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 SEPTEMBER 30, 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) NO CHANGE (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 2 APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY 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 OCTOBER 29, 1999 COMMON STOCK, $0.01 PAR VALUE................ 9,155,512 NON-VOTING COMMON STOCK, $0.01 PAR VALUE..... 0 ---------- TOTAL COMMON STOCK........................... 9,155,512 ========== 3 ACCREDO HEALTH, INCORPORATED INDEX Part I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Statements of Operations (unaudited) For the three months ended September 30, 1998 and 1999 Condensed Consolidated Balance Sheets June 30, 1999 and September 30, 1999 (unaudited) Condensed Consolidated Statements of Cash Flows (unaudited) For the three months ended September 30, 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 (c) Sales of Unregistered Securities (d) Use of Proceeds Item 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits and Reports on Form 8-K Note: Items 1, 3 and 5 of Part II are omitted because they are not applicable. 4 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (000'S OMITTED, EXCEPT SHARE DATA) (UNAUDITED) Three Months Ended September 30, -------------------------------- 1999 1998 ------- -------- Net patient service revenue $72,684 $ 54,365 Other revenue 3,569 2,733 Equity in net income of joint ventures 618 250 ------- -------- Total revenues 76,871 57,348 Cost of services 65,992 48,525 ------- -------- Gross profit 10,879 8,823 General & administrative 5,246 3,997 Bad debts 1,363 1,131 Depreciation and amortization 645 986 ------- -------- Income from operations 3,625 2,709 Interest expense, net 352 865 ------- -------- Income before income taxes 3,273 1,844 Provision for income taxes 1,305 929 ------- -------- Net income 1,968 915 Preferred stock dividends -- (510) ------- -------- Net income to common shareholders $ 1,968 $ 405 ======= ======== Cash dividends declared on common stock $ -- $ -- ======= ======== Basic earnings per common share: Net income $ 0.22 $ 0.16 Preferred stock dividends -- (0.09) ------- -------- Net income per common share $ 0.22 $ 0.07 ======= ======== Diluted earnings per common share: Net income $ 0.20 $ 0.15 Preferred stock dividends -- (0.08) ------- -------- Net income per common share $ 0.20 $ 0.07 ======= ======== See accompanying notes to condensed consolidated financial statements. 5 ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (000'S OMITTED, EXCEPT SHARE DATA) (UNAUDITED) September 30, June 30, 1999 1999 --------------------------- ASSETS Current assets: Cash and cash equivalents $ 5,169 $ 5,542 Patient accounts receivable, less allowance for doubtful accounts of $5,558 at September 30, 1999 and $5,300 at June 30, 1999 52,866 54,816 Due from affiliates 2,275 2,105 Other accounts receivable 6,027 5,856 Inventories 21,997 19,927 Prepaids and other current assets 371 359 Deferred income taxes 1,993 1,554 -------- -------- Total current assets 90,698 90,159 Property and equipment, net 3,285 3,025 Other assets: Joint venture investments 4,033 3,415 Goodwill and other intangible assets, net 49,696 50,147 -------- -------- Total assets $147,712 $146,746 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 53,330 $ 56,029 Accrued expenses 4,606 4,831 Income taxes payable 1,743 393 -------- -------- Total current liabilities 59,679 61,253 Long-term notes payable 20,500 20,500 Deferred income taxes 908 866 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 September 30, 1999; 1,100,000 shares issued and outstanding at June 30, 1999 - 11 Common Stock, $.01 par value; 30,000,000 shares authorized; 9,154,887 and 7,977,087 shares issued and outstanding at September 30, 1999 and June 30, 1999, respectively 92 80 Additional paid-in capital 63,896 63,367 Retained earnings 2,637 669 -------- -------- Total stockholders' equity 66,625 64,127 -------- -------- Total liabilities and stockholders' equity $147,712 $146,746 ======== ======== See accompanying notes to condensed consolidated financial statements. 6 ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (000'S OMITTED) (UNAUDITED) Three Months Ended September 30, 1999 1998 ------------------------ OPERATING ACTIVITIES: Net income $ 1,968 $ 915 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 645 986 Original issue discount amortization -- 59 Provision for losses on accounts receivable 1,363 1,131 Deferred income tax benefit (413) (765) Compensation resulting from stock transactions 46 46 Changes in operating assets and liabilities: Patient receivables and other 416 (10,099) Due from affiliates (170) (61) Inventories (2,070) (2,816) Prepaids and other current assets (12) (83) Recoverable income taxes -- 151 Accounts payable and accrued expenses (2,924) 9,125 Income taxes payable 1,350 1,482 ------- -------- Net cash provided by operating activities 199 71 INVESTING ACTIVITIES: Purchases of property and equipment (455) (200) Change in joint venture investments, net (618) (5) ------- -------- Net cash used in investing activities (1,073) (205) FINANCING ACTIVITIES: Issuance of common stock 501 207 ------- -------- Net cash provided by financing activities 501 207 ------- -------- Increase (decrease) in cash and cash equivalents (373) 73 Cash and cash equivalents at beginning of period 5,542 5,087 ------- -------- Cash and cash equivalents at end of period $ 5,169 $ 5,160 ======= ======== See accompanying notes to condensed consolidated financial statements. 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 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-month period ended September 30, 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. ACQUISITION On October 20, 1999, the Company acquired 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 located in Jacksonville, Florida and Temecula, California, 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 $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 beginning November 1, 1999 and ending April 30, 2000. The Company also paid $500,000 as consideration for an agreement from HMA, SPS and certain other of their affiliates not to compete for a period of five years. No indebtedness was assumed with this acquisition. This transaction will be accounted for using the purchase method of accounting and the results of operations of these pharmacies will be included in the consolidated financial statements of the Company subsequent to the date of acquisition. The excess of the total estimated purchase price, including estimated acquisition costs of $100,000, over the fair market value of the net assets acquired of approximately $234,000, will be allocated to goodwill and other identifiable intangible assets and amortized using the straight-line method over their estimated useful lives. The $500,000 payment for the non-compete agreement will be amortized using the straight-line method over its five year life. The results of operations of these pharmacies would not have been material to the results of the Company for the three months ended September 30, 1999 or 1998. 3. INVESTMENT IN JOINT VENTURE 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 8 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. 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 the two pharmacy locations in Florida and California discussed in Note 2, the Company also assumed the leases for these pharmacy locations. 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 $ 721 2001 574 2002 575 2003 545 2004 225 Thereafter 236 ------- $ 2,876 ======= 5. STOCKHOLDERS' EQUITY During the quarter ended September 30, 1999, the Company's largest shareholder converted 1,100,000 shares of the Company's outstanding Non-voting Common Stock to 1,100,000 shares of voting Common Stock. During the quarter ended September 30, 1999, employees exercised stock options to acquire 77,800 shares for exercise prices ranging between $3.00 and $6.00 per share. 9 6. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share data): Three Months Ended September 30, -------------------------------- 1999 1998 ------------------------------- Numerator for basic and diluted income per share to common stockholders: Net income $ 1,968 $ 915 Preferred stock dividends -- (510) ---------- ------------- Net income to common stockholders $ 1,968 $ 405 ========== ============= Denominator: Denominator for basic income per share to common stockholders - weighted-average shares 9,100,227 5,616,098 Effect of dilutive stock options 690,255 592,745 ---------- ------------- Denominator for diluted income per share to common stockholders - adjusted weighted-average shares 9,790,482 6,208,843 ========== ============= Basic earnings per common share: Net income $ 0.22 $ 0.16 Preferred stock dividends -- (0.09) ---------- ------------- Net income per common share $ 0.22 $ 0.07 ========== ============= Diluted earnings per common share: Net income $ 0.20 $ 0.15 Preferred stock dividends -- (0.08) ---------- ------------- Net income per common share $ 0.20 $ 0.07 ========== ============= 10 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, 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, the impact of year 2000 issues, 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 REVENUES Total revenues increased from $57.3 million to $76.9 million, or 34%, from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999. Approximately $12.9 million, or 66%, of this increase was attributable to the increased sales volume of Avonex(R). Cerezyme(R) and Ceredase(R) drug sales increased approximately $2.6 million, or 13% of the revenue increase, as a result of increased patient volume. Approximately $1.4 million, or 7%, of this increase was attributable to the increased hemophilia revenue associated with increased patient volume. Approximately $700,000, or 4%, of the increase was attributable to the sale of the new drug Remicade(TM) for the treatment of Crohn's Disease. The remaining $2.0 million, or 10%, of the revenue increase was primarily attributable to increased sales of growth hormone, 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 $368,000 from the Company's equity in net income of joint ventures. COST OF SERVICES Cost of services increased from $48.5 million to $66.0 million, or 36%, from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999. This increase is commensurate with the increase in revenues discussed above. As a percentage of revenues, cost of services increased from 84.6% to 85.8% from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999. This increase is primarily a result of an increase in certain hemophilia factor acquisition costs without an associated increase in selling price during the three-month period ended September 30, 1999, in addition to changes in the revenue mix by therapy type. GENERAL AND ADMINISTRATIVE General and administrative expenses increased from $4.0 million to $5.2 million, or 30%, from the three-month period ended September 30, 1998 to the three-month period ended September 30, 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 and new product line launches. General and administrative expenses represented 7.0% and 6.8% of revenues for the three months ended September 30, 1998 and 1999, respectively. 11 BAD DEBTS Bad debts increased from $1,131,000 to $1,363,000, or 21%, from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999. Bad debt expense was 2.0% and 1.8% of revenues for the three months ended September 30, 1998 and 1999, respectively. DEPRECIATION AND AMORTIZATION Depreciation expense increased from $128,000 to $195,000 from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999. The increase was a result of purchases of property and equipment associated with the Company's revenue growth and expansion of its leasehold facility improvements amounting to $1.5 million in fiscal year 1999 and $455,000 in the three-month period ended September 30, 1999. Amortization expense associated with goodwill and other intangible assets decreased from $858,000 to $450,000 from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999 due to certain contract intangibles and a non-compete covenant that were fully amortized by the end of fiscal year 1999. INTEREST EXPENSE, NET Interest expense, net, decreased from $865,000 to $352,000 from the three-month period ended September 30, 1998 to the three-month period ended September 30, 1999 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 $44,000 and $55,000 in the three months ended September 30, 1998 and 1999, respectively. INCOME TAX EXPENSE The Company's effective tax rate decreased from 50.4% to 39.9% from the three-month period ended September 30, 1998 to the three-month period ended September 30, 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 $205,000 of nondeductible amortization expense in the three months ended September 30, 1998 and 1999, respectively, and state income taxes. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1999 and June 30, 1999, the Company had working capital of $31.0 million and $28.9 million, respectively. The Company's net cash provided by operations for the three-month period ended September 30, 1999 was approximately $199,000, while approximately $71,000 was provided by operations for the three-month period ended September 30, 1998. These increases are primarily due to the Company's continued growth in income and the timing of the collection of receivables, inventory purchases and payables. In regards to the timing of the collection of receivables, in particular, the Company is owed approximately $2.0 million as of September 30, 1999 from one of its joint venture partners that has been outstanding for more than 180 days. Although the Company expects to be able to collect these receivables, and has collected approximately $700,000 since June 30, 1999, the length of time these receivables have been outstanding has reduced the amount of cash that would have otherwise been provided by operations during the current period. Net cash used by investing activities was $1,073,000 and $205,000 for the three months ended September 30, 1999 and 1998, respectively. The increase in cash used by investing activities is due to an increase in the purchase of property and equipment as a result of the Company's continued growth and an increase in the amount of undistributed earnings from the Company's joint ventures. Purchases of property and equipment amounted to $455,000 and $200,000 for the three months ended September 30, 1999 and 1998, respectively. There were no cash distributions from the joint ventures during the three-month period ended September 30, 1999 and $245,000 of cash distributions during the three-month period ended September 30, 1998, while the Company's associated equity in the net income of these joint ventures was approximately $618,000 and $250,000, respectively. Net cash provided by financing activities was $501,000 and $207,000 for the three months ended September 30, 1999 and 1998, respectively, from the issuance of its common stock. The cash provided from stock issued during the three months ended September 30, 1999 was the result of stock option exercises and includes a tax benefit of $249,000 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 12 improvements and equipment for the continuing expansion of the Company's leasehold to accommodate personnel necessary to manage the Company's growth. The Company expects the cost of its capital expenditures in fiscal year 2000 to be approximately $3.1 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 negotiated a lease for an additional 30,570 square feet of office and warehouse space and for additional parking space. The term of the lease for the office and warehouse space is six years with lease payments amounting to approximately $122,000 per year in years one through four and approximately $138,000 per year in years five and six. The lease for the additional parking space is also for a period of six years with lease payments amounting to approximately $29,000 per year. Both leases have a five-year extension option. On October 20, 1999, the Company acquired certain assets of the specialty pharmacy businesses operated by certain affiliates of Home Medical of America, Inc. The assets acquired include two pharmacies located in Jacksonville, Florida and Temecula, California, 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 $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 beginning November 1, 1999 and ending April 30, 2000. The Company also paid $500,000 as consideration for an agreement from the seller not to compete for a period of five years. No indebtedness was assumed with this acquisition. 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 three-month period ended September 30, 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. This line of credit allows the partnership to borrow up to $1.5 million, which is repayable in full on November 24, 2000. As of September 30, 1999, CHS had borrowed $1.5 million against 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. 13 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 is 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. 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 will 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 has 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 will correctly manipulate dates and date-related data as the year 2000 is approached and reached. Additionally, as of September 30, 1999, the Company has completed upgrades on its pharmacy management systems, including its billing and accounts receivable systems, in order to address the year 2000 issue. Nevertheless, there can be no assurance that the software applications and hardware platforms on which the Company's business relies will correctly manipulate dates and date-related data as the year 2000 is approached and reached. Such failures could have a material adverse effect on the Company's business, financial condition and results of operations. 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 ("Acquired Business"), which the Company has 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 has completed its process of obtaining written verification from its suppliers, and third party payors, to determine whether there will 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 has been 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, has stated that progress on its efforts to renovate, test and certify the systems operated by its contractors that process and pay Medicare claims have lead 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 have 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 14 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. However, at this time the Company has not identified any specific business functions that will suffer material disruption as a result of year 2000 related events. It is possible, however, that the Company may identify business functions in the future that are specifically at risk of year 2000 disruption. 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 and is continually updating 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 during the remainder of this calendar year 1999 and the year 2000. 15 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 Accredo's 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 years indicated: THREE MONTHS FISCAL YEAR ENDED ENDED ---------------------------------------------------------- SEPTEMBER 30, 1999 JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1997 Genzyme 33% 37% 46% 64% Biogen 38% 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 agreement with Biogen has been extended to November 30, 1999 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 Accredo. 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 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, for which we began offering Remicade(TM) supplied by Centocor during fiscal year 1999; and - Respiratory Synctial Virus (RSV) for which we began offering Synagis supplied by MedImmune during fiscal year 1999. 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 years indicated: THREE MONTHS FISCAL YEAR ENDED ENDED ----------------------------------------------------------- SEPTEMBER 30, 1999 JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1997 Gaucher Disease 33% 37% 46% 64% Multiple Sclerosis 38% 31% 23% 14% Hemophilia 20% 21% 23% 9% Growth Hormone Disorders 6% 6% 7% 10% Crohn's Disease 1% 1% N/A N/A RSV (Seasonal) 0% 1% N/A N/A 16 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 three months ended September 30, 1999 and fiscal years ended June 30, 1999 and 1998, we received approximately 19%, 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 2%, 5% and 16%, respectively, from our joint venture with Alternative Care Systems, located in Dallas, Texas; 2%, 5% and 9%, respectively, from our joint venture with CM Healthcare Resources, Inc. located in Chicago, Illinois; and 12%, 11% and 0%, respectively, from our joint ventures with Children's Home Care 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 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. 17 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 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 Accredo's revenue and profitability. If the Company is 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 three months ended September 30, 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. 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 three months ended September 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 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 18 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. - Patient ordering patterns due to Year 2000 concerns could cause an increase in revenue during our second quarter and a coinciding decrease in revenue during our third fiscal quarter. 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 Accredo will complete any future acquisitions or joint ventures, if we do, Accredo 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. 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. 19 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 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 fiscal 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. 20 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 Accredo. 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 Accredo, 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. 21 WE COULD BE ADVERSELY AFFECTED BY AN IMPAIRMENT OF THE SIGNIFICANT AMOUNT OF GOODWILL ON OUR FINANCIAL STATEMENTS The formation of Accredo and our acquisitions of Southern Health Systems and Hemophilia Health Services 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 Accredo 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 Accredo 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 September 30, 1999, Accredo had goodwill, net of accumulated amortization, of approximately $48.0 million, or 33% of total assets and 72% 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 October 29, 1999, we have outstanding 9,155,512 shares of common stock, 3,450,000 of which were sold in our initial public offering in April 1999 and are freely tradable. Subject to certain volume and other limitations of Rule 144, holders of 5,627,087 restricted shares of common stock are eligible to sell their shares to the public now that the expiration of a "lock-up" period of 180 days following April 15, 1999 ( the effective date of the registration statement relating to our initial public offering ), has occurred. These holders also have contractual rights to have their shares registered for resale free of any limitations imposed by Rule 144. If these holders cause a large number of shares to be sold in the public market, the market for the common stock could be adversely affected. In addition, as of October 29, 1999, 1,519,075 shares of Accredo's registered common stock have been reserved for future stock awards under Company stock plans, and for issuance upon the exercise of outstanding awards. As of October 29, 1999, options to purchase 847,701 of these registered shares have been granted and not yet exercised. Those shares are freely tradable 22 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 Accredo, or could discourage a third party from attempting to acquire our 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 Accredo. 23 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. Since the Company has fixed its interest rate through October 31, 2001 on $25.0 million of its revolving credit facility through such a financial instrument, the Company would not benefit from any decrease in interest rates on this portion of its credit facility. Accordingly, a 100 basis point decrease in interest rates along the entire yield curve would not increase pre-tax income by $62,500 for the three months ended September 30, 1999 as would be expected without this financial instrument. However, a 100 point increase in interest rates along the entire yield curve would also not decrease pre-tax income by $62,500 for the same period as a result of using this derivative financial instrument. Actual changes in rates may differ from the hypothetical assumptions used in computing this exposure. 24 PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. (c) Sales of Unregistered Securities During the quarter, the Company's largest shareholder, Welsh, Carson, Anderson & Stowe VII, L. P., exchanged all of the outstanding shares of the Company's unregistered, "restricted" Non-Voting Common Stock that it owned (1,100,000 shares) for 1,100,000 shares of the Company's unregistered, "restricted" Common Stock. (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. 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits Exhibit 10.1 Amendment No. 3 dated October 14, 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 27 Financial Data Schedule (for SEC use only) (filed herewith) (b) Reports on Form 8-K None. Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. November 15, 1999 Accredo Health, Incorporated BY: /s/ David D. Stevens --------------------- David D. Stevens Chairman of the Board and Chief Executive Officer /s/ Joel R. Kimbrough --------------------- Joel R. Kimbrough Senior Vice President, Chief Financial Officer and Treasurer