1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-25769
ACCREDO HEALTH, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 62-1642871
------------------------------- -------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1640 CENTURY CENTER PKWY, SUITE 101, MEMPHIS, TN 38134
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(901) 385-3688
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
2
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT January 31, 2000
COMMON STOCK, $0.01 PAR VALUE ............... 9,204,851
NON-VOTING COMMON STOCK, $0.01 PAR VALUE.....
---------
TOTAL COMMON STOCK .......................... 9,204,851
=========
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ACCREDO HEALTH, INCORPORATED
INDEX
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (unaudited)
For the three months and six months ended December
31, 1998 and 1999
Condensed Consolidated Balance Sheets
June 30, 1999 and December 31, 1999 (unaudited)
Condensed Consolidated Statements of Cash Flows (unaudited)
For the six months ended December 31, 1998 and 1999
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Part II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Note: Items 1 and 3 of Part II are omitted because they are not
applicable.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ACCREDO HEALTH, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(000'S OMITTED, EXCEPT SHARE DATA)
(UNAUDITED)
Six Months Ended December 31, Three Months Ended December 31,
----------------------------- -------------------------------
1999 1998 1999 1998
-------- --------- ------- --------
Net patient service revenue $154,625 $ 113,748 $81,941 $ 59,383
Other revenue 7,391 5,647 3,823 2,914
Equity in net income of joint ventures 1,210 631 592 381
-------- --------- ------- --------
Total revenues 163,226 120,026 86,356 62,678
Cost of services 139,781 101,909 73,789 53,384
-------- --------- ------- --------
Gross profit 23,445 18,117 12,567 9,294
General & administrative 11,077 8,391 5,831 4,394
Bad debts 2,962 2,284 1,600 1,153
Depreciation and amortization 1,465 1,986 820 1,000
-------- --------- ------- --------
Income from operations 7,941 5,456 4,316 2,747
Interest expense, net 784 1,730 432 865
-------- --------- ------- --------
Income before income taxes 7,157 3,726 3,884 1,882
Provision for income taxes 2,840 1,863 1,535 934
-------- --------- ------- --------
Net income 4,317 1,863 2,349 948
Preferred stock dividends -- (1,021) -- (511)
-------- --------- ------- --------
Net income to common shareholders $ 4,317 $ 842 $ 2,349 $ 437
======== ========= ======= ========
Basic earnings per common share (Note 6 and 7):
Net income $ 0.32 $ 0.22 $ 0.17 $ 0.11
Preferred stock dividends -- (0.12) -- (0.06)
-------- --------- ------- --------
Net income per common share $ 0.32 $ 0.10 $ 0.17 $ 0.05
======== ========= ======= ========
Diluted earnings per common share (Note 6 and 7):
Net income $ 0.29 $ 0.20 $ 0.16 $ 0.10
Preferred stock dividends -- (0.11) -- (0.05)
-------- --------- ------- --------
Net income per common share $ 0.29 $ 0.09 $ 0.16 $ 0.05
======== ========= ======= ========
EARNINGS PER SHARE HAS BEEN COMPUTED REFLECTING THE UPCOMING THREE-FOR-TWO STOCK
SPLIT DISCUSSED IN NOTE 6 BELOW.
See accompanying notes to condensed consolidated financial statements.
5
ACCREDO HEALTH, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(000'S OMITTED, EXCEPT SHARE DATA)
(UNAUDITED)
December 31, June 30,
1999 1999
------------ --------
ASSETS
Current assets:
Cash and cash equivalents $ 6,281 $ 5,542
Accounts receivable, less allowance for doubtful
accounts of $6,303 at December 31, 1999 and
$5,300 at June 30, 1999 59,516 54,816
Due from affiliates 3,192 2,105
Other accounts receivable 6,202 5,856
Inventories 28,224 19,927
Prepaids and other current assets 542 359
Deferred income taxes 2,304 1,554
-------- --------
Total current assets 106,261 90,159
Property and equipment, net 3,918 3,025
Other assets:
Joint venture investments 4,590 3,415
Goodwill and other intangible assets, net 70,403 50,147
-------- --------
Total assets $185,172 $146,746
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 67,284 $ 56,029
Accrued expenses 5,326 4,831
Income taxes payable 489 393
-------- --------
Total current liabilities 73,099 61,253
Long-term notes payable 41,400 20,500
Deferred income taxes 996 866
Stockholders' equity:
Undesignated Preferred Stock, 5,000,000 shares
authorized, no shares issued -- --
Non-voting Common Stock, $.01 par value;
2,500,000 shares authorized; no shares issued and outstanding at
December 31, 1999; 1,100,000 shares
issued and outstanding at June 30, 1999 -- 11
Common Stock, $.01 par value; 30,000,000 shares authorized;
9,204,851 and 7,977,087 shares issued and outstanding at
December 31, 1999 and June 30, 1999, respectively 92 80
Additional paid-in capital 64,599 63,367
Retained earnings (deficit) 4,986 669
-------- --------
Total stockholders' equity 69,677 64,127
-------- --------
Total liabilities and stockholders' equity $185,172 $146,746
======== ========
See accompanying notes to condensed consolidated financial statements.
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ACCREDO HEALTH, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(000'S OMITTED)
(UNAUDITED)
Six Months Ended
December 31,
1999 1998
--------- ---------
OPERATING ACTIVITIES:
Net income $ 4,317 $ 1,863
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 1,465 1,986
Original issue discount amortization -- 120
Provision for losses on accounts receivable 2,962 2,284
Deferred income tax benefit (654) (1,105)
Compensation resulting from stock transactions 92 92
Changes in operating assets and liabilities, net of effect from
business acquisitions:
Patient receivables and other (5,986) (14,883)
Due from affiliates (1,663) (616)
Inventories (7,833) (3,881)
Prepaids and other current assets (177) (728)
Recoverable income taxes -- 151
Accounts payable and accrued expenses 10,938 13,143
Income taxes payable 96 133
--------- ---------
Net cash provided by (used in) operating activities 3,557 (1,441)
INVESTING ACTIVITIES:
Purchases of property and equipment (1,223) (489)
Business acquisitions and joint venture investments (22,496) (1,298)
Change in joint venture investments, net (1,175) (430)
--------- ---------
Net cash used in investing activities (24,894) (2,217)
FINANCING ACTIVITIES:
Proceeds from long-term obligations 20,900 --
Issuance of common stock 1,176 207
--------- ---------
Net cash provided by financing activities 22,076 207
--------- ---------
Increase (decrease) in cash and cash equivalents 739 (3,451)
Cash and cash equivalents at beginning of period 5,542 5,087
--------- ---------
Cash and cash equivalents at end of period $ 6,281 $ 1,636
======== =========
See accompanying notes to condensed consolidated financial statements.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DECEMBER 31, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary to
present fairly the condensed consolidated financial position, results of
operations and cash flows of Accredo Health, Incorporated (the "Company" or
"Accredo") have been included. Operating results for the three and six-month
periods ended December 31, 1999, are not necessarily indicative of the results
that may be expected for the fiscal year ended June 30, 2000.
The balance sheet at June 30, 1999 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended June 30, 1999.
2. ACQUISITIONS
On October 20, 1999, the Company acquired, through an indirect
subsidiary, the majority of the operating assets of the specialty pharmacy
businesses operated by certain affiliates of Home Medical of America, Inc., of
Cherry Hill, New Jersey ("HMA"). The assets acquired consist of two pharmacies,
one located in Jacksonville, Florida and the other in Temecula, California, each
of which are engaged in the pharmaceutical care of certain chronic, long-term
patients, including those requiring growth hormone, hemophilia and intravenous
gammaglobulin products and services.
The purchase price for these assets consists of a cash payment
of approximately $7.7 million, plus a potential earn-out payment of up to $1.2
million if certain revenue goals are achieved by the Company from this
acquisition during the six-month period ending April 30, 2000. The Company also
paid $500,000 as consideration for an agreement from HMA and some of its other
affiliates not to compete for a period of five years. No indebtedness was
assumed with this acquisition.
This transaction was accounted for using the purchase method
of accounting. The total value of tangible assets acquired was $234,000. The
excess of the total purchase price of $7,765,000, including acquisition costs of
$91,000, over the fair value of the tangible assets acquired, was allocated to
goodwill and other identifiable intangible assets. The Company preliminarily
recorded $7,181,000 in goodwill, $300,000 in acquired patient population, and
$50,000 in other intangible assets. These assets are being amortized using the
straight-line method over their estimated useful lives of 40 years for goodwill
and 5 years for acquired patient population and other intangible assets. The
$500,000 payment for the non-compete agreement is being amortized using the
straight-line method over its five year life. The operating results of these
pharmacies are included in the Company's consolidated statement of operations
beginning October 21, 1999 but are not material to the results of the Company
for the three months ended December 31, 1999.
As previously reported on a Form 8-K filed on December 16,
1999 (amended on February 11, 2000), the Company acquired, through a subsidiary,
all of the outstanding stock of Sunrise Health Management, Inc. ("Sunrise") from
its shareholders effective December 1, 1999. Sunrise is headquartered in
Norcross, Georgia and is a provider of pharmaceutical care for certain chronic,
long-term patient populations, including those requiring intravenous
immunoglobulin, clotting factor and growth hormone.
The purchase price for Sunrise was approximately $13.7
million, plus a potential earn-out payment of up to $1.0 million if certain
financial goals are achieved by Sunrise during the six-month period ending May
31, 2000. The Company also paid $500,000 as consideration for an agreement with
the selling shareholders and a prior officer of Sunrise not to compete with the
Company in certain product lines for ten years.
This transaction was accounted for using the purchase method of
accounting. Total assets acquired and liabilities assumed were $1,903,000 and
$875,000, respectively. The excess of the total purchase price of $13,731,000,
including acquisition costs of $45,000, over the fair value of the net assets
acquired of $1,028,000, was allocated to goodwill and other
8
identifiable intangible assets. The Company preliminarily recorded $11,987,000
in goodwill, $646,000 in acquired patient population, and $70,000 in other
intangible assets. These assets are being amortized using the straight-line
method over their estimated useful lives of 40 years for goodwill and 5 years
for acquired patient population and other intangible assets. The $500,000
payment for the non-compete agreement is being amortized using the straight-line
method over its ten year life. The operating results of Sunrise are included in
the Company's consolidated statement of operations beginning December 1, 1999.
Pro forma amounts for the six months and three months ended December 31, 1999
and 1998, as if the acquisition of Sunrise had occurred on July 1, 1998, are as
follows:
Six Months Ended December 31, Three Months Ended December 31,
----------------------------- -------------------------------
1999 1998 1999 1998
--------- --------- -------- --------
Pro forma total revenues $ 167,002 $ 123,586 $ 87,864 $ 64,386
Pro forma net income 4,509 2,016 2,410 1,017
Basic earnings per common share (See Note 6 below):
Pro forma net income $ 0.33 $ 0.24 $ 0.18 $ 0.12
Diluted earnings per common share (See Note 6 below):
Pro forma net income $ 0.31 $ 0.22 $ 0.16 $ 0.11
3. INVESTMENT IN JOINT VENTURES
On October 1, 1999, the Company entered into a joint venture
agreement with Children's National Medical Center in Washington, DC, to market,
sell, provide and distribute Synagis(R) and growth hormone and related services
and supplies. The term of the joint venture is for a period of five years unless
terminated at an earlier date pursuant to the terms of the agreement. Both
companies contributed $50,000 in capital to the joint venture and will share
equally in the assets, liabilities, profits and losses.
In conjunction with the formation of this joint venture, the
Company also entered into a management, service and sales agreement with the
joint venture, whereby the Company will provide specialty pharmacy and
management services to the joint venture in exchange for a monthly management
fee and the reimbursement of certain expenses. The Company previously had a
direct management agreement relationship with an affiliate of Children's
National Medical Center.
On January 1, 2000, the Company entered into a joint venture
agreement with Specialized Pharmaceutical Services, Inc. ("SPS") to market,
sell, provide and distribute intravenous immunoglobulin ("IVIG") products and
related services and supplies in thirteen northeastern and eastern states. The
term of the joint venture is for a period of six years unless terminated at an
earlier date pursuant to the terms of the agreement. Both companies will
contribute an initial $200,000 in capital to the joint venture and an additional
$300,000 within 120 days from its formation. The companies will share equally in
the assets, liabilities, profits and losses of the joint venture.
In conjunction with the formation of the joint venture, the
Company entered into management, service and sales agreements with the joint
venture, whereby the Company will provide specialty pharmacy and management
services to the joint venture in exchange for a monthly management fee and the
reimbursement of certain expenses and will also sell IVIG products to the joint
venture. SPS has also entered into a marketing and sales agreement to provide
marketing and sales support to the joint venture in exchange for a monthly fee
and reimbursement of certain expenses.
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4. COMMITMENTS
In October 1999, the Company entered into a six-year lease
agreement with its current landlord for approximately 30,570 square feet of
additional office and warehouse space in Memphis, Tennessee, and a land lease
for an expanded parking lot adjacent to the office and warehouse space. In
conjunction with the acquisition of Sunrise Health Management, Inc. and the two
pharmacy locations in Florida and California discussed in Note 2, the Company
also assumed the leases for their facilities.
Revised future minimum payments, by fiscal year and in the
aggregate, under non-cancelable operating leases with initial terms of one year
or more consist of the following after taking into account these most recent
lease obligations (in thousands):
2000 $ 745
2001 603
2002 579
2003 545
2004 225
Thereafter 236
-------
$ 2,933
=======
5. STOCKHOLDERS' EQUITY
During the quarter ended December 31, 1999, employees
exercised stock options to acquire 13,075 shares of Accredo common stock for
exercise prices ranging between $3.00 and $6.00 per share.
Employees of the Company also acquired 36,889 shares of
Accredo common stock during the quarter pursuant to the provisions of the
Company's Employee Stock Purchase Plan at a price of $13.60 per share. Shares
acquired under the plan were purchased on December 31, 1999 from employee funds
accumulated via payroll deductions from April through December, 1999.
6. SUBSEQUENT EVENT
On January 31, 2000, the Company announced a three-for-two
stock split in the form of a 50% stock dividend for shareholders of record on
February 11, 2000. Shareholders will receive one additional share of common
stock on February 21, 2000 for every two shares held on the record date. The
Company has computed earnings per share for the six-month and three-month
periods presented in this Form 10-Q on a post-split basis.
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7. EARNINGS PER SHARE
The following table sets forth the computation of basic and
diluted earnings per share (in thousands, except share data) (See Note 6 above):
Six Months Ended December 31, Three Months Ended December 31,
----------------------------- -------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Numerator for basic and diluted income per
share to common stockholders:
Net income $ 4,317 $ 1,863 $ 2,349 $ 948
Preferred stock dividends -- (1,021) -- (511)
----------- ----------- ----------- -----------
Net income to common stockholders $ 4,317 $ 842 $ 2,349 $ 437
=========== =========== =========== ===========
Denominator (See Note 6 above):
Denominator for basic income per
share to common stockholders -
weighted-average shares 13,696,317 8,431,263 13,742,295 8,438,381
Effect of dilutive stock options 993,902 903,183 947,990 889,792
----------- ----------- ----------- -----------
Denominator for diluted income per
share to common stockholders -
adjusted weighted-average shares 14,690,219 9,334,446 14,690,285 9,328,173
=========== =========== =========== ===========
Basic earnings per common share (See Note 6 above):
Net income $ 0.32 $ 0.22 $ 0.17 $ 0.11
Preferred stock dividends -- (0.12) -- (0.06)
----------- ----------- ----------- -----------
Net income per common share $ 0.32 $ 0.10 $ 0.17 $ 0.05
=========== =========== =========== ===========
Diluted earnings per common share (See Note 6 above):
Net income $ 0.29 $ 0.20 $ 0.16 $ 0.10
Preferred stock dividends -- (0.11) -- (0.05)
----------- ----------- ----------- -----------
Net income per common share $ 0.29 $ 0.09 $ 0.16 $ 0.05
=========== =========== =========== ===========
EARNINGS PER SHARE HAS BEEN COMPUTED REFLECTING THE UPCOMING THREE-FOR-TWO STOCK
SPLIT DISCUSSED IN NOTE 6 ABOVE.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
Some of the information in this quarterly report contains
forward-looking statements that involve substantial risks and uncertainties. You
can identify these statements by forward-looking words such as "may," "will,"
"expect," "anticipate," "believe," "intend," "estimate" and "continue" or
similar words. You should read statements that contain these words carefully for
the following reasons:
- the statements discuss our future expectations;
- the statements contain projections of our future earnings or of our
financial condition; and
- the statements state other "forward-looking" information.
There may be events in the future that we are not accurately able to
predict or over which we have no control. The risk factors discussed below, as
well as any cautionary language in this quarterly report, provide examples of
risks, uncertainties and events that may cause our actual results to differ
materially from the expectations we describe in our forward-looking statements.
Examples of these risks, uncertainties and events include the availability of
new drugs, our relationship with the manufacturers whose drugs we handle,
competitive or regulatory factors affecting the drugs we handle or their
manufacturers, the demand for Accredo's services, our ability to expand through
joint ventures and acquisitions, our ability to maintain existing pricing
arrangements with suppliers, the impact of government regulation, our need for
additional capital, the seasonality of our operations and our ability to
implement our strategies and objectives.
Investors in our common stock should be aware that the occurrence of
any of the events described in the risk factors discussed elsewhere in this
quarterly report and other events that we have not predicted or assessed could
have a material adverse effect on our earnings, financial condition and
business. In such case, the trading price of our common stock could decline and
you may lose all or part of your investment.
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
1998
REVENUES
Total revenues increased from $62.7 million to $86.4 million, or 38%, from the
three-month period ended December 31, 1998 to the three-month period ended
December 31, 1999. Approximately $12.5 million, or 53%, of this increase was
attributable to the increased sales volume of Avonex(R). Approximately $4.2
million, or 18%, of this increase was attributable to the increased hemophilia
revenue associated with increased patient volume. Cerezyme(R) and Ceredase(R)
drug sales increased approximately $3.0 million, or 13% of the revenue increase,
as a result of increased patient volume. Approximately $3.0 million, or 13%, of
the increase was attributable to the increased sales volume in the growth
hormone products. The remaining $1.0 million, or 3%, of the revenue increase was
primarily attributable to increased sales volume of other ancillary drugs the
Company dispenses as part of the patient's primary therapy or under contractual
obligations within certain managed care contracts and an increase of
approximately $211,000 from the Company's equity in net income of joint
ventures. Total revenues included approximately $3.3 million of revenues from
companies acquired during the three-month period ended December 31, 1999.
COST OF SERVICES
Cost of services increased from $53.4 million to $73.8 million, or 38%, from the
three-month period ended December 31, 1998 to the three-month period ended
December 31, 1999. This increase is commensurate with the increase in revenues
discussed above. As a percentage of revenues, cost of services increased from
85.2% to 85.4% from the three-month period ended December 31, 1998 to the
three-month period ended December 31, 1999. This increase is primarily the
result of changes in the revenue mix by therapy type and increased pharmacy and
warehouse costs included in cost of services.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased from $4.4 million to $5.8 million,
or 32%, from the three-month period ended December 31, 1998 to the three-month
period ended December 31, 1999. This increase was primarily the result of
increased salaries and benefits associated with the expansion of the Company's
reimbursement, sales, marketing, administrative and support staffs due to
existing product line revenue growth, new product line launches and the two
acquisitions made during the three-month period ended December 31, 1999. General
and administrative expenses represented 7.0% and 6.8% of revenues for the three
months ended December 31, 1998 and 1999, respectively.
12
BAD DEBTS
Bad debts increased from $1,153,000 to $1,600,000, or 39%, from the three-month
period ended December 31, 1998 to the three-month period ended December 31, 1999
primarily due to the increase in revenues. Bad debt expense was 1.8% and 1.9% of
revenues for the three months ended December 31, 1998 and 1999, respectively.
DEPRECIATION AND AMORTIZATION
Depreciation expense increased from $142,000 to $253,000 from the three-month
period ended December 31, 1998 to the three-month period ended December 31, 1999
as a result of purchases of property and equipment associated with the Company's
revenue growth and expansion of its leasehold facility improvements. Capital
expenditures amounted to $1.5 million in fiscal year 1999 and $768,000 in the
three-month period ended December 31, 1999. Amortization expense associated with
goodwill and other intangible assets decreased from $858,000 to $567,000 from
the three-month period ended December 31, 1998 to the three-month period ended
December 31, 1999 due to certain contract intangibles and a non-compete covenant
that were fully amortized by the end of fiscal year 1999. Amortization expense
attributable to the acquisitions made during the three-month period ended
December 31, 1999 amounted to approximately $114,000.
INTEREST EXPENSE, NET
Interest expense, net, decreased from $865,000 to $432,000 from the three-month
period ended December 31, 1998 to the three-month period ended December 31,
1999. This decrease is due to lower interest and margin rates payable under the
Company's existing revolving line of credit agreement with its lenders, lower
fixed interest rate payments associated with its interest rate swap agreement,
and a reduced level of debt resulting from the early payoff of a significant
portion of the Company's debt with a portion of the proceeds from the initial
public offering completed in April 1999. The Company generated interest income
of approximately $42,000 and $54,000 in the three months ended December 31, 1998
and 1999, respectively.
INCOME TAX EXPENSE
The Company's effective tax rate decreased from 49.6% to 39.5% from the
three-month period ended December 31, 1998 to the three-month period ended
December 31, 1999 as a result of the increase in income before taxes while
nondeductible amortization expense decreased. The difference between the
recognized tax rate and the statutory tax rate was primarily attributed to
approximately $615,000 and $204,000 of nondeductible amortization expense in the
three months ended December 31, 1998 and 1999, respectively, and state income
taxes.
SIX MONTHS ENDED DECEMBER 31, 1999 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
1998
REVENUES
Total revenues increased 36% from $120.0 million to $163.2 million, from the
six-month period ended December 31, 1998 to the six-month period ended December
31, 1999. Approximately $25.4 million, or 59%, of this increase was attributable
to the increased sales volume of Avonex(R). Cerezyme(R) and Ceredase(R) drug
sales increased approximately $5.7 million, or 13% of the revenue increase, as a
result of increased patient volume. Approximately $5.6 million, or 13%, of this
increase was attributable to the increased hemophilia revenue associated with
increased patient volume. Approximately $4.0 million, or 9%, of the increase was
attributable to the increased sales volume in the growth hormone products. The
remaining $2.5 million, or 6%, of the revenue increase was primarily
attributable to increased sales volume of other ancillary drugs the Company
dispenses as part of the patient's primary therapy or under contractual
obligations within certain managed care contracts and an increase of
approximately $579,000 from the Company's equity in net income of joint
ventures. Total revenues included approximately $3.3 million of revenues from
companies acquired during the six-month period ended December 31, 1999.
COST OF SERVICES
Cost of services increased 37% from $101.9 million to $139.8 million from the
six-month period ended December 31, 1998 to the six-month period ended December
31, 1999. This increase is commensurate with the increase in the Company's
revenues. As a percentage of revenues, cost of services increased from 84.9% to
85.6% from the six-month period ended December 31, 1998 to the same period in
1999. The increase is primarily the result of changes in the revenue mix by
therapy type and increased pharmacy and warehouse costs included in cost of
services.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased from $8.4 million to $11.1
million, or 32%, for the six-month period ended December 31, 1998 compared to
the six-month period ended December 31, 1999. This increase was primarily the
result of increased salaries and benefits associated with the expansion of the
Company's reimbursement, sales, marketing, administrative and support staffs due
to existing product line revenue growth, new product line launches and the two
acquisitions made during the six-month period ended December 31, 1999. General
and administrative expenses represented 7.0% and 6.8% of revenues for the
six-months ended December 31, 1998 and 1999, respectively.
13
BAD DEBTS
Bad debts increased from $2.3 million to $3.0 million, or 30%, from the
six-month period ended December 31, 1998 to the six-month period ended December
31, 1999. Bad debt expense was 1.9% and 1.8% of revenues for the six-months
ended December 31, 1998 and 1999, respectively.
DEPRECIATION AND AMORTIZATION
Depreciation expense increased from $270,000 to $448,000 from the six-month
period ended December 31, 1998 to the six-month period ended December 31, 1999
as a result of purchases of property and equipment associated with the Company's
revenue growth and expansion of its leasehold facility improvements. Capital
expenditures amounted to $1.5 million in fiscal year 1999 and $1.2 million in
the six-month period ended December 31, 1999. Amortization expense associated
with goodwill and other intangible assets decreased from $1,716,000 to
$1,017,000 from the six-month period ended December 31, 1998 to the six-month
period ended December 31, 1999 due to certain contract intangibles and a
non-compete covenant that were fully amortized by the end of fiscal year 1999.
Amortization expense attributable to the acquisitions made during the six-month
period ended December 31, 1999 amounted to approximately $114,000.
INTEREST EXPENSE, NET
Interest expense, net decreased from $1,730,000 to $784,000 from the six-month
period ended December 31, 1998 to the six-month period ended December 31, 1999.
This decrease is due to lower interest and margin rates payable under the
Company's existing revolving line of credit agreement with its lenders, lower
fixed interest rate payments associated with its interest rate swap agreement,
and a reduced level of debt resulting from the early payoff of a significant
portion of the Company's debt with a portion of the proceeds from the initial
public offering completed in April 1999. The Company had interest income of
approximately $86,000 and $109,000 in the six-months ended December 31, 1998 and
1999, respectively.
INCOME TAX EXPENSE
The Company's effective tax rate decreased from 50.0% to 39.7% from the
six-month period ended December 31, 1998 to the six-month period ended December
31, 1999 as a result of the increase in income before taxes while nondeductible
amortization expense decreased. The difference between the recognized effective
tax rate and the statutory tax rate is primarily attributed to approximately
$1,230,000 and $408,000 of nondeductible amortization expense in the six-months
ended December 31, 1998 and 1999, respectively, and state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, the Company's working capital was $33.2 million, cash and
cash equivalents were $6.3 million, and the current ratio was approximately 1.5
to 1.0.
Cash provided by operations was $3.6 million for the six months ended December
31, 1999. During the six months ended December 31, 1999, accounts receivable,
net of acquisitions, increased $4.7 million, inventory, net of acquisitions,
increased $7.8 million and accounts payable, net of acquisitions, increased
$10.9 million. The increases are primarily due to the Company's revenue growth
and the timing of the collection of receivables, inventory purchases and
payments of accounts payable.
As of December 31, 1999, the Company is owed approximately $2.0 million from one
of its joint venture partners that has been outstanding for more than 360 days.
The collection of this balance is based upon the ability of the joint venture
partner to successfully collect amounts due it pursuant to certain claims filed
with the State of California's MediCal program. The Company believes that any
potential bad debt resulting from the failure to collect some of these
receivables is sufficiently provided for in the allowance for doubtful accounts.
These receivables have reduced the amount of cash that would have otherwise been
provided by operations during the current period.
Net cash used by investing activities was $24.9 million for the six months ended
December 31, 1999. Cash used in investing activities consisted primarily of
$22.5 million for acquisitions, $1.2 million for purchases of property and
equipment and $1.2 million of undistributed earnings from the Company's joint
ventures.
Net cash provided by financing activities was $22.1 million for the six months
ended December 31, 1999. Cash provided by financing activities consisted
primarily of $20.9 million of net borrowings on the revolving line of credit to
finance the acquisitions and $1.2 million from the proceeds of stock option
exercises and the tax benefit associated with the disqualifying disposition of a
portion of those shares.
Historically, the Company has funded its operations and continued internal
growth through cash provided by operations. The Company anticipates its capital
expenditures for the year ending June 30, 2000 will consist primarily of
additional leasehold improvements, equipment and software systems for the
continuing expansion of the Company's leasehold and to enhance its computer
systems to meet the needs of the Company's growth. The Company expects the cost
of its capital expenditures in fiscal
14
year 2000 to be approximately $3.5 million, exclusive of any acquisitions of
businesses, and expects to fund these expenditures through cash provided by
operating activities and/or borrowings under the revolving credit agreement with
its bank.
The Company has a $60.0 million revolving credit facility under the terms of its
existing Credit Agreement. The Credit Agreement contains a $20.0 million
sub-limit for working capital loans and letters of credit and is subject to a
borrowing base limit that is based on the Company's cash flow. All outstanding
principal and interest on loans made under the Credit Agreement is due and
payable on December 1, 2001. Interest on loans under the Credit Agreement
accrues at a variable rate index, at the Company's option, based on the prime
rate or London Inter Bank Offered Rate ("LIBOR") for one, two, three or six
months (as selected by the Company), plus in each case, a margin depending on
the amount of the Company's debt to cash flow ratio as defined by the Credit
Agreement and measured at the end of each quarter for prospective periods.
During the six-month period ended December 31, 1999, the Company paid a margin
rate of .75%.
The Company's obligations under the Credit Agreement are secured by a lien on
substantially all of the assets of the Company, including a pledge of all of the
common stock of each direct or indirect wholly owned subsidiary of the Company.
Each wholly owned subsidiary has also guaranteed all of the obligations of the
Company under the Credit Agreement, which guarantee obligations are secured by a
lien on substantially all of the assets of each such subsidiary.
The Credit Agreement contains operating and financial covenants, including
requirements to maintain a certain debt to equity ratio and certain leverage and
debt coverage ratios. In addition, the Credit Agreement includes customary
affirmative and negative covenants, including covenants relating to transactions
with affiliates, use of proceeds, restrictions on subsidiaries, limitations on
indebtedness, limitations on liens, limitations on capital expenditures,
limitations on certain mergers, acquisitions and sales of assets, limitations on
investments, prohibitions on payment of dividends and stock repurchases, and
limitations on certain debt payments (including payment of subordinated
indebtedness) and other distributions. The Credit Agreement also contains
customary events of default, including certain events relating to changes in
control of the Company.
The Company is also a guarantor of a bank loan made to Children's Hemophilia
Services ("CHS"), a California general partnership in which the Company owns a
50% interest. The original line of credit amounted to $1,500,000. The payment
schedule requires that all outstanding principal amounts in excess of $1,000,000
are due on January 1, 2000, all outstanding principal amounts in excess of
$500,000 are due on July 1, 2000 and all remaining principal shall be due in
full on November 24, 2000. As of December 31, 1999, CHS had $1.0 million
outstanding under the line of credit.
Interest rate swap agreements are used to manage the Company's interest rate
expense under the Credit Agreement. The Company has effectively converted, for
the period through October 31, 2001, $25.0 million of floating-rate borrowings
to fixed rate borrowings. The Company has a 5.5% fixed interest rate (exclusive
of the margin rate) under its current interest rate swap agreement.
While the Company anticipates its cash from operations, along with the short
term use of the Credit Agreement will be sufficient to meet its internal
operating requirements and growth plans for at least the next 12 months, the
Company expects that additional funds would be required in the future to
successfully continue any growth that would extend beyond that 12-month period
or in the event that the Company grows more than expected within such period.
The Company may be required to raise additional funds through sales of equity or
debt securities or seek additional financing from financial institutions. There
can be no assurance, however, that financing will be available on terms that are
favorable to the Company or, if obtained, will be sufficient for the Company's
needs.
15
YEAR 2000 COMPLIANCE
Introduction. The term "year 2000 issue" is a general term used to
describe the various problems that may result from the improper processing of
dates and date-sensitive calculations by computers and other machinery as the
year 2000 was approached and reached. These problems arise from hardware and
software unable to distinguish dates in the "2000's" from dates in the "1900's"
and from other sources such as the use of special codes and conventions in
software that make use of a date field.
As of this filing, the Company has not identified any specific business
functions that have suffered material disruption as a result of year 2000
related events nor has the Company experienced any year 2000 related business
function disruptions subsequent to the arrival of year 2000.
The Company's State of Readiness. The Company's efforts in addressing
the year 2000 issue focused in the following three areas: (i) implementing
procedures to determine whether the Company's software systems and hardware
platforms are year 2000 compliant; (ii) communicating with suppliers and third
party payors to determine whether there would be any interruption in their
systems that could affect the Company's ability to receive timely shipments of
inventory or payment for services as a result of the year 2000 issue; (iii)
evaluating and making necessary modifications to other systems that contain
embedded chips, such as phone systems, which process dates and date sensitive
material.
The Company completed its process of obtaining written verification
from vendors to the effect that the Company's software applications and hardware
platforms acquired from such vendors would correctly manipulate dates and
date-related data as the year 2000 was approached and reached. Additionally, as
of September 30, 1999, the Company had completed upgrades on its pharmacy
management systems, including its billing and accounts receivable systems, in
order to address the year 2000 issue.
The Company's business relies heavily upon its ability to obtain
pharmaceuticals from a limited number of biotechnology manufacturers and from
its ability to obtain reimbursement from third-party payors, including Medicare
and Medicaid. The Company recently acquired two new pharmacy locations and
Sunrise Health Management, Inc. ("Acquired Business"), which the Company had
assessed as not presenting a material year 2000 issue. With the exception of
third-party payors and suppliers unique to the Acquired Business, the Company
completed its process of obtaining written verification from its suppliers, and
third-party payors, to determine whether there would be any material
interruption in the provision of pharmaceuticals or receipt of payment resulting
from the year 2000 issue. As a result of the Company's analysis and those
written responses received from its third-party payors, the Company believes
that there is minimal cash flow risk associated with the issue of year 2000
compliance of its significant third-party payors, including those payors unique
to the Acquired Business. However, the Company was unable to assess the year
2000 compliance status of all of its third-party payors. The Health Care
Financing Administration ("HCFA"), which administers the Medicare and Medicaid
programs, stated that progress on its efforts to renovate, test and certify the
systems operated by its contractors that process and pay Medicare claims led to
its expectation of being ready on January 1, 2000 to process and pay claims. The
failure of HCFA or any of the Company's other significant third-party payors to
remedy year 2000 related problems could result in a delay in the Company's
receipt of payments for services which could have a material adverse impact on
the Company's business, financial condition and results of operations. However,
the Company does have contingency plans in place in order to respond to a year
2000 related failure of a third-party payor. Those contingency plans include
lines of credit sufficient to minimize the impact which could result from any
disruption in the Company's cash flow from third-party payors. Furthermore, a
delay in receiving pharmaceuticals from certain key biotechnology manufacturers
could hinder the Company's ability to provide services to its customers which
could have a material adverse impact on the Company's business, financial
condition and results of operations.
The Company is aware that certain of its systems, such as phone
systems, facsimile machines, heating and air conditioning, security systems and
other non-data processing oriented systems may include embedded chips which
process dates and date sensitive material. These embedded chips are both
difficult to identify in all instances and difficult to repair; often, total
replacement of the chips is necessary. The inventory and evaluation for year
2000 compliance of Company hardware, telecommunications, and environmental
support systems was completed in the first quarter of fiscal year 1999 and those
systems requiring remediation (repair), rebuilding or replacing (re-engineering)
were identified. As of September 30, 1999, all identified re-engineering,
remediation, and replacement requirements had been completed and tested.
However, failure of the Company to identify or remediate any embedded chips
(either on an individual or an aggregate basis) on which significant business
operations depend, such as phone systems, could have a material adverse impact
on the Company's business, financial condition and results of operations.
Costs to Address the Company's Year 2000 Issues. The Company completed
its year 2000 related software and hardware upgrades prior to September 30,
1999. Although the Company is continuing to monitor its internal systems for
year 2000 compliance, no material additional expenses are anticipated. In the
unlikely event that any additional year 2000 software or
16
hardware related requirements are identified as part of the Company's ongoing
due diligence process, the Company plans to fund the costs of installing those
year 2000 modifications from cash flows resulting from operations or borrowings
and does not expect such costs to have a material effect on the financial
condition of the Company or its results of operations.
Risks Presented by Year 2000 Issues. The Company maintains an ongoing
process of evaluating potential disruptions or complications that might result
from year 2000 related problems. The absence of any such determination at this
point represents only the Company's current status of evaluating potential year
2000 related problems and facts presently known to the Company, and should not
be construed to mean that there is no risk of year 2000 related disruption.
Moreover, due to the unique and pervasive nature of the year 2000 issue, it is
impracticable to anticipate each of the wide variety of year 2000 events,
particularly outside of the Company, that might arise in a worst case scenario
which might have a material adverse impact on the Company's business, financial
condition and results of operations.
The Company's Contingency Plans. The Company has in place its
contingency plans for significant business risks that might result from year
2000 related events. To date, the Company has not identified any specific
internal business function that will be materially at risk of significant year
2000 related disruptions. However, these contingency plans will be monitored and
adjusted as required for any risks identified subsequent to the arrival of the
current calendar year 2000.
17
RISK FACTORS
You should carefully consider the risks we describe below before
investing in Accredo. The risks and uncertainties described below are NOT the
only risks and uncertainties that could develop. Other risks and uncertainties
that we have not predicted or evaluated could also affect our company.
If any of the following risks occur, our earnings, financial condition
or business could be materially harmed, and the trading price of our common
stock could decline, resulting in the loss of all or part of your investment.
OUR BUSINESS IS HIGHLY DEPENDENT ON RELATIONSHIPS WITH A LIMITED NUMBER
OF BIOTECHNOLOGY DRUG SUPPLIERS
The substantial majority of our revenue and profitability is derived
from our relationships with three biotechnology drug companies, Genzyme
Corporation, Biogen, Inc. and Genentech, Inc. The concentration of our revenue
derived from these relationships is shown in the table below as a percentage of
revenue for the periods indicated:
SIX MONTHS FISCAL YEAR ENDED
ENDED ----------------------------------------------------------
DECEMBER 31, 1999 JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1997
Genzyme 32% 37% 46% 64%
Biogen 37% 31% 23% 14%
Genentech 4% 5% 6% 9%
Our agreements with these suppliers are generally short-term and
cancelable by either party without cause on 60 to 90 days prior notice. Our
current agreements with Biogen and Genentech have been extended to February 29,
2000 and renewal terms are currently under negotiation. These agreements also
generally limit our ability to handle competing drugs during and in some cases
after the term of the agreement, but allow the supplier to distribute through
channels other than us. Further, the pricing and other terms of these
relationships are periodically adjusted. Any termination or adverse adjustment
to any of these relationships could have a material adverse affect on our
business, financial condition and results of operation.
OUR BUSINESS IS FOCUSED ON A LIMITED NUMBER OF DRUGS FOR SPECIFIC
DISEASES
Drugs handled and diseases served. We focus almost exclusively on a
limited number of complex and expensive drugs that serve small patient
populations. The primary diseases currently treated by the drugs we handle are
as follows:
- Gaucher Disease, for which we offer Ceredase(R) and
Cerezyme(R) supplied by Genzyme;
- Multiple Sclerosis, for which we primarily offer Biogen's
Avonex(R) (Interferon Beta-la);
- Growth hormone-related disorders, for which we primarily
offer Protropin(R), Nutropin(R) and Nutropin AQ(R) supplied
by Genentech;
- Hemophilia, for which we offer all currently approved
clotting factor products;
- Crohn's Disease and Rheumatoid Arthritis, for which we offer
Remicade(TM) supplied by Centocor, Inc; and
- Respiratory Synctial Virus (RSV) for which we offer
Synagis(R) supplied by MedImmune, Inc.
18
The concentration of our revenue related to these diseases and the
associated drugs is shown in the table below as a percentage of revenue for the
periods indicated:
SIX MONTHS FISCAL YEAR ENDED
ENDED -----------------------------------------------------------
DECEMBER 31, 1999 JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1997
Gaucher Disease 32% 37% 46% 64%
Multiple Sclerosis 37% 31% 23% 14%
Hemophilia 20% 21% 23% 9%
Growth Hormone
Disorders 7% 6% 7% 10%
Crohn's Disease 1% 1% N/A N/A
RSV (Seasonal) 1% 1% N/A N/A
Many factors affect the demand for our services. Reduced demand for our
services could be caused by a number of circumstances, including:
- Patient shift to other available treatments;
- A new treatment that does not require our specialty services;
- The recall of or adverse reaction caused by a drug;
- The expiration or challenge of a drug patent;
- A competing treatment from a new drug or a new use of an
existing drug;
- The loss of a managed care or other payor relationship
covering a number of high revenue patients;
- The cure of a disease we service; or
- The death of a high-revenue patient.
Our business could also be adversely affected by the expiration or
challenge to the "orphan drug" status that has been granted by the Food and Drug
Administration to four drugs that we handle. When the FDA grants "orphan drug"
status, it will not approve a second drug for the same treatment for a period of
seven years unless the new drug is physiochemically different or clinically
superior. The "orphan drug" status applicable to drugs handled by Accredo
expires as follows: Nutropin(R) expires November 2000; Cerezyme(R) expires May
2001; Avonex(R) expires May 2003 and Remicade(TM) expires September 2005. The
loss of orphan drug status could result in competitive drugs entering the
market.
Our ability to continue to service Avonex(R) could also be affected by
a pending challenge by Berlex Laboratories, Inc. that Biogen is infringing on a
Berlex patent in the production of Avonex(R). No trial date has been set in this
case.
Due to the small patient populations that use the drugs we handle, our
future growth is highly dependent on expanding our base of drugs. Further, a
loss of patient base or reduction in demand for any reason of the drugs we
currently handle could have a material adverse effect on our business, financial
condition and results of operation.
A DISRUPTION OF OUR RELATIONSHIPS WITH CERTAIN MEDICAL CENTERS COULD
HURT OUR BUSINESS
Accredo has significant relationships with seven medical centers that
involve services primarily related to hemophilia and growth hormone-related
disorders. For the six months ended December 31, 1999 and fiscal years ended
June 30, 1999 and 1998, we received approximately 17%, 23% and 30%,
respectively, of our income before income taxes and extraordinary items from
equity in the net income from our joint ventures related to hemophilia and
growth hormone-related disorders. Specifically, we derived 1%, 5% and 16%,
respectively, from our joint venture with Alternative Care Systems, Inc. located
in Dallas, Texas; 3%, 5% and 9%, respectively, from our joint venture with CM
Healthcare Resources, Inc. located in Chicago, Illinois; and 11%, 11% and 0%,
respectively, from our joint ventures with Children's Home Care, Inc. located in
Los Angeles, California for such periods.
Our agreements with the medical centers are short-term, between one and
five years, and may be cancelled by either party without cause upon notice of
between one and twelve months. Adverse changes in our relationships with those
medical centers could be caused, for example, by:
- Changes caused by consolidation within the hospital industry;
- Changes caused by regulatory uncertainties inherent in the
19
structure of the relationships; or
- Restrictive changes to regulatory requirements.
Any termination or adverse change of these relationships could have a material
adverse effect on our business, financial condition and results of operations.
OUR BUSINESS IS HIGHLY DEPENDENT ON CONTINUED RESEARCH, DEVELOPMENT AND
PRODUCTION IN THE BIOTECHNOLOGY DRUG INDUSTRY
Our business is highly dependent on continued research, development,
manufacturing and marketing expenditures of biotechnology drug companies, and
the ability of those companies to develop, supply and generate demand for drugs
that are compatible with the services we provide. Our business would be
materially and adversely affected if those companies stopped outsourcing the
services we provide or failed to support existing drugs or develop new drugs.
Our business could also be harmed if the biotechnology drug industry suffers
from unfavorable developments, including:
- Supply shortages;
- Adverse drug reactions;
- Drug recalls;
- Increased competition among biotechnology drug companies;
- An inability of drug companies to finance product development
because of capital shortages;
- A decline in product research, development or marketing;
- A reduction in the retail price of drugs because of
governmental or private market initiatives;
- Changes in the FDA approval process; or
- Governmental or private initiatives that would alter how drug
manufacturers, health care providers or pharmacies promote or
sell products and services.
DECREASES IN PAYMENTS BY OR LOSS OF RELATIONSHIPS WITH THIRD-PARTY
PAYORS COULD HURT OUR BUSINESS
Our profitability depends on payment from governmental and
nongovernmental third-party payors, and we could be materially and adversely
affected by trends toward cost containment measures in the health care industry
or by financial difficulties suffered by private payors. Cost containment
measures affect pricing, purchasing and usage patterns in health care. Private
payors, managed care organizations and similar groups also influence decisions
regarding the use of a particular drug treatment and focus on product cost in
light of how the product may impact the overall cost of treatment. Further, some
private payors, including large managed care organizations and some private
physician practices, have recently experienced financial trouble. The ability to
collect from third-party payors also affects our revenue and profitability. If
we are unable to collect from third-party payors, it could have a material
adverse impact on our business and financial condition.
Our dependence on reimbursement from private payors is evident from the
portion of total revenue they constitute. For the six months ended December 31,
1999 and fiscal years ended June 30, 1999, 1998 and 1997, we derived
approximately 82%, 82%, 80% and 83%, respectively, of our gross patient service
revenue from private payors (including self-pay), which included 5%, 6%, 7% and
11%, respectively, from sales to private physician practices whose ultimate
payor is typically Medicare.
Many third-party payors seek to limit the number of providers that
supply drugs to their enrollees. From time to time, payors with whom we have
relationships require that we and our competitors bid to keep their business,
and there can be no assurance that we will be retained when that happens. The
loss of a payor relationship could result in the loss of a significant number of
patients and have a material adverse effect on our business, financial condition
and results of operations.
CHANGES IN MEDICARE OR MEDICAID COULD HURT OUR BUSINESS
Changes in the Medicare, Medicaid or similar government programs or the
rates paid by those programs for our services may adversely affect our earnings.
We estimate that approximately 18% of our gross patient service revenue for the
six months ended December 30, 1999, 18% of our gross patient service revenue for
the fiscal year ended June 30, 1999, 20% of our gross patient service revenue
for the fiscal year ended June 30, 1998 and 17% of our gross patient service
revenue for the fiscal year ended June 30, 1997 consisted of reimbursements from
federal and state programs, excluding sales to private physicians whose ultimate
payor is typically Medicare. Any reductions in amounts reimbursable by
government programs for our services or
20
changes in regulations governing such reimbursements could materially and
adversely effect our business, financial condition and results of operations:
OUR QUARTERLY FINANCIAL RESULTS MAY FLUCTUATE SIGNIFICANTLY
Our financial results have historically fluctuated on a quarterly
basis, and this pattern is expected to continue. These quarterly fluctuations
could adversely affect the market price of our common stock and are attributable
to many factors, including:
- Below-expected sales of a new drug;
- Increases in our operating expenses in anticipation of the
launch of a new drug;
- Price and term adjustments with our suppliers;
- Inaccuracies in our estimates of the cost of ongoing
programs;
- The timing and integration of our acquisitions;
- Changes in governmental regulations;
- The annual renewal of deductible and co-payment requirements,
so that patient ordering patterns are affected, causing a
seasonal reduction in revenue from existing drug programs for
our third fiscal quarter;
- Our provision of drugs, now or in the future, to treat
seasonal illnesses such as RSV;
- Physician prescribing patterns; and
- General economic conditions.
LIABILITIES AND COSTS MAY ARISE FROM OUR JOINT VENTURES AND
ACQUISITIONS
As part of our growth strategy we continually evaluate joint venture
and acquisition opportunities. Although we cannot predict or provide assurance
that we will complete any future acquisitions or joint ventures, if we do, we
will be exposed to a number of risks, including:
- Difficulty in assimilating the new operations;
- Increased transaction costs;
- Diversion of management's attention from existing operations;
- Dilutive issuances of equity securities that may negatively
impact the market price of our stock;
- Increased debt;
- Increased amortization expense related to goodwill and other
intangible assets that would decrease our earnings.
Accredo may also expose itself to unknown or contingent liabilities
resulting from the pre-acquisition operations of the entities it acquires, such
as liability for failure to comply with health care or reimbursement laws.
Accredo could be exposed to liability for pre-acquisition operations with
respect to the following transactions:
- The purchase in May 1996 of Southern Health Systems, Inc.
Southern Health had four subsidiaries, each of which had prior
operating histories. While Southern Health divested all of its
subsidiaries with unrelated businesses before closing, Accredo
could potentially be held liable for matters relating to the
operations of the divested subsidiaries for periods before the
divestiture.
- The purchase in June 1997 of Hemophilia Health Services, Inc.,
which had an extensive operating history.
- The purchase in November 1998 of a 50% interest in two
California general partnerships.
- The purchase in October 1999 of the assets of pharmacies
in Jacksonville, Florida and Temecula, California.
- The purchase in December 1999 of Sunrise Health Management,
Inc.
21
OUR INDUSTRY IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION
The marketing, sale and purchase of drugs and medical supplies is
extensively regulated by federal and state governments, and if we fail or are
accused of failing to comply with laws and regulations, we could suffer a
material adverse effect to our business, financial condition and results of
operations. Our business could also be materially and adversely effected if the
suppliers or clients we work with are accused of violating laws or regulations.
The applicable regulatory framework is complex, and the laws are very broad in
scope. Many of these laws remain open to interpretation, and have not been
addressed by substantive court decisions.
The health care laws and regulations that especially apply to our
activities include:
- The federal "Anti-Kickback Law" prohibits the offer or
solicitation of compensation in return for the referral of
patients covered by almost all governmental programs, or the
arrangement or recommendation of the purchase of any item,
facility or service covered by those programs. The Health
Insurance Portability and Accountability Act of 1996 ("HIPAA")
created new violations for fraudulent activity applicable to
both public and private health care benefit programs and
prohibits inducements to Medicare or Medicaid eligible
patients. The potential sanctions for violations of these laws
range from significant fines, to exclusion from participation
in the Medicare and Medicaid programs, to criminal sanctions.
Although certain "safe harbor" regulations attempt to clarify
when an arrangement may fall outside of the scope of the
Anti-Kickback Law, our business arrangements and the services
we provide may not fit within these exceptions.
- The Department of Health and Human Services recently proposed
regulations implementing the Administrative Simplification
provision of HIPAA, concerning the maintenance and
transmission of electronic health information. The new
regulations, when enacted, will require the development and
implementation of security standards for all electronic health
information and impose significant use and disclosure
obligations on entities that send or receive individually
identifiable electronic health information. Failure to comply
with these regulations could result in the imposition of
administrative or criminal sanctions, including exclusion
from the Medicare and state Medicaid programs.
- The Ethics in Patient Referrals Act of 1989, as amended,
commonly referred to as the "Stark Law," prohibits physician
referrals to entities with which the physician or their
immediate family member has a "financial relationship." A
violation of the Stark Law is punishable by civil sanctions,
including significant fines and exclusion from participation
in Medicare and Medicaid.
- State laws prohibit the practice of medicine, pharmacy and
nursing without a license. To the extent that we assist
patients and providers with prescribed treatment programs, a
state could consider our activities to constitute the practice
of medicine. If we are found to have violated those laws, we
could face civil and criminal penalties and be required to
reduce, restructure, or even cease our business in that state.
- Federal and state investigations and enforcement actions have
recently begun focusing on the health care industry,
scrutinizing a wide range of items such as joint venture
arrangements, referral and billing practices, product discount
arrangements, home health care services, dissemination of
confidential patient information, clinical drug research
trials and gifts for patients.
- The False Claims Act encourages private individuals to file
suits on behalf of the government, and can result in
significant financial sanctions.
OUR BUSINESS WILL BE HARMED IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR
GROWTH
Our rapid growth over the past three and a half years has placed a
strain on our resources, and if we cannot effectively manage our growth, our
business, financial condition and results of operations could be materially and
adversely affected. We have experienced a large increase in the number of our
employees, the size of our programs and the scope of our operations. If this
growth continues, the strain could cause us to relocate our operations to a new
city or area. Our ability to manage this growth and be successful in the future
will depend partly on our ability to retain skilled employees, enhance our
management team and improve our management information and financial control
systems.
22
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY THE SUBSTANTIAL COMPETITION
WITHIN OUR INDUSTRY.
The specialty pharmacy industry is highly competitive and is continuing
to become more competitive. All of the drugs, supplies and services that we
provide are also available from our competitors. Accredo's current and potential
competitors include:
- Specialty pharmacy divisions of wholesale drug distributors;
- Specialty pharmacy distributors;
- Pharmacy benefit management companies
- Hospital-based pharmacies;
- Retail pharmacies;
- Home infusion therapy companies;
- Comprehensive hemophilia treatment centers; and
- Other alternative site health care providers.
Many of our competitors have substantially greater resources and more
established operations and infrastructure than we have. We are particularly at
risk for one of our suppliers deciding to pursue its own distribution and
services. Some of our competitors, such as hospitals and hemophilia treatment
centers, have the advantage of federally mandated drug discounts that are not
available to us, and which are proposed to be available to even more potentially
competing centers. A significant factor in effective competition will be an
ability to maintain and expand relationships with managed care companies,
pharmacy benefit managers and other payors who can effectively determine the
pharmacy source for their enrollees.
OUR PRODUCT DELIVERY REQUIREMENTS DEPEND HEAVILY ON AVAILABLE SHIPPING
SERVICES APPROPRIATE TO OUR PRODUCTS
Since almost all of our revenues result from the sale of drugs we
deliver to our patients, we depend heavily on our shipping services for
efficient, cost effective delivery of our product. There are many risks
associated with this dependence, all of which could materially and adversely
affect our business. Those risks include:
- Any significant increase in shipping rates;
- Strikes or other service interruptions by our primary
carrier, Federal Express, or by another carrier that could
affect Federal Express; or
- Product spoilage during shipment, since our drugs are
expensive and often require special handling, such as
refrigeration. We do not maintain insurance against product
spoilage during shipment and the loss of even small shipments
could represent a significant cost.
WE RELY ON A FEW KEY PEOPLE
We depend on a number of our key executives, and the loss of their
services could cause a material adverse effect to our company. We do not
maintain "key person" life insurance policies on any of those executives. As a
result, Accredo is not insured against the losses resulting from the death of
its key executives. Further, we must be able to attract and retain other
qualified, essential employees for our technical operating and professional
staff, such as pharmacists.
WE MAY NEED ADDITIONAL CAPITAL TO FINANCE OUR GROWTH AND CAPITAL
REQUIREMENTS
In order to implement our growth strategy, we will need substantial
capital resources and will incur, from time to time, additional short- and
long-term indebtedness, the terms of which will depend on market and other
conditions. We cannot be certain that existing or additional financing will be
available to us on acceptable terms, if at all. As a result, we could be unable
to fully pursue our growth strategy. Further, additional financing may involve
the issuance of equity securities that would reduce the percentage ownership of
our then current stockholders.
23
WE COULD BE ADVERSELY AFFECTED BY AN IMPAIRMENT OF THE SIGNIFICANT
AMOUNT OF GOODWILL ON OUR FINANCIAL STATEMENTS
Our formation and our acquisitions of Southern Health Systems and
Hemophilia Health Services, and most recently Sunrise Health Management and the
specialty pharmacy businesses of Home Medical of America resulted in the
recording of a significant amount of goodwill on our financial statements. The
goodwill was recorded because the value of the tangible and intangible assets
owned by those companies at the time they were acquired was less than the
purchase price. We have determined that the goodwill recorded as a result of
those acquisitions will benefit us for a period of no less than 40 years and, as
a result, we amortize this goodwill evenly over a 40-year period. There can be
no assurance that we will realize the full value of this goodwill. We evaluate
on an on-going basis whether events and circumstances indicate that all or some
of the carrying value of goodwill is no longer recoverable, in which case we
would write off the unrecoverable goodwill in a charge to our earnings.
If the amortization period for a material portion of goodwill is overly
long, it causes an overstatement of earnings in periods immediately following
the transaction in which the goodwill was recorded. In later periods, it causes
earnings to be understated because of an amortization charge for an asset that
no longer provides a corresponding benefit. Earnings in later periods could also
be significantly affected if the remaining balance of goodwill is impaired and
written off as a charge against earnings. We are not presently aware of any
persuasive evidence that any material portion of our goodwill will be impaired
and written off against earnings. As of December 31, 1999, Accredo had goodwill,
net of accumulated amortization, of approximately $66.8 million, or 36% of total
assets and 96% of stockholders' equity.
Since our growth strategy may involve the acquisition of other
companies, we may record additional goodwill in the future. The amortization and
possible write-off of this goodwill could negatively impact our future earnings.
Also, in future acquisitions we may be required to allocate a portion of the
purchase price to the value of non-competition agreements, patient base and
contracts that are acquired. The value of any amounts allocated to these items
could be amortized over a period much shorter than 40 years. As a result, our
earnings and potentially our stock price could be negatively impacted.
THE PRICE OF OUR STOCK COULD BE VOLATILE AND SUBJECT TO SUBSTANTIAL
FLUCTUATIONS
Our common stock is traded on the Nasdaq National Market. Since our
stock has only been publicly traded for a short time, an active trading market
for the stock may not develop or be maintained. Also, the market price of our
common stock could fluctuate substantially based on a variety of factors,
including the following:
- Future announcements concerning us, our competitors, the drug
manufacturers with whom we have relationships or the
health care market;
- Changes in government regulations;
- Changes in earnings estimates by analysts; and
- Changes in operating results from quarter to quarter.
Furthermore, stock prices for many companies fluctuate widely for
reasons that may be unrelated to their operating results. These fluctuations,
coupled with changes in demand or reimbursement levels for our services and
general economic, political and market conditions, may adversely affect the
market price of our common stock.
FUTURE SALES OF OUR COMMON STOCK COULD CAUSE THE PRICE OF OUR SHARES TO
DECLINE
Sales of substantial amounts of our common stock in the public market,
or the belief those sales might occur, could cause the price of our stock to
decline. As of January 31, 2000, we have outstanding 9,204,851 shares of common
stock, 3,450,000 of which were sold in our initial public offering in April 1999
and are freely tradable. Almost all of the remaining 5,754,851 shares are freely
tradeable, some of which have already been sold in the public market and the
balance of which may enter the public market at any time. A small number of
shares are held by our affiliates and may be sold in the public market subject
to the volume and other restrictions under Rule 144.
In addition, as of January 31, 2000, 1,469,736 shares of Accredo's
registered common stock have been reserved for future stock awards under
Accredo's stock plans, and for issuance upon the exercise of outstanding awards.
As of January 31, 2000, options to purchase 983,823 of these registered shares
have been granted and not yet exercised. Those shares are freely tradable upon
exercise, except to the extent that the holders are deemed to be affiliates of
Accredo, in which case the transferability of such shares will be subject to the
volume limitations of Rule 144.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS COULD INHIBIT A TAKEOVER OF
ACCREDO, RESULTING IN A DECLINE IN THE MARKET PRICE FOR THE COMMON STOCK
Certain provisions of our Amended and Restated Certificate of
Incorporation and Amended and Restated Bylaws could make it more difficult for a
third-party to acquire control of us, or could discourage a third-party from
attempting to acquire our
24
company. These provisions might limit the price that investors would pay in the
future for shares of our common stock. Examples of these provisions include:
- The classification of our Board of Directors into three
classes;
- Blank check preferred stock that may be issued by our Board of
Directors, without stockholder approval, containing
preferences or rights objectionable to an acquiror;
- Restrictions on calling special meetings at which an
acquisition or change in control might be brought to a vote
of the stockholders;
- The right to impose procedural and other requirements that
could make it more difficult for stockholders to effect
certain corporate actions.
We are subject to a provision of the Delaware General Corporation Law
(Section 203), that restricts certain business combinations with an "interested
stockholder" and could delay, defer or prevent a change in control of our
company.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company uses derivative financial instruments to manage its exposure to
rising interest rates on its variable-rate debt, primarily by entering into
variable-to-fixed interest rate swaps. We have fixed the interest rate through
October 31, 2001 on $25.0 million of our revolving credit facility through such
a financial instrument. Accordingly, we would not benefit from any decrease in
interest rates on this portion of our credit facility, nor would we be
detrimentally impacted by rising rates on the same portion of our outstanding
debt.
As of December 31, 1999, approximately $16.4 million of our outstanding debt was
not covered by a variable-to-fixed interest rate swap. As a result, the Company
was exposed to the risk of rising interest rates on this portion of its debt.
Accordingly, a 100 basis point increase in interest rates along the entire yield
curve would have reduced our pre-tax income by approximately $82,000 during the
six months ended December 31, 1999 if this debt had been outstanding throughout
the period.
26
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(d) Use of Proceeds
The Company's Registration Statement on Form S-1 (File No 333-62769)
was declared effective on April 15, 1999. There has been no change in the Use of
Proceeds since that reported in the Company's Form 10-K for the year ended June
30, 1999.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the annual meeting of stockholders held on November 18, 1999 in
Memphis, Tennessee, stockholders holding 89.4% of the issued and outstanding
shares of the common stock of the Company adopted the following matters.
1. Proposal to elect Kevin L. Roberg, David D. Stevens and Kenneth J.
Melkus to serve as directors until the expiration of their term in 2002
or until their successors are elected and qualified.
VOTED FOR: 8,176,524 VOTED AGAINST: 6,600
2. Proposal to ratify the appointment of Ernst & Young LLP as independent
public accountants to audit the Company's financial statements for the
fiscal year ended June 30, 2000.
VOTED FOR: 8,182,424 VOTED AGAINST: 200 ABSTAINED: 500
ITEM 5. OTHER INFORMATION.
On January 31, 2000, the Company announced a three-for-two stock split
in the form of a 50% stock dividend for shareholders of record on February 11,
2000. Shareholders will receive one additional share of common stock on February
21, 2000 for every two shares held on the record date. The Company has computed
earnings per share for the six-month and three-month periods presented in this
Form 10-Q on a post-split basis.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 10.1 Amendment No. 4 dated December 3, 1999 to Loan and
Security Agreement as amended on June 5, 1997 among
Accredo Health, Incorporated and its Subsidiaries and
Bank of America, N.A., First Tennessee Bank National
Association and Brown Brothers Harriman & Co. and
Bank of America, N.A., as Agent
Exhibit 10.2 Non-Qualified Stock Option Agreement of Patrick J.
Welsh dated November 10, 1999
Exhibit 10.3 Non-Qualified Stock Option Agreement of Andrew M.
Paul dated November 10, 1999
Exhibit 10.4 Non-Qualified Stock Option Agreement of Kenneth J.
Melkus dated November 10, 1999
Exhibit 10.5 Non-Qualified Stock Option Agreement of Kenneth R.
Masterson dated November 10, 1999
Exhibit 10.6 Non-Qualified Stock Option Agreement of Kevin L.
Roberg dated November 10, 1999
Exhibit 10.7 Non-Qualified Stock Option Agreement of Kevin L.
Roberg dated November 18, 1999
Exhibit 27 Financial Data Schedule (for SEC use only) (filed
herewith)
(b) Reports on Form 8-K
27
The Company filed a Current Report on Form 8-K on December 16, 1999, in
connection with the acquisition of all of the outstanding stock of Sunrise
Health Management, Inc. effective on December 1, 1999. On February 11, 2000, the
Company filed an amendment No. 1 to such Current Report on Form 8-K/A,
containing the financial statements of Sunrise Health Management, Inc. and
certain pro forma financial information.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
February 14, 2000 Accredo Health, Incorporated
/s/ David D. Stevens
-----------------------------------------
David D. Stevens
Chairman of the Board and
Chief Executive Officer
/s/ Joel R. Kimbrough
-----------------------------------------
Joel R. Kimbrough
Senior Vice President, Chief
Financial Officer and Treasurer
28
Exhibit Index
Exhibit
Number Description of Exhibits
10.1 Amendment No. 4 dated December 3, 1999 to Loan and Security Agreement
as amended on June 5, 1997 among Accredo Health, Incorporated and its
Subsidiaries and Bank of America, N.A., First Tennessee Bank National Association
and Brown Brothers Harriman & Co. and Bank of America, N.A., as Agent
10.2 Non-Qualified Stock Option Agreement of Patrick J. Welsh dated November 10, 1999
10.3 Non-Qualified Stock Option Agreement of Andrew M. Paul dated November 10, 1999
10.4 Non-Qualified Stock Option Agreement of Kenneth J. Melkus dated November 10, 1999
10.5 Non-Qualified Stock Option Agreement of Kenneth R. Masterson dated November 10, 1999
10.6 Non-Qualified Stock Option Agreement of Kevin L. Roberg dated November 10, 1999
10.7 Non-Qualified Stock Option Agreement of Kevin L. Roberg dated November 18, 1999
27 Financial Data Schedule (for SEC use only) (filed herewith)