 2006. The revisions contained in this Amendment No. 1 on Form 10-Q/A include the restatement of our condensed consolidated balance sheet at December 31, 2005 and March 31, 2006 to reflect the reclassification of additional paid in capital to accumulated deficit. Part I, Item 1 of this Form 10-Q/A contains more information about the restatement in “Note 2. Restatement of Financial Statements,” which accompanies the condensed financial statements in this report. Additionally, we have provided enhanced disclosure concerning other comments provided by the Staff. Specifically, footnote 7 has been revised to provide enhanced disclosure regarding acquisitions. Part I, Item 2, Critical Accounting Policies—Revenue Recognition has also been amended to reflect enhanced disclosure regarding premium reimbursement, as appropriate. Additionally, Part I, Item 4, Controls & Procedures has been amended.
For convenience and ease of reference, we are filing the amended Quarterly Report in its entirety. Unless otherwise stated, all information contained in this amended Quarterly Report is as of May 10, 2006, the filing date of our original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006. For more current information, readers should refer to the reports and other documents we have filed with or furnished to the Commission subsequent to May 10, 2006.
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ALLION HEALTHCARE, INC. AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
| Item 1. FINANCIAL | STATEMENTS |
CONDENSED CONSOLIDATED BALANCE SHEETS
At March 31, 2006 (UNAUDITED and | At December 31, 2005 (RESTATED—See Note 2) | |||||||
ASSETS | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 34,404,893 | $ | 3,845,037 | ||||
Short term investments and securities held for sale | 15,614,788 | 23,000,553 | ||||||
Accounts receivable, (net of allowance for doubtful accounts of $288,624 in 2006 and $282,824 in 2005) | 16,215,595 | 14,640,304 | ||||||
Inventories | 3,385,645 | 3,228,225 | ||||||
Prepaid expenses and other current assets | 938,301 | 762,466 | ||||||
Total current assets | 70,559,222 | 45,476,585 | ||||||
Property and equipment, net | 849,826 | 671,396 | ||||||
Goodwill | 23,624,565 | 19,739,035 | ||||||
Intangible assets | 21,517,907 | 20,314,866 | ||||||
Other assets | 89,908 | 87,123 | ||||||
Total Assets | $ | 116,641,428 | $ | 86,289,005 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Accounts payable and accrued expenses | $ | 16,505,493 | $ | 17,205,977 | ||||
Notes payable-subordinated | 686,973 | 675,000 | ||||||
Current portion of capital lease obligations | 82,549 | 107,379 | ||||||
Other current liabilities | 5,023 | — | ||||||
Total current liabilities | 17,280,038 | 17,988,356 | ||||||
LONG TERM LIABILITIES: | ||||||||
Notes payable—subordinated | — | 682,710 | ||||||
Capital lease obligations | 81,436 | 92,818 | ||||||
Deferred income taxes | 238,957 | 153,000 | ||||||
Other | 47,010 | 28,892 | ||||||
Total liabilities | 17,647,441 | 18,945,776 | ||||||
COMMITMENTS & CONTINGENCIES | ||||||||
STOCKHOLDERS’ EQUITY | ||||||||
Preferred stock, $.001 par value, shares authorized 20,000,000; issued and outstanding 0 at March 31, 2006 and December 31, 2005 | — | — | ||||||
Common stock, $.001 par value; shares authorized 80,000,000; issued and outstanding 16,131,316 at March 31, 2006 and 12,956,382 at December 31, 2005. | 16,131 | 12,956 | ||||||
Additional paid-in capital | 110,704,797 | 80,228,664 | ||||||
Accumulated deficit | (11,803,923 | ) | (12,936,944 | ) | ||||
Accumulated other comprehensive income | 76,982 | 38,553 | ||||||
Total stockholders’ equity | 98,993,987 | 67,343,229 | ||||||
Total liabilities and stockholders’ equity | $ | 116,641,428 | $ | 86,289,005 | ||||
See notes to condensed consolidated financial statements.
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ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| Three months ended March 31, | |||||||
| 2006 | 2005 | ||||||
Net sales | $ | 41,285,202 | $ | 22,695,749 | |||
Cost of goods sold | 34,631,118 | 19,122,146 | |||||
Gross profit | 6,654,084 | 3,573,603 | |||||
Operating expenses: | |||||||
Selling, general and administrative expenses | 5,800,303 | 3,448,228 | |||||
Operating income | 853,781 | 125,375 | |||||
Interest income (expense) | 410,836 | (106,939 | ) | ||||
Other income | 102 | — | |||||
Income from continuing operations before taxes | 1,264,719 | 18,436 | |||||
Provision for taxes | 131,698 | — | |||||
Income before discontinued operations | 1,133,021 | 18,436 | |||||
Loss from discontinued operations | — | 5,340 | |||||
Net income | $ | 1,133,021 | $ | 13,096 | |||
Basic earnings per common share: | |||||||
Earnings from continuing operations | $ | 0.07 | $ | 0.01 | |||
Loss from discontinued operations | 0.00 | 0.00 | |||||
Earnings per share | $ | 0.07 | $ | 0.01 | |||
Diluted earnings per common share: | |||||||
Earnings from continuing operations | $ | 0.07 | $ | 0.00 | |||
Loss from discontinued operations | 0.00 | 0.00 | |||||
Earnings per share | $ | 0.07 | $ | 0.00 | |||
Basic weighted average of common shares outstanding | 15,192,061 | 3,100,000 | |||||
Diluted weighted average of common shares outstanding | 16,648,743 | 8,799,702 | |||||
See notes to condensed consolidated financial statements.
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ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three months ended March 31, | ||||||||
| 2006 | 2005 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net income | $ | 1,133,021 | $ | 13,096 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 736,435 | 298,044 | ||||||
Deferred rent | 18,118 | — | ||||||
Provision for doubtful accounts | 49,000 | — | ||||||
Amortization of debt discount on acquisition notes | 4,263 | — | ||||||
Tax benefit realized from the exercise of employee stock options | 45,741 | — | ||||||
Non-cash stock compensation expense | 39,329 | — | ||||||
Deferred Income Taxes | 85,957 | — | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (1,624,291 | ) | 78,743 | |||||
Inventories | 274,151 | 176,513 | ||||||
Prepaid expenses and other assets | (352,801 | ) | 17,856 | |||||
Accounts payable and accrued expenses | (331,001 | ) | 214,077 | |||||
Net cash provided by operating activities: | 77,922 | 798,329 | ||||||
CASH FLOWS USED IN INVESTING ACTIVITIES: | ||||||||
Purchase of property and equipment | (264,829 | ) | (30,089 | ) | ||||
Purchases of short term securities | (31,331,920 | ) | — | |||||
Sales of short term securities | 38,756,114 | |||||||
Payments for acquisition of North American, net of cash acquired of $88,808 | (16,614 | ) | (5,196,408 | ) | ||||
Payments for acquisition of Specialty Pharmacy | (8,815 | ) | (5,002,628 | ) | ||||
Payments for acquisition of Oris Medical’s Assets | (153,262 | ) | (100,000 | ) | ||||
Payments for acquisition of Priority’s Assets | (1,317,534 | ) | — | |||||
Payments for acquisition of Maiman’s Assets | (5,243,527 | ) | — | |||||
Payments for acquisition of H&H’s Assets | (2,993 | ) | — | |||||
Payments for acquisition of Whittier’s Assets | (26,845 | ) | — | |||||
Net cash used in investing activities | 389,775 | (10,329,125 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Net proceeds from sale of Preferred Stock | — | 103,554 | ||||||
Proceeds from line of credit | — | 12,355,840 | ||||||
Repayment of line of credit | — | (10,317,148 | ) | |||||
Net proceeds from IPO | — | (83,083 | ) | |||||
Net proceeds from secondary public offering | 28,987,311 | — | ||||||
Proceeds from exercise of employee stock options and warrants | 1,816,060 | — | ||||||
Repayment of notes payable and capital leases | (711,212 | ) | (29,644 | ) | ||||
Proceeds from notes payable | — | 1,500,000 | ||||||
Net cash provided by financing activities | 30,092,159 | 3,529,519 | ||||||
NET INCREASE / (DECREASE) IN CASH AND CASH EQUIVALENTS | 30,559,856 | (6,001,277 | ) | |||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 3,845,037 | 6,979,630 | ||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 34,404,893 | $ | 978,353 | ||||
See notes to condensed consolidated financial statements.
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NOTE 1 ORGANIZATION AND DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION
(a) Allion Healthcare, Inc. (the “Company” or “Allion”) was originally incorporated in 1983 under the name The Care Group Inc. In 1999, the Company changed its name to Allion Healthcare, Inc. The Company is a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. The Company operates primarily under its trade name MOMS Pharmacy.
(b) The condensed consolidated financial statements include the accounts of Allion Healthcare, Inc. and its subsidiaries. The condensed consolidated balance sheet as of March 31, 2006 and the condensed consolidated statements of operations for the three months ended March 31, 2006 and 2005, and the condensed consolidated statements of cash flows for the three months ended March 31, 2006 and 2005, are unaudited and have been prepared by the Company. The unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required to be presented for complete financial statements. The accompanying financial statements reflect all adjustments (consisting only of normal recurring items), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The accompanying condensed consolidated balance sheet at December 31, 2005 has been derived from audited financial statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2005 as filed with the Securities and Exchange Commission (the “SEC”) on April 19, 2006. The Company believes that the disclosures provided are adequate to make the information presented not misleading.
The financial statements and related disclosures have been prepared with the assumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company believes that the disclosures provided are adequate to make the information presented not misleading. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto included in the Annual Report on Form 10-K/A for the year ended December 31, 2005 as filed with the SEC on April 19, 2006.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States require the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results to be expected for the year ending December 31, 2006 or any other interim period.
NOTE 2 RESTATEMENT OF FINANCIAL STATEMENTS
The Company recently received a comment letter from the SEC’s Division of Corporation Finance (“Staff”) relating to a routine review of Allion’s Form 10-K/A for the 2005 fiscal year and Form 10-Q for the quarter ended March 31, 2006. In the course of responding to the Staff’s comments, the Company reviewed the accounting treatment for certain warrants considered derivatives under Emerging Issue Task Force No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” Specifically, in February 2005, the Company issued warrants for 351,438 shares of common stock in connection with its acquisition of Specialty Pharmacies, Inc., half of which were redeemed as required under the terms of the warrants upon the Company’s initial public offering (“IPO”) in June 2005 and the other half of which became non-redeemable as a result of the IPO. Although the Company appropriately classified these warrants as liabilities when issued as required by EITF 00-19, the warrants that became non-redeemable as a
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result of the IPO became reclassified as equity at that time and should have been revalued at fair value prior to that reclassification with any increase in value charged to other income (expense).
On November 6, 2006, after discussion with the Company’s independent registered public accounting firm, and consultation with management and the Board of Directors, the Company concluded that the financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month period ended September 30, 2005 and the year ended December 31, 2005 should be restated to reflect the fair value adjustment of redeemable warrants that became non-redeemable upon the completion of the Company’s IPO. The fair value of the warrants was approximately $1.5 million and resulted in a fair value adjustment of $1.2 million that will be recorded as a non-cash charge to other expense in the restated financial statements for the three-month and six-month periods ended June 30, 2005. This expense is a one time charge to the income statement and does not affect operating income.
The condensed consolidated balance sheets at March 31, 2006 and December 31, 2005 in this Form 10-Q/A for the three months ended March 31, 2006, have been restated to reflect the reclassification of additional paid in capital to accumulated deficit as a result of the charge to other expense in June 2005. The restatement also affected the three-month and six-month periods ended June 30, 2005, which will be reported on Form 10-Q/A for the quarter ended June 30, 2006, and the nine-month period ended September 30, 2005, which was reported on Form 10Q for the quarter ended September 30, 2006.
The following table reports the items in the condensed consolidated balance sheet at March 31, 2006 and December 31, 2005 that were affected by the restatement.
| Balance Sheet at March 31, 2006 | Balance Sheet at December 31, 2005 | |||||||||||||||
| As Originally Reported | As Restated | As Originally Reported | As Restated | |||||||||||||
| (in thousands of dollars) | ||||||||||||||||
Additional paid in capital | $ | 109,255 | $ | 110,705 | $ | 78,779 | $ | 80,229 | ||||||||
Accumulated deficit | $ | (10,354 | ) | $ | (11,804 | ) | $ | (11,487 | ) | $ | (12,937 | ) | ||||
NOTE 3 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. Preferred stock convertible into common stock of 0 and 4,570,009 shares were outstanding at March 31, 2006 and 2005, respectively. Options and warrants to purchase approximately 1,796,495 and 3,331,575 shares of common stock were outstanding at March 31, 2006 and 2005, respectively. The diluted shares outstanding for the three month period ended March 31, 2006 was 16,648,743.
NOTE 4 CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The carrying amount of cash approximates its fair value. Our short-term securities are generally government obligations and are carried at amortized cost, which approximates fair market value. The gross unrealized gain at March 31, 2006 was $62,194 and is recorded as a component of accumulated other comprehensive income. There were no short term securities included in cash and cash equivalents at December 31, 2005. Cash and cash equivalents consist of the following at March 31, 2006:
Cash | $ | 6,610,779 | |
Short-term securities | 27,794,114 | ||
Total | $ | 34,404,893 |
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NOTE 5 SHORT TERM INVESTMENTS
Investment in short term securities include certificates of deposit and available for sale securities, which are carried at amortized cost. Due to the short term nature of these investments, the amortized cost approximates fair market value. The gross unrealized gain at March 31, 2006 and December 31, 2005 was $14,788 and $38,553, respectively, and is recorded as a component of accumulated other comprehensive income. All of these investments mature within 12 months and consist of the following at March 31, 2006:
Certificates of Deposit | $ | 1,500,000 | |
Auction Rate Securities | 14,114,788 | ||
Total | $ | 15,614,788 |
NOTE 6 SECONDARY PUBLIC OFFERING
On January 26, 2006, the Company along with certain selling stockholders completed a secondary public offering of its common stock. The Company sold 1,800,000 shares of its common stock and participating stockholders sold 2,636,454 shares of common stock at a price of $12.83 per share less an underwriting discount and commission of $0.71 per share. In addition, the Company granted the underwriters an option, exercisable until February 27, 2006, to purchase up to an additional 665,468 shares at the secondary public offering price. On January 27, 2006, the underwriters exercised their over-allotment option to purchase 665,468 shares of common stock at $12.83 per share, less an underwriting discount and commission of $0.71 per share. The Company received net proceeds of $21.8 million and $8.1 million from the secondary public offering and from the exercise of the over-allotment option respectively, less expenses incurred of $1.0 million. The Company did not receive any proceeds from the sale of shares by the participating stockholders. The Company received $1.8 million from the payment of the exercise price of options and warrants to purchase 574,500 shares of our common stock.
NOTE 7 ACQUISITIONS
On January 4, 2005, MOMS Pharmacy, Inc. (“MOMS Pharmacy”), a California corporation and wholly-owned subsidiary of the Company entered into a stock purchase agreement with Michael Stone and Jonathan Spanier, who owned 100% of the stock of North American Home Health Supply, Inc. (“NAHH”), a California corporation. NAHH is engaged primarily in the pharmacy business in California. On the same day, MOMS Pharmacy acquired 100% of the stock of NAHH from Messrs. Stone and Spanier, in accordance with the terms of a stock purchase agreement.
In accordance with the terms of the Stock Purchase Agreement, on January 4, 2005 MOMS Pharmacy acquired 100% of the stock of NAHH in exchange for payment by Allion of the following consideration:
| • | $5,615,996 of cash paid, including $473,999 of direct acquisition costs (less cash acquired of $88,808); |
| • | promissory notes of MOMS Pharmacy, due January 1, 2006, in the aggregate principal amount of $675,000; |
| • | promissory notes of MOMS Pharmacy, due January 1, 2007, in the aggregate principal amount of $700,000; and |
| • | warrants issued by Allion to purchase an aggregate of 150,000 shares of Allion common stock, at an exercise price of $6.26 per share; the warrants were recorded at $241,760, which represents the fair market value of the warrants as of the acquisition date. |
The notes accrue interest at a rate of 2.78% per year. Allion unconditionally guaranteed the payment of the promissory notes by its MOMS Pharmacy subsidiary, pursuant to a guaranty, dated January 4, 2005, in favor of Messrs. Stone and Spanier. Under the guaranty, Allion is absolutely, irrevocably and unconditionally liable for the performance of each and every obligation of MOMS Pharmacy under the promissory notes.
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The purchase price was subject to a post-closing adjustment based on the amount of NAHH’s working capital as of the closing date as well as cash collected from March 31, 2005 through December 31, 2005 in respect to accounts receivable as of the closing date. Allion paid an additional $141,997 to Messrs. Stone and Spanier in respect of the post-closing adjustment obligation. The purchase price also is subject to reduction for changes in the Medi-Cal rules and regulations at any time after the closing date, which result in reduced reimbursement payments to NAHH for any enteral or nutritional products it sold in 2004. Any purchase price reduction due to changes in the Medi-Cal rules and regulations will be payable solely by offset against the outstanding principal amounts of the promissory notes issued in the transaction.
The fair value of the warrants was estimated on the date of the issuance using the Black-Scholes option-pricing model. Valuation assumptions used in the Black-Scholes calculation consisted of a volatility of 20%, a stock price of $6.25, a risk free rate equal to the U.S. treasury rate, and an expected term equivalent to the contractual life of each warrant.
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the California HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
On February 28, 2005, MOMS Pharmacy entered into a stock purchase agreement with the owners (the “Specialty Sellers”) of 100% of the stock of Specialty Pharmacies, Inc., a Washington corporation (“Specialty” or “SPI”). Specialty is engaged primarily in the business of providing HIV/AIDS pharmacy services in Washington and California. On the same day, MOMS Pharmacy acquired 100% of the stock of Specialty from the Specialty Sellers, in accordance with the terms of a stock purchase agreement.
Pursuant to the terms of the Stock Purchase Agreement, MOMS Pharmacy acquired 100% of the stock of Specialty for the following combination of cash and securities:
| • | $5,505,017 of cash paid, including $496,546 of direct acquisition costs; |
| • | promissory notes of MOMS Pharmacy, due February 28, 2006, in the aggregate principal amount of $1,900,000. The notes were subsequently reduced in the amount of $498,631 for a post closing working capital adjustment; and |
| • | warrants issued by Allion to purchase an aggregate of 351,438 shares of Allion common stock, at an exercise price of $6.26 per share; the warrants were recorded at $1,898,215, which represents the fair market value of the mandatorily redeemable warrants as of the acquisition date. |
At the closing of Allion’s initial public offering the notes were paid in full.
The warrants for 351,438 shares of common stock have a fair market value of $1,898,215 and were recorded as a liability because the warrants were mandatorily redeemable in full at the option of the holders if the Company failed to complete an initial public offering (“IPO”) by a specified date, or 50% mandatorily redeemable upon a qualifying initial public offering. The valuation of the warrants was based on the value of the various financial outcomes to the holders of the warrants. The various outcomes were based on the Company’s ability to complete an IPO by June 1, 2006. A value was determined under each scenario and then the probability of the outcome was applied to the value of each outcome to get a weighted average value. Upon completion of an IPO, the Company would be required to redeem 50% of the warrants; therefore, 50% of the warrants were valued at $9.00 per share, which is the fixed price at which the Company would redeem such warrants. The fair value of the remaining 50% of the warrants was valued using the Black-Scholes option-pricing model. Valuation assumptions used in the Black-Scholes calculation consisted of a volatility of 20%, a risk free rate equal to the
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U.S. treasury rate, and an expected term equivalent to the contractual life of each warrant. If the Company was unable to complete an IPO by June 1, 2006, the holders of these warrants had the right to have the Company acquire 100% of their warrants at a price of $6.26 per share. In this scenario, 100% of the warrants were valued using the Black-Scholes option pricing model using the same assumptions set forth above.
Upon completion of its IPO in June 2005, Allion redeemed and acquired 50% of the warrants issued to the former owners of Specialty Pharmacies, Inc. at a price of $9.00 per share in accordance with the terms of the warrants. Allion paid $1,581,471 with proceeds from the IPO to repurchase 175,719 shares or 50% of the warrants issued to the Specialty Sellers. The warrants for the remaining 50%, or 175,719 shares, were revalued at fair value and reclassified to equity. The fair value of the remaining 50% was $1,449,959 and resulted in a fair value adjustment of $1,133,215 that was recorded as other expense in June 2005.
The purchase price was subject to a post-closing adjustment based on the amount of Specialty’s working capital as of the closing, which resulted in a $498,631 reduction in the purchase price. In addition, MOMS Pharmacy agreed to reimburse Specialty Sellers up to a maximum of $200,000, for any amounts received by Specialty from Medi-Cal relating to the California Pilot Program for prescriptions filled between September 1, 2004 and December 31, 2004.
On February 28, 2005, MOMS Pharmacy also acquired from Michael Tubb, pursuant to a Purchase Agreement signed on the same day, all rights he has to acquire capital stock of Specialty. Under the agreement, MOMS Pharmacy paid $1,200,000 to Mr. Tubb, consisting of $600,000 cash at closing and a $600,000 one-year promissory note payable in two equal installments on February 28, 2006 and March 31, 2006. The contingent consideration of the $600,000 promissory note is treated as non-recurring compensation based on his continued employment for one year post acquisition. The Company accrued $50,000 per month as compensation expense over the twelve month period of the agreement. This note accrued interest at a rate equal to the lowest applicable federal rate. These payments were expressly conditioned on (i) the fulfillment of the non-solicitation and non-competition provisions of the purchase agreement between MOMS Pharmacy and Mr. Tubb, and (ii) Mr. Tubb’s continued employment with Specialty and his use of best efforts, time and attention to and on behalf of Specialty. Having satisfactorily met these conditions, payment of the promissory note was made to Mr. Tubb on February 28, 2006 and March 31, 2006.
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the Northern California and Washington HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
On August 5, 2005, Medicine Made Easy (“MME”), a California corporation and wholly-owned subsidiary of the Company, purchased certain assets of Frontier Pharmacy & Nutrition, Inc. d/b/a PMW Pharmacy (“PMW”), a California-based specialty pharmacy focused on HIV/AIDS pharmacy services in the Long Beach, California area. Under the terms of the asset purchase agreement between MME and PMW, MME acquired selected assets, including PMW’s customer list of HIV/AIDS patients and inventory, for the following:
| • | $8,875,379 of cash paid, including $145,379 of direct acquisition costs paid (total acquisition costs have been estimated at $300,000—$154,621 remains accrued at March 31, 2006); |
| • | $970,000 escrow payment paid 90 days after closing; and |
| • | $151,765 cash paid for inventories. |
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the Long Beach, California HIV/AIDS market. The acquisition was recorded by allocating the
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purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
On December 9, 2005, MME purchased certain assets of Priority Pharmacy, Inc. (“Priority”), a California-based specialty pharmacy focused on HIV/AIDS pharmacy services in the San Diego, California area. Under the terms of the asset purchase agreement between MME and Priority, MME acquired selected assets, including Priority’s customer list of HIV/AIDS patients and inventory, for the following:
| • | $7,769,905 of cash paid, including $169,905 of direct acquisition costs paid (total acquisition costs have been estimated at $250,000—$80,095 remains accrued at March 31, 2006); |
| • | $95,000 of additional cash paid as part of a subsequent Asset Purchase Agreement dated January 23, 2006; and |
| • | $379,192 cash paid for inventories. |
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the San Diego, California HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
On March 13, 2006, MOMS Pharmacy of Brooklyn, Inc. (“MOMS of Brooklyn”), a New York corporation and wholly owned subsidiary of the Company purchased certain assets of H.S. Maiman Rx, Inc. (“Maiman”), a Brooklyn, New York pharmacy. Under the Asset Purchase Agreement between MOMS of Brooklyn and Maiman, MOMS of Brooklyn acquired selected assets, including Maiman’s customer list of HIV/AIDS patients and inventory, for the following:
| • | $4,811,956 of cash paid, including $86,956 of direct acquisition costs paid (total acquisition costs have been estimated at $125,000—$38,044 remains accrued at March 31, 2006); |
| • | $525,000 additional payment due; and |
| • | $431,571 cash paid for inventories. |
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the New York City HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
The goodwill recorded as the result of the NAHH acquisition will not be deductible for tax purposes. The goodwill recorded as the result of the Specialty, PMW, Priority and Maiman acquisitions is expected to be deductible for tax purposes.
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The following tables describe the allocation of purchase price for these five acquisitions:
Purchase Price Paid for North American | ||||
Cash paid | $ | 5,141,996 | ||
Notes Payable | 1,375,000 | |||
Fair value of warrants issued | 241,760 | |||
Direct acquisition costs | 473,999 | |||
Total Purchase Price | 7,232,755 | |||
less: net tangible assets | (243,630 | ) | ||
debt discount | (51,253 | ) | ||
| $ | 6,937,872 | |||
Allocation of Purchase Price for North American | ||||
Covenant Not to Compete (5 year life) | $ | 50,000 | ||
Referral Lists (15 year life) | 4,514,331 | |||
Goodwill | 2,373,541 | |||
| $ | 6,937,872 | |||
Purchase Price Paid for Specialty | ||||
Cash paid | $ | 5,000,000 | ||
Notes Payable | 1,401,369 | |||
Fair value of warrants issued | 1,898,215 | |||
Direct acquisition costs | 655,017 | |||
Total Purchase Price | 8,954,601 | |||
plus: net liabilities | 415,493 | |||
| $ | 9,370,094 | |||
Allocation of Purchase Price for Specialty | ||||
Covenant Not to Compete (5 year life) | $ | 75,000 | ||
Covenant Not to Compete (3 year life) | 222,672 | |||
Referral Lists (15 year life) | 4,153,386 | |||
Workforce (part of goodwill) | 400,190 | |||
Goodwill | 4,518,846 | |||
| $ | 9,370,094 | |||
Purchase Price Paid for PMW | ||||
Cash paid | $ | 8,730,000 | ||
Escrow payment payable | 970,000 | |||
Inventories | 151,765 | |||
Direct acquisition costs | 300,000 | |||
Total purchase price | 10,151,765 | |||
less: net tangible assets | (151,765 | ) | ||
| $ | 10,000,000 | |||
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Allocation of Purchase Price for PMW | |||
Referral list (15 year life) | $ | 5,819,174 | |
Non compete—participating owner (3 year life) | 851,822 | ||
Non compete—non-participating owner (3 year life) | 25,000 | ||
Workforce (part of goodwill) | 110,350 | ||
Goodwill | 3,193,654 | ||
| $ | 10,000,000 | ||
Purchase Price Paid for Priority | ||||
Cash paid | $ | 7,600,001 | ||
Additional cash paid—subsequent purchase | 95,000 | |||
Inventories | 379,192 | |||
Direct acquisition costs | 250,000 | |||
Total purchase price | 8,324,193 | |||
less: net tangible assets | (389,227 | ) | ||
operating expense | (8,250 | ) | ||
| $ | 7,926,716 | |||
Allocation of Purchase Price for Priority | ||||
Referral list (15 year life) | $ | 2,577,240 | ||
Non compete—active owner (5 year life) | 418,561 | |||
Non compete—inactive owner (5 year life) | 25,000 | |||
Workforce (part of goodwill) | 118,661 | |||
Goodwill | 4,787,254 | |||
| $ | 7,926,716 | |||
Purchase Price Paid for Maiman | ||||
Cash paid | $ | 4,725,000 | ||
Additional payments due | 525,000 | |||
Inventories | 431,571 | |||
Direct acquisition costs | 125,000 | |||
Total purchase price | 5,806,571 | |||
less: net tangible assets | (431,571 | ) | ||
| $ | 5,375,000 | |||
Preliminary Allocation of Purchase Price for Maiman* | ||||
Referral list (15 year life) | $ | 1,700,000 | ||
Non compete (5 year life) | 25,000 | |||
Workforce (part of goodwill) | 120,000 | |||
Goodwill | 3,530,000 | |||
| $ | 5,375,000 | |||
| * | Maiman allocation of purchase price is subject to change based on finalization of independent valuation. |
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The following pro forma results were developed assuming the acquisition of Specialty, PMW, Priority and Maiman occurred on January 1, 2005. The pro forma results do not purport to represent what our results of operations actually would have been if the transactions set forth above had occurred on the date indicated or what our results of operations will be in future periods.
Three Months Ended March 31, | ||||||
| 2006 | 2005 | |||||
Revenue | $ | 43,454,812 | $ | 41,450,253 | ||
Net Income | 1,130,740 | 809,840 | ||||
Earnings per common share: | ||||||
Basic | $ | 0.07 | $ | 0.26 | ||
Diluted | $ | 0.07 | $ | 0.09 | ||
On June 30, 2005, Oris Health, Inc, a newly-formed California corporation and wholly-owned subsidiary of the Company, acquired, pursuant to an asset purchase agreement dated May 19, 2005, all right, title and interest in and to certain intellectual property and other assets owned, leased or held for use by Oris Medical System, Inc. (“Oris”) a development stage company incorporated in Washington, including an assignment of Oris’ license to use Ground Zero Software, Inc.’s computer software program known asLabTracker—HIV™, and Oris System, an electronic prescription writing system. Pursuant to the terms of an earn-out formula set forth in the asset purchase agreement, Oris and Ground Zero may receive up to an additional $40,000,000 in the aggregate, paid on a quarterly basis, based on the net number of HIV patients of physician customers utilizing theLabTracker—HIV™ software or the Oris System to fill their prescriptions at MOMS Pharmacy or an affiliate of MOMS Pharmacy. During the first quarter of 2006, we serviced 1,041 total patients that were monitored under LabTracker and/or Oris software. This includes an incremental 104 patients that we brought on during the three months ended March 31, 2006 that will be paid under the Oris earn-out agreement. Oris’ and Ground Zero’s rights to these additional payments terminate 40 months after the closing of the acquisition and, under certain circumstances set forth in the asset purchase agreement, portions of these additional payments may be made in stock of the Company. Earn-out payments are recorded quarterly as earned. Payments made to Oris for the patients from existing clinics will be allocated to the clinic list and amortized over a fixed 15 year period beginning from when Oris was acquired, and from new clinics, will be expensed. Payments made to Ground Zero for patients from both new and existing clinics will be allocated to the exclusiveLabTracker license agreement and will be amortized over its remaining life. Oris does not qualify as a business so the transaction was accounted for as the acquisition of certain assets and liabilities of Oris.
Purchase Price Paid for Oris’ Intangible Assets | ||||
Cash paid | $ | 1,000,000 | ||
Earn out obligation | 229,000 | |||
Operating expenses paid to seller | 250,000 | |||
Employee severance payments | 72,520 | |||
Direct acquisition costs | 61,058 | |||
Total Purchase Price | 1,612,578 | |||
less: net tangible assets | (29,000 | ) | ||
| $ | 1,583,578 | |||
Allocation of Purchase Price for Oris’ Intangible Assets | ||||
License agreement—LabTracker—exclusive rights (40 month life) | $ | 1,119,957 | ||
Clinic List (15 year life—from date of purchase) | 177,500 | |||
Computer software (3 year life) | 86,121 | |||
Non compete (40 month life) | 200,000 | |||
| $ | 1,583,578 | |||
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The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition for both NAHH and Specialty.
| NAHH | Specialty | ||||||
Accounts receivable | $ | 1,592,726 | $ | 2,135,450 | |||
Other current assets | 267,874 | 882,461 | |||||
Property & equipment, net | 15,679 | 57,158 | |||||
Intangible assets | — | 49,805 | |||||
Other assets | 19,737 | — | |||||
Total assets acquired | 1,896,016 | 3,124,874 | |||||
Accounts payable | $ | 1,478,675 | $ | 3,447,362 | |||
Other current liabilities | 173,711 | 83,170 | |||||
Other long term liabilities | — | 9,835 | |||||
Total liabilities acquired | 1,652,386 | 3,540,367 | |||||
Net assets (liabilities) acquired | $ | 243,630 | $ | (415,493 | ) | ||
The changes in the carrying amount of goodwill for the three-month period ended March 31, 2006, are as follows:
Balance as of December 31, 2005 | $ | 19,739,035 | |
Goodwill acquired during year | 3,885,530 | ||
Impairment losses | — | ||
Balance as of March 31, 2006 | $ | 23,624,565 | |
NOTE 8 CONTINGENCIES—LEGAL PROCEEDINGS
On March 9, 2006, we alerted the staff of the SEC’s Division of Enforcement to the issuance of our press release of that date announcing our intent to restate our quarterly filings for the periods ended June 30, 2005 and September 30, 2005. On March 13, 2006, we received a letter from the Division of Enforcement notifying us that the Division of Enforcement had commenced an informal inquiry and requested that we voluntarily produce certain documents and information. In that letter, the SEC also stated that the informal inquiry should not be construed as an indication that any violations of law have occurred. We are cooperating fully with the Division of Enforcement’s inquiry.
We are involved from time to time in legal actions arising in the ordinary course of our business. We currently have no pending or threatened litigation that we believe will result in an outcome that would materially adversely affect our business. Nevertheless, there can be no assurance that future litigation, to which the Company may become a party, will not have a material adverse effect on our business.
NOTE 9 STOCK-BASED COMPENSATION PLAN
The Company maintains stock option plans that include both incentive and non-qualified options reserved for issuance to key employees, including officers and directors. All options are issued at fair market value at the grant date and vesting terms vary according to the plans. The plans allow for the payment of option exercises through the surrender of previously owned mature shares based on the fair market value of such shares at the date of surrender.
Prior to January 1, 2006, the Company followed Accounting Principles Board Opinion No. 25, ”Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations in accounting for its employee stock-based compensation. Under APB No. 25, compensation expense was recorded if, on the
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date of grant, the market price of the underlying stock exceeded its exercise price. As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure—An Amendment of FASB Statement No. 123” (“SFAS No. 148”), the Company had retained the accounting prescribed by APB No. 25 and presented the disclosure information prescribed by SFAS No. 123 and SFAS No. 148.
Had compensation expense for stock option grants issued been determined under the fair value method of SFAS No. 123, the Company’s net loss and loss per share (EPS) for the three-month period ended March 31, 2005 would have been:
Three Months Ended March 31, 2005 | ||||
Reported Income | $ | 13,096 | ||
Stock-based compensation cost | (104,976 | ) | ||
Pro-forma net loss | $ | (91,880 | ) | |
Reported basic EPS | 0.01 | |||
Reported diluted EPS | 0.00 | |||
Pro-forma basic & diluted EPS | (0.03 | ) | ||
Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment”, which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their fair values and over the requisite service period. For the three months ended March 31, 2006, the Company recorded non-cash compensation expense in the amount of $39,329 ($.002 per basic and diluted share) relating to stock options. The Company elected to utilize the modified-prospective application method, whereby compensation expense is recorded for all awards granted
after January 1, 2006 and for the unvested portion of awards granted prior to this date. Accordingly, prior period amounts have not been restated.
A summary of stock option activity for the three-months ended March 31, 2006 is presented below:
Options | Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value | |||||||
Outstanding at January 1, 2006 | 1,452,000 | $ | 3.21 | ||||||||
Granted | 0 | — | |||||||||
Exercised | (357,250 | ) | 2.55 | ||||||||
Forfeited or expired | (12,083 | ) | 5.31 | ||||||||
Outstanding at March 31, 2006 | 1,082,667 | $ | 3.40 | 5.0 | $ | 10,994,767 | |||||
Exercisable at March 31, 2006 | 763,779 | $ | 2.21 | 4.5 | $ | 8,644,649 | |||||
The total intrinsic value of options exercised during the three-months ended March 31, 2006 was $3,324,595.
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A summary of the status of the Company’s non-vested shares as of March 31,2006 is as follows:
Non-vested Shares | Shares | Weighted Avg. Grant Date Fair Value | ||||
Non vested at January 1, 2006 | 341,805 | $ | 1.64 | |||
Granted | — | — | ||||
Vested | (10,834 | ) | 2.44 | |||
Forfeited | (12,083 | ) | 0.92 | |||
Non vested at March 31, 2006 | 318,888 | $ | 1.64 | |||
As of March 31, 2006, there was $191,883 of total unrecognized compensation cost, net of estimated forfeitures, related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted-average period of 1.5 years. The total fair value of shares vested during the three-months ended March 31, 2006 was $39,329, which was recorded as part of general and administrative expenses.
NOTE 10 CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
The Company provides prescription medications to its customers in the United States through its nine distribution centers. Credit losses relating to customers historically have been minimal and within management’s expectations.
At December 31, 2005 and March 31, 2006 the Company maintained the majority of its cash and short term investments with two financial institutions. Such cash balances, at times, may exceed FDIC limits. The Company has not experienced any losses in such accounts.
Federal and state third-party reimbursement programs represented approximately 88% and 88% of total sales for the three month periods ended March 31, 2006 and 2005, respectively. At March 31, 2006 and December 31, 2005, the Company had an aggregate outstanding receivable from federal and state agencies of approximately $11,801,671 and $11,736,073, respectively.
NOTE 11 MAJOR SUPPLIERS
During the three months ended March 31, 2006 and 2005, the Company purchased approximately $28,304,686 and $18,166,000, respectively, from one major drug wholesaler. Amounts due to this supplier at March 31, 2006 and December 31, 2005 were approximately $9,600,422 and $12,358,000, respectively.
In September 2003, the Company signed a five-year agreement with a drug wholesaler that requires certain minimum purchases. If the Company does not meet the minimum purchase commitments as set forth in the agreement, the Company will be charged a prorated amount of 0.20% of the projected volume remaining on the term of the Agreement. The agreement also provides that the Company’s minimum purchases during the term of the agreement will be no less than $400,000,000. The Company has purchased approximately $196,474,000 from this drug wholesaler since the beginning of the term of this agreement and believes it will be able to meet its minimum purchase obligations under this agreement.
NOTE 12 SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES
Interest paid on credit facilities, notes and capital leases for the three months ended March 31, 2006 and 2005 was $29,450 and $94,330, respectively. During 2005, the Company made two acquisitions of assets with part of the consideration paid with notes payable. The detail for these transactions can be found in Note 7.
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NOTE 13 DISCONTINUED OPERATIONS
In March 2005, the Company decided to cease its operations in Texas and discontinue its business of serving organ transplant and oncology patients. The Company closed this facility as of June 30, 2005. In accordance with the provisions of Statement of Financial Accounting Standard, Accounting for the Impairment or Disposal of Long- Lived Assets (SFAS No. 144), the results of operations for the Company’s Texas operations have been classified as discontinued operations for all periods presented in the accompanying consolidated statements of operations.
Three Months Ended March 31, | |||||||
| 2006 | 2005 | ||||||
Revenue | $ | 0 | $ | 782,128 | |||
Net Loss | 0 | (5,340 | ) | ||||
NOTE 14 SUBSEQUENT EVENTS
On April 6, 2006, MME purchased certain assets of the HIV business of H&H Drug Stores, Inc. d/b/a Western Drug (“H&H”), a Glendale, California based pharmacy. Under the terms of the asset purchase agreement between MME and H&H, the Company paid H&H $4.6 million to acquire selected assets, including H&H’s customer list of HIV/AIDS patients. In addition, MME agreed to pay to H&H an amount equal to H&H’s wholesale acquisition cost for inventory of the HIV business acquired by MME. For the twelve month period ended December 31, 2005, H&H reported net sales (unaudited) of approximately $11.6 million.
On April 21, 2006, the Company allowed its credit facility with GE HFS Holdings, Inc. f/k/a Heller Healthcare Finance (“GE”) to expire. The GE credit facility provided for the Company to borrow up to a maximum of $6,000,000, based on the Company’s accounts receivable. At this time, the Company has not elected to renew this credit facility but is having discussions with GE about maintaining the current facility.
On May 1, 2006, in accordance with the terms of the Asset Purchase Agreement dated April 28, 2006, MME acquired substantially all of the assets of Whittier Goodrich Pharmacy, Inc. (“Whittier”), a Los Angeles, California based pharmacy. Under the terms of the Asset Purchase Agreement, MME paid $15.0 million, plus an amount equal to the fair market value of certain of Whittier’s inventory, to acquire substantially all of Whittier’s business and assets, including fixed assets, inventory, prescription files, and goodwill (cash and accounts receivable were excluded). For the 12-month period ended December 31, 2005, Whittier reported net sales (un-audited) of approximately $29.4 million.
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| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
RESTATEMENT
As discussed more fully in Note 2 to the condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report, we are restating our previously reported condensed consolidated financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month period ended September 30, 2005 and our fiscal year ended December 31, 2005. This Form 10-Q/A reflects the restatement of the condensed consolidated balance sheet at December 31, 2005 to reclassify additional paid in capital to accumulated deficit as a result of the change to other expense in June 2005 and the restatement’s impact on the condensed consolidated balance sheet at March 31, 2006.
This discussion and analysis (MD&A) should be read in conjunction with the restated financial statements and notes appearing elsewhere in this Report and our 2005 Annual Report on Form 10-K/A filed on November 17, 2006, which reflects the restatement of our financial statements for the year ended December 31, 2005 noted above.
FORWARD-LOOKING STATEMENTS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and notes thereto included in Item 1 of Part I of this Quarterly Report and our 2005 Annual Report on Form 10-K/A filed November 17, 2006. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The forward-looking statements included herein and any expectations based on such forward-looking statements are subject to risks and uncertainties and other important factors that could cause actual results to differ materially from the results contemplated by the forward-looking statements, including, but not limited to:
| • | The effect of regulatory changes, including but not limited to, the Medicare Prescription Drug improvement and Modernization Act of 2003; |
| • | The reduction of reimbursement rates for primary services provided by government and other third-party payers; |
| • | Changes in reimbursement policies and possible other potential reductions in reimbursements by other state agencies; |
| • | The ability of the Company to market its customized packaging system and the acceptance of such system by healthcare providers and patients; |
| • | The ability of the Company to manage its growth with a limited management team; and |
| • | The availability of appropriate acquisition candidates and or ability to successfully complete and integrate acquisitions. |
These and other risks and uncertainties are discussed in detail in our 2005 Annual Report on Form 10-K/A and in Part II Item 1A. Risk Factors of this Quarterly Report, and should be reviewed carefully. All forward-looking statements included or incorporated by reference in this Quarterly Report on Form 10-Q are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any such forward-looking statements. Stockholders are cautioned not to place undue reliance on such statements.
OVERVIEW
We are a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. We sell HIV/AIDS medications, ancillary drugs and nutritional supplies under our trade name MOMS
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Pharmacy. We work closely with physicians, nurses, clinics and AIDS Service Organizations, or ASO’s, and with government and private payors, to improve clinical outcomes and reduce treatment costs for our patients. Most of our patients rely on Medicaid and other state-administered programs, such as the AIDS Drug Assistance Program, or ADAP, to pay for their HIV/AIDS medications. The following discussion and analysis provides information that our management believes is relevant to an assessment and understanding of our results of operations and financial condition.
We operate our business as a single segment configured to serve key geographic areas most efficiently. As of March 31, 2006, we operated nine distribution centers that are located strategically in California (5 separate locations), New York (2 separate locations), Florida and Washington to serve major metropolitan areas in which high concentrations of HIV/AIDS patients reside. In discussing our results of operations, we address changes in the net sales contributed by each of these distribution centers because we believe this provides a meaningful indication of the historical performance of our business.
In March 2005, we decided to cease operating our Austin, Texas distribution center as of June 30, 2005. A significant portion of the operations of our Austin, Texas distribution center was dedicated to serving organ transplant and oncology patients, and consistent with our strategy of focusing on the HIV/AIDS market, we decided not to continue this business. We did not record any material expense associated with the discontinuance of these operations and the closing of our Austin, Texas facility. In 2005, our Austin, Texas distribution center contributed approximately $1.5 million of net sales to our financial results. As a result of our decision to discontinue our Texas operations, we have presented the results of the Texas distribution center as “discontinued operations.” As required by generally accepted accounting principles, we have restated prior periods to reflect the presentation of the Texas facility as “discontinued operations,” so that period-to-period results are comparable.
On December 8, 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003, or the MMA, was signed into law. This complex legislation made significant structural changes to the Federal Medicare program, including providing for a Medicare prescription drug benefit. Under the MMA, Medicare Part D prescription drug plans, or PDPs, were selected by the Centers for Medicare & Medicaid Services, or CMS, through a competitive bidding process so that beneficiaries will have a choice between at least two plans in the area in which they live. CMS announced the results of its bidding process and the selected PDPs through a press release on September 23, 2005.
Effective January 1, 2006, Medicaid coverage of prescription drugs for Medicaid beneficiaries who are also eligible for Medicare were shifted to the Medicare program. These enrollees are referred to as “dual eligibles.” In general, dual eligibles are persons (1) who have low income qualifying them for Medicaid benefits and (2) who also qualify for Medicare because they have chronic illnesses and disabilities, or they are over age 65. Previously, dual eligibles filled their prescriptions through their state Medicaid programs. Medicaid drug coverage ended for people who were eligible for Medicare on December 31, 2005. Previously Medicare helped pay for basic health care services, like physician and hospital care, while Medicaid filled gaps and covered certain supplies, like prescription drugs, not covered by Medicare.
In connection with the implementation of the MMA, all dual eligibles had the opportunity to enroll in a PDP that administers the Medicare drug benefit and pays providers like us for providing drugs under the program. Dual eligibles who did not voluntarily pick a PDP plan were enrolled automatically in a plan. This change in payor requires us to seek payment for our dual eligible patients from their PDP instead of the government. We have contracts in place with multiple PDPs in each of the markets we serve. However, we may not have a negotiated agreement with all of the PDPs in which our patients are enrolled. As a result, we may have lost patients who enrolled in a PDP that we did not have a contract with. In addition, if patients move to a PDP that we do not have an agreement with, we may not be able to provide services to them in the future. In some cases, we have to accept a lower reimbursement rate from the PDPs than we previously received under Medicaid. Some PDPs do not cover all the drugs and services we previously provided to our dual eligible patients. A combination of a lower reimbursement rate and different coverage has negatively impacted our earnings and resulted in lower
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net sales and a lower gross profit to us for the dual eligible patients who we serve. In March 2006 the effects of
Part D impacted more of our patients than anticipated. Approximately 18%, of our total patient population serviced in March 2006, were covered by Part D; however, approximately 43% of our patients previously covered by Medi-Cal and serviced out of our HIV pharmacies in California had been moved to Part D in March.
The key components of our financial results are our net sales, our gross profit and our operating expenses.
Net Sales. We sell HIV/AIDS prescription and ancillary medications, and nutritional supplies. As of March 31, 2006, approximately 88% of our net sales came from payments from Medicaid, Medicare (including Medicare Part D) and ADAP. These are all highly regulated government programs that are subject to frequent changes and cost containment measures. We continually monitor changes in reimbursement for HIV/AIDS medications.
Gross Profit. Our gross profit reflects net sales less the cost of goods sold. Cost of goods sold is the cost of pharmaceutical products we purchase from wholesalers, and is primarily dependent on contract pricing with our main wholesaler, AmerisourceBergen. The amount that we are reimbursed by government and private payors has historically increased as the price of the pharmaceuticals we purchase has increased. However, as a result of cost containment initiatives prevalent in the healthcare industry, private and government payors have reduced reimbursement rates, which prevents us from recovering the full amount of any price increases.
North American Home Health Supply, Inc., which we acquired on January 4, 2005, has historically reported higher gross margins than our historical business. The higher gross margin for NAHH is due to a product mix that is reimbursed at higher amounts than the HIV/AIDS medications we sell. The purchasers of these higher margin products are primarily not HIV/AIDS patients. In light of our focus on serving HIV/AIDS patients, we expect that this higher margin business will become a smaller portion of our overall business over time. Consequently, we expect our gross margin to decline over time to levels more consistent with our historical HIV/AIDS operations.
While we believe that we now have a sufficient revenue base to continue to operate profitably given our anticipated operating and other expenses, our business remains subject to uncertainties and potential changes, as discussed below, that could result in losses. In particular, changes to reimbursement rates (including Part D), unexpected increases in operating expenses, difficulty integrating acquisitions or declines in the number of patients we serve or the number of prescriptions we fill could adversely affect our future results.
Operating Expenses. Our operating expenses are made up of both variable and fixed costs. Variable costs increase as net sales increase. Our principal variable costs are labor and delivery. Fixed costs do not vary directly with changes in net sales. Our principal fixed costs are facilities and equipment and insurance.
We have grown our business by acquiring other specialty pharmacies and expanding our existing business. We expect to continue to make acquisitions and to continue to expand our existing business. Since the beginning of 2003, we have acquired seven specialty pharmacies in California and one specialty pharmacy in New York. We also generate internal growth primarily by increasing the number of patients we serve and filling more prescriptions per patient.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies affect the amount of income and expense we record in each period as well as the value of our assets and liabilities and our disclosures regarding contingent assets and liabilities. In applying these critical accounting policies, we must make estimates and assumptions to prepare our financial statements that, if made differently, could have a positive or negative effect on our financial results. We believe that our estimates and assumptions are both reasonable and appropriate, in light of applicable accounting rules. However, estimates involve judgments with respect to numerous factors that are difficult to predict and are beyond management’s control. As a result, actual amounts could differ materially from estimates.
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Management believes that the following accounting policies represent “critical accounting policies,” which the SEC defines as those that are most important to the portrayal of a company’s financial condition and results of operations and require management’s most difficult, subjective, or complex judgments, often because management must make estimates about uncertain and changing matters.
Revenue Recognition. Net sales refer to our sales of medications and nutritional supplements to patients and are reported net of contractual allowances to patients, government and private payors and others in the period when delivery to our patients is completed. Any customer can initiate the filling of prescriptions by having a doctor call in prescriptions to our pharmacists, faxing over a prescription, or mailing prescriptions to one of our facilities. Once we have verified that the prescriptions are valid and have received authorization from a customer’s insurance company or state insurance program, the pharmacist then fills the prescriptions and ships the medications to the customers through our outside delivery service, an express courier service, postal mail, or the patient picks up the prescription at the pharmacy. We served 12,502 patients in the month of March 2006.
As of September 1, 2004, as part of the passage of the State of California budget, reimbursement rates for pharmacy services provided under Medi-Cal were reduced. Under the reduced reimbursement rate, prescriptions are reimbursed at the Average Wholesale Price, or AWP, less 17%, and the provider is paid a $7.25 dispensing fee. The previous reimbursement rate was AWP less 10% with a $4.05 dispensing fee. On September 28, 2004, California approved a three year HIV/AIDS Pharmacy Pilot Program that funds an additional $9.50 fee per prescription for qualified pharmacies that participate in the program. The payments are retroactive and apply to services rendered since September 1, 2004. We own two of the ten pharmacies that have qualified for the pilot program in California. We have recognized revenue for the higher reimbursement in California and in September 2005 we received the first payment of the additional reimbursement under this program from California.
In New York, reimbursement rates for pharmacy services provided under Medicaid were reduced in September 2004. Under the reduced reimbursement rate, prescriptions were reimbursed at the AWP less 12.75% plus a dispensing fee of $3.50 for brand name drugs and AWP less 16.5% plus a dispensing fee of $4.50 for generic drugs. Despite this reduction, approved specialized HIV pharmacies were reimbursed at a more favorable pre-reduction reimbursement rate of AWP less 12% plus a dispensing fee of $3.50 for brand name drugs and $4.50 for generic drugs. The legislation authorizing the more favorable reimbursement rate is effective until further legislation changes it. We have been notified by the Department of Health in New York that we qualify for the specialized pharmacy reimbursement and we have recognized the expected revenues. The first payment under this reimbursement program was subsequently received in April 2006. Our continuing qualification for specialized HIV pharmacy reimbursement is dependent upon our recertification by the Department of Health in New York as an approved specialized HIV pharmacy. We are currently certified through September 2006.
We began recognizing revenue related to premium reimbursement in June 2005 and September 2005 following notification by the states of New York and California, respectively that certain of our pharmacies had qualified to participate in these programs. Both states provided for retroactive payment of prescriptions dating back to September 2004. No revenues were recorded for premium reimbursement prior to our receipt of notification from the appropriate governing state agency that we had qualified to participate in these premium reimbursement programs. Thus, for our three licensed pharmacies that qualified to participate in one of these programs, we reviewed our internal records and estimated the expected premium reimbursement for the then-current period and retroactive payments to be received for prior periods. These estimated retroactive premium reimbursement amounts were then recorded as revenue.
Premium reimbursement for eligible prescriptions dispensed in the current period are recorded as a component of net sales in the period in which the patient receives the medication. Prescriptions are filled as described above, once we have verified that the prescriptions are valid and have received authorization from a customer’s state insurance program. We have begun to receive regular payments for premium reimbursement
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which are paid in conjunction with the regular reimbursement amounts due through the normal payment cycle for the California pilot program and have received annual payment under the New York program beginning in April 2006.
Allowance for Doubtful Accounts. We are reimbursed for the medications we sell by government and private payors. The net sales and related accounts receivable are recorded net of payor contractual discounts to reflect the estimated net billable amounts for the products delivered. We estimate the allowance for contractual discounts on a payor-specific basis, given our experience or interpretation of the contract terms if applicable. However, the reimbursement rates are often subject to interpretation that could result in payments that differ from our estimates. Additionally, updated regulations and contract negotiations occur frequently, necessitating our continual review and assessment of the estimation process. While management believes the resulting net carrying amounts for accounts receivable are fairly stated at each quarter-end and that we have made adequate provision for uncollectible accounts based on all available information, no assurance can be given as to the level of future provisions for uncollectible accounts, or how they will compare to the levels experienced in the past.
Intangible Asset Impairment. In assessing the recoverability of our intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If we determine that impairment indicators are present and that the assets will not be fully recoverable, their carrying values are reduced to estimated fair value. Impairment indicators include, among other conditions, cash flow deficits, a historic or anticipated decline in net sales or operating profit, adverse legal or regulatory developments, accumulation of costs significantly in excess of amounts originally expected to acquire the asset, and a material decrease in the fair value of some or all of the assets. Changes in strategy and/or market conditions could significantly impact these assumptions, and thus we may be required to record impairment charges for these assets. We adopted Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) effective January 1, 2002, and the adoption of the Statement had no impact on our consolidated financial position or results of operations.
Goodwill and Other Intangible Assets. In accordance with Statement of Financial Accounting Standard (“FAS”) No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets associated with acquisitions that are deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Such impairment tests require the comparison of the fair value and carrying value of reporting units. Measuring fair value of a reporting unit is generally based on valuation techniques using multiples of sales or earnings, unless supportable information is available for using a present value technique, such as estimates of future cash flows. We assess the potential impairment of goodwill and other indefinite-lived intangible assets annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an interim impairment review include the following:
| • | Significant underperformance relative to expected historical or projected future operating results; |
| • | Significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and |
| • | Significant negative industry or economic trends. |
If we determine through the impairment review process that goodwill has been impaired, we record an impairment charge in our consolidated statement of income. Based on our impairment review process, we have not recorded any impairment during the three month period ended March 31, 2006.
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment”, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) supersedes Accounting Principals Board (“APB”) Opinion No. 25, “Accounting for Stock
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Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:
| • | “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of statement 123(R) that remain unvested on the effective date. |
| • | “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented, or (b) prior interim periods of the year of adoption. |
We adopted SFAS No. 123(R) effective January 1, 2006.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
The following table sets forth the net sales and operating data for each of our distribution centers for the three months ended March 31, 2006 and 2005:
Three Months Ended March 31, | |||||||||||||||
| 2006 | 2005 | ||||||||||||||
Distribution Region | Net Sales | Prescriptions | Patient Months | Net Sales | Prescriptions | Patient Months | |||||||||
California (1) | $ | 27,730,824 | (3) | 117,319 | 25,730 | $ | 11,691,612 | 55,441 | 14,107 | ||||||
New York (2) | 12,310,459 | 45,834 | 6,333 | 10,149,794 | 40,005 | 5,710 | |||||||||
Florida | 413,655 | 2,484 | 325 | 550,917 | 3,576 | 422 | |||||||||
Seattle (1) | 830,264 | 4,936 | 890 | 303,426 | 1,736 | 293 | |||||||||
Total | $ | 41,285,202 | 170,573 | 33,278 | $ | 22,695,749 | 100,758 | 20,532 | |||||||
| (1) | California & Seattle operations for the three months ended March 31, 2005 include one month of contribution from Specialty Pharmacies, Inc. |
| (2) | New York operations for the three months ended March 31, 2006 include a partial month of contribution from Maiman. |
| (3) | California operations for the three months ended March 31, 2006 includes $858,457 of retroactive premium reimbursement for prior periods in 2005 and 2004. |
The prescription and patient month data has been presented to provide additional data about operations. A prescription typically represents a 30-day supply of medication for an individual patient. “Patient months” represents a count of the number of months during a period that a patient received at least one prescription. If an individual patient received multiple medications during each month of a three month period, a count of three would be included in patient months irrespective of the number of medications filled in each month.
NET SALES
Net sales for the three months ended March 31, 2006 increased to $41,285,202 from $22,695,749 for the three months ended March 31, 2005, an increase of 82%. The increase in net sales for the three months ended March 31, 2006 as compared to the same period in 2005 is primarily attributable to the Company’s acquisitions
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and to an increase in volume from the addition of new patients in California and New York. Increases in net sales for the three months ended March 31, 2006 were partially offset by the implementation of MMA, which resulted in lower reimbursement rates for our dual eligible patients.
For the three month period ended March 31, 2006, the Company has recognized $858,457 of net sales for retroactive premium reimbursement relating to prior periods in 2005 and 2004 for the CA Pilot Program. This adjustment to retroactive premium reimbursement is based on information provided to us by the state of California concerning the amount we should be receiving for our Specialty operations. We expect to receive this payment in the second quarter of 2006. As of March 31, 2006, we had $1,882,559 of accrued revenue relating to premium reimbursement in New York and California including retroactive payments for prior periods. In April 2006, we received an annual payment of approximately $400,000 for these accrued amounts under the New York program. In addition, we have not received payment from California relating to the former operations of Specialty Pharmacies, Inc. Based on discussions with this state agency, we believe that we will receive payment for the accrued revenues associated with the CA Pilot Program for our Specialty operations during the second quarter of 2006.
GROSS PROFIT
Gross profit was $ 6,654,084 and $3,573,603 for the three months ended March 31, 2006 and 2005 respectively, and represents 16.1% and 15.7% of net sales, respectively. Excluding the $858,457 related to the retroactive premium reimbursement (in net sales) from prior periods, the adjusted gross margin would have been 14.3%. The Company’s adjusted gross margin for the three months ended March 31, 2006 decreased 1.4% as compared with the gross margin for the three months ended March 31, 2005 primarily due to lower reimbursement on patients that moved from state Medicaid programs to Medicare Part D and the increased focus on lower margin HIV business as the higher margin NAHH business becomes a smaller portion of the overall business.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $5,800,303 and $3,448,228 for the three months ended March 31, 2006 and 2005, respectively, and represented 14.0% and 15.2% of net sales, respectively. The increase in selling, general and administrative expenses of $2,352,075 for the three months ended March 31, 2006 as compared to the same period in 2005 was primarily due to the acquisitions of Maiman, Priority, PMW and SPI. These acquisitions represented approximately $1,875,773 of the increase. In addition to the increases in expenses related to the acquisitions the following increases were associated with the historical Company businesses:
Components of Selling, General and Administrative Expense | Change ($) | ||
Labor Expense | $ | 202,762 | |
Sarbanes Oxley Compliance Expense | 173,267 | ||
Vacation Accrual for Employee Vacation Carryover * | 116,000 | ||
Non-Cash Stock Compensation Expense | 39,329 | ||
Shipping & Postage Expense | 20,288 | ||
| * | The company recognized approximately $116,000 of non-recurring compensation relating to vacation accruals for employees that were allowed to carry over vacation as part of the standardization of benefits across locations. |
OPERATING INCOME
Operating income was $853,781 and $125,375 for the three months ended March 31, 2006 and 2005, respectively and represents 2.1% and 0.6% of net sales, respectively. The increase in operating income is attributable to an increase in gross profit of $3,080,481 and a decrease in selling, general and administrative expenses as a percent of net sales of 1.2%.
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INTEREST INCOME (EXPENSE)
Interest income was $410,836 and interest expense was $106,939 for the three months ended March 31, 2006 and 2005, respectively. The increase in interest income is primarily attributable to the Company’s investment in short-term securities and other investment of cash.
PROVISION FOR TAXES
We recorded a provision for taxes in the amount of $131,698 for the quarter ended March 31, 2006. The provision relates primarily to state income tax and federal alternative minimum tax that would have been payable before income tax deductions relating to stock based compensation which created a taxable loss and deferred taxes which related to tax-deductible goodwill. Because the amount is not payable by the Company, the amount was credited to the additional paid in capital account. We did not record any provision for income taxes for the three months ended March 31, 2005.
NET INCOME
For the three months ended March 31, 2006, the Company recorded net income of $1,133,021 as compared to a net income of $13,096 for the comparable period in the prior year. The increase in net income is primarily attributable to revenue growth and the related gross margins.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2006, we had approximately $50,020,000 in cash and short-term investments.
On June 22, 2005, we completed an initial public offering of our common stock. We sold 4,000,000 shares of our common stock at a price of $13.00 per share, less underwriting discounts and commissions of $0.91 per share. In addition, we granted the underwriters an option, exercisable until July 21, 2005, to purchase up to an additional 600,000 shares at the initial public offering price to cover over-allotments. On July 8, 2005, the over-allotment option was exercised at $13.00 per share, less underwriting discounts and commissions of $0.91 per share. We used the initial public offering proceeds to repay approximately $12 million of our debt on June 27, 2005. Since the completion of the initial public offering, until May 1, 2006, we have completed five acquisitions, which have used approximately $42.9 million of our IPO proceeds.
On January 25, 2006, we completed the sale of 5,101,922 common shares in a secondary offering at the price of $12.83 per share, less an underwriting discount, for total net proceeds of $61,857,488. There were 2,465,468 shares sold by us (including 665,468 shares through the over-allotment exercised by the underwriters after the offering) and 2,636,454 shares sold by certain selling stockholders. We received total proceeds, net of expenses of $28,987,311 from the sale of its shares and did not receive any proceeds from the sale of shares by the selling stockholders. In addition, the Company received gross proceeds of $1,777,413 from the payment of the exercise price of options and warrants to purchase 574,000 shares of our common stock.
Accounts receivable increased $1.6 million in the three months ended March 31, 2006. This increase is primarily due to outstanding receivables for Medicare Part D and growth in the business. Payments by the PDPs were initially delayed as a result of the MMA implementation; however, we have begun to receive payments in a more timely manner, which is consistent with our historical days’ sales outstanding from other payors.
On April 21, 2006, the Company’s allowed its credit facility with GE HFS Holdings, Inc. f/k/a Heller Healthcare Finance (‘GE”) to expire. The GE credit facility provided for the Company to borrow up to a maximum of $6,000,000, based on the Company’s accounts receivable. At this time, the Company has not elected to renew this credit facility but is having discussions with GE about maintaining the current facility.
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Operating Requirements
Our primary liquidity need is cash to purchase the medications that we require to fill prescriptions. Our primary vendor, AmerisourceBergen, requires payment within 31 days of delivery of the medications to us. We are reimbursed by third-party payors, on average, within 30 days after a prescription is filled and a claim is submitted in the appropriate format.
Our operations provided $77,922 of cash over the three month period ended March 31, 2006, which decreased from the same period in 2005, when our operations provided $798,329 of cash. The change was primarily a result of increased accounts receivable balances due to Medicare Part D and retroactive premium reimbursement receivables outstanding of approximately $1.9 million.
The five-year purchase agreement that we signed with AmerisourceBergen in September 2003 improved our supplier payment terms from 13 to 31 days. These payment terms improved our liquidity and enabled us to reduce our working capital. If we do not meet the aggregate minimum purchase commitments under our agreement with AmerisourceBergen by the end of the five-year term, we will be charged 0.2% of the un-purchased volume commitment. At current purchasing levels, we expect to satisfy the minimum required purchase levels. Pursuant to the terms of this agreement, AmerisourceBergen has a subordinated security interest in all of our assets.
Long-Term Requirements
We expect that the cost of additional acquisitions will be our primary long-term funding requirement. In addition, as our business grows, we anticipate that we will need to invest in additional capital equipment, such as the machines we use to create the MOMSPak for dispensing medication to our patients. We also may be required to expand our existing facilities or to invest in modifications or improvements to new or additional facilities. If our business operates at a loss in the future, we will also need funding for such losses.
As the result of our initial and secondary public offerings, we believe that our cash balances are sufficient to provide us with the capital required to fund our working capital needs and operating expense requirements for at least the next 12 months. Although, we currently believe that we have sufficient capital resources to meet our anticipated working capital and capital expenditure requirements beyond the next twelve months, unanticipated events and opportunities may make it necessary for us to return to the public markets or establish new credit facilities or raise capital in private transactions in order to meet our capital requirements.
CONTRACTUAL OBLIGATIONS
At March 31, 2006, our contractual cash obligations and commitments over the next five years were as follows:
| Payments due by Period | |||||||||||||||
| Total | Less than 1 year | 1-3 years | 4-5 years | More than 5 years | |||||||||||
Long-Term Debt Obligation (1) | $ | 686,973 | $ | 686,973 | $ | — | $ | — | $ | — | |||||
Capital Lease Obligations (1) | 163,985 | 82,549 | 81,436 | — | — | ||||||||||
Operating Leases | 2,015,782 | 607,217 | 1,025,478 | 383,087 | — | ||||||||||
Purchase Commitments (2) | 203,526,314 | 68,922,147 | 134,604,167 | — | — | ||||||||||
Total | $ | 206,393,054 | $ | 70,298,886 | $ | 135,711,081 | $ | 383,087 | $ | — | |||||
| (1) | Interest payments on these amounts will be approximately $37,737 over the next three years. |
| (2) | If we fail to satisfy the minimum purchase obligation under our purchase agreement with AmerisourceBergen, we would be required to pay an amount equal to 0.2% of the un-purchased commitments at the end of the five-year term of the contract. |
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OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Interest Rate Sensitivity. We have limited exposure to financial market risks, including changes in interest rates. At March 31, 2006, we had cash and cash equivalents of approximately $6.6 million and short-term investments of approximately $43.4 million. Cash and cash equivalents consisted of demand deposits, money market accounts and investment grade debt. Short-term investments consisted of highly liquid investments in debt obligations of the U.S. Government and other highly rated entities with maturities of one year or less. These investments are classified as available-for-sale and are considered short-term, because we expect to sell them within 12 months. These investments are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates continue to rise, the value of our short-term investments would decrease. We may sell these investments prior to maturity, and therefore, we may not realize the full value of these investments. We currently hold no derivative instruments and do not earn foreign-source income. We expect to invest only in short-term, investment grade, interest-bearing instruments and thus do not expect future interest rate risk to be significant. The interest rates on outstanding notes payable are not subject to change with changes in market interest rates. We have not hedged against our interest rate risk exposure for our cash, investments or the notes payable. As a result, our interest income will increase from increasing interest rates and our interest income will decrease from declining rates.
| Item 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports 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 our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As previously disclosed in our annual report for the period ended December 31, 2005, we identified a material weakness relating to the valuation of warrants that were issued in the period ended June 30, 2005. As a result, we subsequently restated our second and third quarter 2005 quarterly reports on Form 10-Q/A on April 19, 2006. We have worked with our independent auditor and external SOX 404 consultant to review valuation techniques for options and warrants. As a result, we have instituted checklists and processes during the end of 2005 that we believe will strengthen our ability to identify and value option and warrant grants. As a result of the restatement, we have adjusted our valuation models and techniques and will continue to use these techniques for future option or warrant grants. There were no warrants issued in the period ended March 31, 2006. Therefore, we have not been able to test the new valuation procedures in place.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2006.
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Changes in Internal Control over Financial Reporting
We have implemented changes in the identification and valuation of option and warrant grants, which include instituting checklists and processes surrounding our valuation models and techniques. We implemented the Great Plains accounting system as of January 1, 2006. There have been no other changes in our internal control over financial reporting during the quarter ended March 31, 2006 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reports.
Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
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ALLION HEALTHCARE, INC. AND SUBSIDIARIES
PART II OTHER INFORMATION
On March 9, 2006, we alerted the staff of the SEC’s Division of Enforcement to the issuance of our press release of that date announcing our intent to restate our quarterly filings for the periods ended June 30, 2005 and September 30, 2005. On March 13, 2006, we received a letter from the Division of Enforcement notifying us that the Division of Enforcement had commenced an informal inquiry and requested that we voluntarily produce certain documents and information. In that letter, the SEC also stated that the informal inquiry should not be construed as an indication that any violations of law have occurred. We are cooperating fully with the Division of Enforcement’s inquiry.
In addition to the matters noted above, we are involved from time to time in legal actions arising in the ordinary course of our business. We currently have no pending or threatened litigation that we believe will result in an outcome that would materially affect our business. Nevertheless, there can be no assurance that future litigation to which we become a party will not have a material adverse effect on our business.
Information regarding risk factors appears in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements,” in Part I – Item 2 of this Form 10-Q and in Part I – Item 1A of our Annual Report on Form 10-K/A for the year ended December 31, 2005. The following information sets forth material changes from the risk factors previously disclosed in our Annual Report on Form 10-K/A dated November 17, 2006.
Our revenues could be adversely affected if our patients who are “dual-eligible” under the Medicare Modernization Act cease to use our services or if prescription drug plans, or PDPs, reduce reimbursement rates.
Beginning January 1, 2006, under Part D of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or the MMA, we began being reimbursed by PDPs, and not Medicaid, for the prescription drugs we provide to our dual eligible patients. Reimbursement rates for these patients are less favorable than the rates we received from Medicaid and result in lower gross margins for our dual eligible patients. In March 2006, we serviced 2,235 patients under Medicare Part D or approximately 18% of our patients; however, 43% of our patients who previously received Medicaid in California at our HIV pharmacies were provided services under a Medicare Part D plan. Our earnings have been negatively impacted from the movement of patients from Medicaid to a Medicare Part D plan. If a higher number of our patients become eligible under MMA, there is a risk that our gross margins will decline further and negatively impact earnings. Additional risks that could affect financial performance include:
| • | The possibility that the reimbursement rates we currently receive from the PDPs for our services could be reduced; |
| • | Regulations that strictly limit our ability to market to our current and new patients, which may limit our ability to maintain and grow our current patient base; |
| • | The possibility that Part D may not continue to cover all the medications needed for persons with HIV/AIDS, including our patients; |
| • | The possibility that our contracts with PDPs could be terminated if we fail to comply with the terms and conditions of such contracts. |
We previously disclosed that in New York we were eligible to receive preferred reimbursement rates for HIV/AIDS medication that we sell in New York until March 31, 2006. The renewal of premium reimbursement
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is dependent upon the passage of a New York State budget for 2006 that provides for premium reimbursement. As of the date of this filing, New York State had not passed its 2006 budget. If New York State does not pass a budget, if we do not continue to qualify for the preferred reimbursement program, or if the rates under any preferred reimbursement program that may be enacted are lower than the rates we currently receive, our net sales could decline.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In March, 2006, we used $5,375,000 of initial public offering proceeds to acquire certain assets of Maiman.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
None.
| (a) |
| Exhibits | ||
| 31.1 | Certification of the Chief Executive Officer pursuant Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of the Chief Executive Officer and acting Chief Financial Officer pursuant to 18 U.S.C. §1350 (Section 906 of the Sarbanes-Oxley Act of 2002). | |
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SIGNATURES
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.
Date: December 4, 2006
ALLION HEALTHCARE, INC. | ||
| By: | /S/ JAMES G. SPENCER | |
James G. Spencer Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) | ||
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