10-Q 1 g76412e10-q.txt ACCREDO HEALTH, INCORPORATED 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 MARCH 31, 2002 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 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 April 30, 2002 COMMON STOCK, $0.01 PAR VALUE ... 26,223,714 ---------- TOTAL COMMON STOCK .............. 26,223,714 ==========
ACCREDO HEALTH, INCORPORATED INDEX Part I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Statements of Income (unaudited) For the three months and nine months ended March 31, 2001 and 2002 Condensed Consolidated Balance Sheets June 30, 2001 and March 31, 2002 (unaudited) Condensed Consolidated Statements of Cash Flows (unaudited) For the nine months ended March 31, 2001 and 2002 Notes to Condensed Consolidated Financial Statements (unaudited) 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 5. Other Information Item 6. Exhibits and Reports on Form 8-K Note: Items 1, 2, 3 and 4 of Part II are omitted because they are not applicable PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (000'S OMITTED, EXCEPT SHARE DATA) (UNAUDITED)
Nine Months Ended March 31, Three Months Ended March 31, ----------------------------- ----------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- Net patient revenue $ 451,408 $ 325,814 $ 173,563 $ 120,406 Other revenue 12,478 11,075 4,362 3,551 Equity in net income of joint ventures 1,445 838 572 323 --------- --------- --------- --------- Total revenues 465,331 337,727 178,497 124,280 Cost of sales 391,766 289,320 148,995 106,861 --------- --------- --------- --------- Gross profit 73,565 48,407 29,502 17,419 General & administrative 31,154 21,861 11,851 7,650 Bad debts 3,826 4,729 1,770 1,535 Depreciation and amortization 2,369 3,061 907 1,021 --------- --------- --------- --------- Income from operations 36,216 18,756 14,974 7,213 Interest income, net 838 2,126 38 870 Minority interest in consolidated subsidiary (966) (476) (333) (170) --------- --------- --------- --------- Income before income taxes 36,088 20,406 14,679 7,913 Provision for income taxes 14,006 8,086 5,691 3,124 --------- --------- --------- --------- Net income $ 22,082 $ 12,320 $ 8,988 $ 4,789 ========= ========= ========= ========= Cash dividends declared on common stock $ -- $ -- $ -- $ -- ========= ========= ========= ========= Earnings per share: Basic $ 0.85 $ 0.50 $ 0.34 $ 0.19 Diluted $ 0.82 $ 0.48 $ 0.33 $ 0.18
See accompanying notes to condensed consolidated financial statements. ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (000'S OMITTED, EXCEPT SHARE DATA)
(Unaudited) March 31, June 30, 2002 2001 ---------- -------- ASSETS Current assets: Cash and cash equivalents $ 1,103 $ 54,520 Marketable securities 1,000 2,000 Patient accounts receivable, less allowance for doubtful accounts of $12,815 at March 31, 2002 and $10,808 at June 30, 2001 129,179 76,592 Due from affiliates 2,210 2,440 Other accounts receivable 16,013 13,275 Inventories 61,342 30,711 Prepaids and other current assets 702 537 Deferred income taxes 6,028 4,703 -------- -------- Total current assets 217,577 185,138 Property and equipment, net 11,317 8,195 Other assets: Joint venture investments 4,114 2,809 Goodwill and other intangible assets, net 136,322 93,102 -------- -------- Total assets $369,330 $289,244 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $136,304 $ 88,611 Accrued expenses 9,303 7,168 Income taxes payable 3,227 1,071 -------- -------- Total current liabilities 148,834 96,850 Deferred income taxes 3,481 2,122 Minority interest in consolidated joint venture 1,567 1,102 Stockholders' equity: Undesignated Preferred Stock, 5,000,000 shares authorized, no shares issued -- -- Common Stock, $.01 par value; 50,000,000 shares authorized; 26,223,714 and 25,954,232 shares issued and outstanding at March 31, 2002 and June 30, 2001, respectively 262 259 Additional paid-in capital 165,284 161,091 Retained earnings 49,902 27,820 -------- -------- Total stockholders' equity 215,448 189,170 -------- -------- Total liabilities and stockholders' equity $369,330 $289,244 ======== ========
See accompanying notes to condensed consolidated financial statements. ACCREDO HEALTH, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (000'S OMITTED) (UNAUDITED)
Nine Months Ended March 31, 2002 2001 -------- -------- OPERATING ACTIVITIES: Net income $ 22,082 $ 12,320 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,369 3,061 Provision for losses on accounts receivable 3,826 4,729 Deferred income tax benefit (19) (989) Compensation resulting from stock transactions 139 139 Tax benefit of disqualifying disposition of stock options 2,148 2,506 Minority interest in income of consolidated joint venture 966 476 Changes in operating assets and liabilities: Patient receivables and other (49,333) (16,969) Due from affiliates 230 (1,628) Inventories (25,197) (898) Prepaids and other current assets (141) 89 Accounts payable and accrued expenses 44,286 8,286 Income taxes payable 2,116 (649) -------- -------- Net cash provided by operating activities 3,472 10,473 INVESTING ACTIVITIES: Purchases of marketable securities (6,000) (11,499) Proceeds from maturities of marketable securities 7,000 10,000 Purchases of property and equipment (4,466) (1,419) Business acquisitions and joint venture investments (47,467) (520) Change in joint venture investments, net (1,805) (683) -------- -------- Net cash used in investing activities (52,738) (4,121) FINANCING ACTIVITIES: Decrease in long-term notes payable (6,111) (37,200) Issuance of common stock 1,960 91,225 Payment of costs related to public offerings -- (583) -------- -------- Net cash provided by (used in) financing activities (4,151) 53,442 -------- -------- Increase (decrease) in cash and cash equivalents (53,417) 59,794 Cash and cash equivalents at beginning of period 54,520 10,204 -------- -------- Cash and cash equivalents at end of period $ 1,103 $ 69,998 ======== ========
See accompanying notes to condensed consolidated financial statements. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 2002 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States 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 nine-month periods ended March 31, 2002, are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 2002. The balance sheet at June 30, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States 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, 2001 as amended by Form 10-K/A filed on May 10, 2002. 2. PRIOR PERIOD ACQUISITIONS The Company acquired all of the outstanding stock of Pharmacare Resources, Inc. ("Pharmacare") and NCL Management, Inc. in May 2001 and BioPartners in Care, Inc. ("BioPartners") in December 2001. NCL Management was merged with Pharmacare in June 2001. The operating results of Pharmacare and BioPartners are included in the Company's consolidated statement of operations beginning in May and December 2001, respectively. Pro forma amounts for the nine months and three months ended March 31, 2002 and 2001, as if these acquisitions had occurred on July 1, 2000, are as follows:
Nine Months Ended March 31, Three Months Ended March 31, ---------------------------- ---------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- Pro forma total revenues $ 483,127 $ 367,429 $ 178,497 $ 135,431 Pro forma net income 22,562 12,157 8,988 5,097 Basic earnings per common share: Pro forma net income $ 0.87 $ 0.49 $ 0.34 $ 0.20 Diluted earnings per common share: Pro forma net income $ 0.84 $ 0.47 $ 0.33 $ 0.19
3. PENDING ACQUISITION On January 2, 2002, the Company announced that it had entered into an agreement with Gentiva Health Services, Inc. ("Gentiva") to purchase the specialty pharmaceutical services ("SPS") business of Gentiva for $415,000,000, subject to adjustment as set forth in the asset purchase agreement. The purchase price is to be paid in an equal combination of cash and the Company's common stock, with the stock portion of the purchase price being subject to a price collar set forth in the asset purchase agreement. The acquisition is expected to close in the second quarter of 2002 and is contingent upon approval by the shareholders of each company and approval by the applicable federal regulatory agencies. 4. STOCKHOLDERS' EQUITY During the quarter ended March 31, 2002, employees exercised stock options to acquire 139,690 shares of Accredo common stock at a weighted exercise price of $3.38 per share. 5. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share data) :
Nine Months Ended March 31, Three Months Ended March 31, ------------------------------ ------------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Numerator for basic and diluted income per share to common stockholders: Net income $ 22,082 $ 12,320 $ 8,988 $ 4,789 =========== =========== =========== =========== Denominator: Denominator for basic income per share to common stockholders - weighted-average shares 26,075,638 24,700,863 26,174,890 25,662,716 Effect of dilutive stock options 897,378 1,197,028 970,729 1,073,131 =========== =========== =========== =========== Denominator for diluted income per share to common stockholders - adjusted weighted-average shares 26,973,016 25,897,891 27,145,619 26,735,847 =========== =========== =========== =========== Earnings per common share: Basic $ 0.85 $ 0.50 $ 0.34 $ 0.19 Diluted $ 0.82 $ 0.48 $ 0.33 $ 0.18
6. GOODWILL AND OTHER INTANGIBLE ASSETS On July 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. The Company is providing transitional, pro-forma, disclosure in the table below for net income and earnings per share for the comparative prior periods as if SFAS No. 142 had also been adopted in those periods (in thousands, except for earnings-per-share amounts).
Nine Months Ended March 31, Three Months Ended March 31, --------------------------- ---------------------------- 2002 2001 2002 2001 --------- ---------- ---------- ---------- Reported net income $ 22,082 $ 12,320 $ 8,988 $ 4,789 Add back: Goodwill amortization -- 1,075 -- 359 -------- -------- ------- ------- Adjusted net income $ 22,082 $ 13,395 $ 8,988 $ 5,148 ======== ======== ======= ======= Basic earnings per share: Reported net income $ 0.85 $ 0.50 $ 0.34 $ 0.19 Goodwill amortization -- 0.04 -- 0.01 -------- -------- ------- ------- Adjusted net income $ 0.85 $ 0.54 $ 0.34 $ 0.20 ======== ======== ======= ======= Diluted earnings per share: Reported net income $ 0.82 $ 0.48 $ 0.33 $ 0.18 Goodwill amortization -- 0.04 -- 0.01 -------- -------- ------- ------- Adjusted net income $ 0.82 $ 0.52 $ 0.33 $ 0.19 ======== ======== ======= =======
The impact of the adoption of SFAS No. 142 resulted in an increase in net income for the nine month and three month periods ended March 31,2002 of approximately $1,320,000 and $440,000, respectively and an increase in diluted earnings per share of approximately $0.05 and $0.016, respectively. 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 under the headings "Risk Factors" and "Risk Factors Relating to the Proposed Acquisition", 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 relationships with the manufacturers whose drugs we handle, competitive or regulatory factors affecting the drugs we handle or their manufacturers, the demand for our 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 MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001 REVENUES Total revenues increased 44% from $124.3 million to $178.5 million from the three months ended March 31, 2001 to the three months ended March 31, 2002. Net patient revenues increased 44% from $120.4 million to $173.6 million from the three months ended March 31, 2001 to the three months ended March 31, 2002. The increase in revenues is the result of volume growth in all of our core products for the treatments of multiple sclerosis, growth hormone disorders, hemophilia and Gaucher Disease with the addition of new patients and additional sales to existing patients. We also experienced an increase in our seasonal drug SYNAGIS(R) for the treatment of Respiratory Synctial Virus as a result of increased patient volume. Revenues from acquisitions, which consist primarily of sales of hemophilia factor and intravenous immunoglobulin ("IVIG"), amounted to $18.4 million of the increase in the three months ended March 31, 2002. COST OF SALES Cost of sales increased from $106.9 million to $149.0 million, or 39%, from the three months ended March 31, 2001 to the three months ended March 31, 2002, which is commensurate with the increase in revenues discussed above. As a percentage of revenues, cost of sales decreased from 86.0% to 83.5% from the three months ended March 31, 2001 to the three months ended March 31, 2002 resulting in gross margins of 14.0% and 16.5% for the three months ended March 31, 2001 and 2002, respectively. Gross margins for the individual products have remained relatively stable; however, a change in product mix resulted in an increase in the composite gross margin in the three months ended March 31, 2002. The primary drivers for the improvement in gross margins were increased revenues from hemophilia factor and IVIG, which have lower acquisition costs as a percentage of revenue than most of the other products we distribute. GENERAL AND ADMINISTRATIVE General and administrative expenses increased from $7.7 million to $11.9 million, or 55%, from the three months ended March 31, 2001 to the three months ended March 31, 2002. This increase was primarily the result of increased salaries and benefits associated with the expansion of our reimbursement, sales and marketing, administrative and support staffs, the addition of office space and related furniture and fixtures to support the revenue growth and acquisitions. General and administrative expenses represented 6.2% and 6.6% of revenues for the three months ended March 31, 2001 and 2002, respectively. BAD DEBTS Bad debts increased from $1,535,000 to $1,770,000 from the three months ended March 31, 2001 to the three months ended March 31, 2002. As a percentage of revenues, bad debt expense decreased from 1.2% to 1.0% from the three months ended March 31, 2001 to the three months ended March 31, 2002. The decrease in bad debts as a percentage of revenues is primarily due to the increased percentage of our revenues that was reimbursed by prescription card benefits versus major medical benefit plans. The majority of the reimbursement provided by prescription card benefit plans is subject to much lower co-payment and deductible amounts (typically $10 to $15) resulting in lower bad debt. DEPRECIATION AND AMORTIZATION Depreciation expense increased from $367,000 to $592,000 from the three months ended March 31, 2001 to the three months ended March 31, 2002 as a result of purchases of property and equipment associated with our revenue growth and expansion of our leasehold facility improvements. Amortization expense decreased from $654,000 to $315,000 from the three months ended March 31, 2001 to the three months ended March 31, 2002. The decrease is due to the adoption of SFAS 142, Goodwill and Other Intangible Assets during the first quarter of fiscal year 2002. The application of the non-amortization of goodwill provisions of the pronouncement resulted in a reduction in amortization expense of approximately $612,000 in the three months ended March 31, 2002. INTEREST INCOME, NET Interest income, net, decreased from $870,000 to $38,000 from the three months ended March 31, 2001 to the three months ended March 31, 2002. The decrease is due to a decrease in the average amount of cash invested during the quarter primarily as a result of cash used for acquisitions and a decrease in interest rates earned on investments. INCOME TAX EXPENSE The effective tax rate was 39.5% and 38.8% for the three months ended March 31, 2001 and 2002, respectively. The decrease in the effective tax rate is primarily due to the adoption of the non-amortization provisions of SFAS 142 discussed above. The difference between the recognized effective tax rate and the statutory rate is primarily attributed to state income taxes. NINE MONTHS ENDED MARCH 31, 2002 COMPARED TO NINE MONTHS ENDED MARCH 31, 2001 REVENUES Total revenues increased 38% from $337.7 million to $465.3 million from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. Net patient revenues increased 39% from $325.8 million to $451.4 million from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. The increase in revenues is the result of volume growth in all of our core products for the treatments of multiple sclerosis, growth hormone disorders, hemophilia and Gaucher Disease with the addition of new patients and additional sales to existing patients. We also experienced an increase in our seasonal drug SYNAGIS(R) for the treatment of Respiratory Synctial Virus as a result of increased patient volume. Revenues from acquisitions, which consist primarily of sales of hemophilia factor and IVIG, amounted to $32.1 million of the increase in the nine months ended March 31, 2002. COST OF SALES Cost of sales increased from $289.3 million to $391.8 million, or 35%, from the nine months ended March 31, 2001 to the nine months ended March 31, 2002, which is commensurate with the increase in revenues discussed above. As a percentage of revenues, cost of sales decreased from 85.7% to 84.2% from the nine months ended March 31, 2001 to the nine months ended March 31, 2002 resulting in gross margins of 14.3% and 15.8% for the nine months ended March 31, 2001 and 2002, respectively. Gross margins for the individual products have remained relatively stable; however, a change in product mix resulted in an increase in the composite gross margin in the nine months ended March 31, 2002. The primary drivers for the improvement in gross margins were increased revenues from hemophilia factor and IVIG, which have lower acquisition costs as a percentage of revenue than most of the other products we distribute. GENERAL AND ADMINISTRATIVE General and administrative expenses increased from $21.9 million to $31.2 million, or 42%, from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. This increase was primarily the result of increased salaries and benefits associated with the expansion of our reimbursement, sales and marketing, administrative and support staffs, the addition of office space and related furniture and fixtures to support the revenue growth and acquisitions. General and administrative expenses represented 6.5% and 6.7% of revenues for the nine months ended March 31, 2001 and 2002, respectively. BAD DEBTS Bad debts decreased from $4,729,000 to $3,826,000 from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. As a percentage of revenues, bad debt expense decreased from 1.4% to .8% from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. The decrease in bad debts as a percentage of revenues is primarily due to the increased percentage of our revenues that was reimbursed by prescription card benefits versus major medical benefit plans. The majority of the reimbursement provided by prescription card benefit plans is subject to much lower co-payment and deductible amounts (typically $10 to $15) resulting in lower bad debt. DEPRECIATION AND AMORTIZATION Depreciation expense increased from $1,115,000 to $1,552,000 from the nine months ended March 31, 2001 to the nine months ended March 31, 2002 as a result of purchases of property and equipment associated with our revenue growth and expansion of our leasehold facility improvements. Amortization expense decreased from $1,946,000 to $817,000 from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. The decrease is due to the adoption of SFAS 142, Goodwill and Other Intangible Assets during the first quarter of fiscal year 2002. The application of the non-amortization of goodwill provisions of the pronouncement resulted in a reduction in amortization expense of approximately $1,836,000 in the nine months ended March 31, 2002. INTEREST INCOME, NET Interest income, net, decreased from $2,126,000 to $838,000 from the nine months ended March 31, 2001 to the nine months ended March 31, 2002. The decrease is due to a decrease in the average amount of cash invested during the period as a result of cash used for acquisitions and a decrease in interest rates earned on investments. INCOME TAX EXPENSE The effective tax rate was 39.6% and 38.8% for the nine months ended March 31, 2001 and 2002, respectively. The decrease in the effective tax rate is primarily due to the adoption of the non-amortization provisions of SFAS 142 discussed above. The difference between the recognized effective tax rate and the statutory rate is primarily attributed to state income taxes. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2002, our working capital was $68.7 million, cash and cash equivalents were $1.1 million, marketable securities were $1.0 million and the current ratio was 1.5 to 1.0. Our net cash provided by operations was $3.5 million for the nine months ended March 31, 2002. During the nine months ended March 31, 2002, accounts receivable increased $45.6 million, inventories increased $25.2 million and accounts payable, accrued expenses and income taxes increased $46.4 million. These increases are due primarily to our revenue growth and the timing of the collection of receivables, inventory purchases and payments of accounts payable. Net cash used in investing activities was $52.7 million for the nine months ended March 31, 2002. Cash used in investing activities consisted of $37.5 million for the acquisition of BioPartners in Care, Inc., $6.3 million in earn out payments related to the acquisition of Pharmacare Resources, Inc., $.4 million in earn out payments related to Childrens' Hemophilia Services (an 80% owned joint venture), $3.2 million for costs related to the planned acquisition of the Specialty Pharmaceutical Services division of Gentiva Health Services, Inc., $4.5 million for purchases of property and equipment, $1.8 million of undistributed earnings from our joint ventures and less $1.0 million for net sales of marketable securities, which have an initial maturity date of greater than 90 days. Net cash used in financing activities was $4.2 million for the nine months ended March 31, 2002. Net cash used in financing activities consisted of $6.1 million of repayments of debt assumed in the acquisition of BioPartners in Care, Inc. less $1.9 million from the proceeds of stock option exercises. Historically, we have funded our operations and continued internal growth through cash provided by operations. We anticipate that our capital expenditures for the fiscal years ending June 30, 2002 and 2003 will consist primarily of additional computer hardware, a fully integrated pharmacy and reimbursement software system and costs to build out and furnish additional space needed to meet the needs of our growth. We expect the cost of our capital expenditures in fiscal years 2002 and 2003 to be approximately $7.5 million and $10.0 million, respectively, exclusive of any acquisitions of businesses. We expect to fund these expenditures through cash provided by operating activities and/or borrowings under a revolving credit facility with our bank. In addition, in connection with an acquisition made in December 2001, we may be obligated to make up to $16 million in earn-out payments during the next twelve months. We have a revolving credit facility under the terms of our existing credit agreement. The agreement has an initial commitment of $30 million. We may increase the commitment up to $60 million upon (i) 15 days written notice, (ii) the payment of an additional commitment fee and (iii) delivery of a current compliance certificate demonstrating no event of default exists and will not exist following the increase in the commitment. All outstanding principal and interest on loans made under the credit agreement is due and payable on December 1, 2003. There were no borrowings under the credit agreement as of March 31, 2002. Interest on loans under the credit agreement accrues at a variable rate index based on the prime rate or the London Inter-Bank Offered Rate for one, two, three or six months (as selected by us), plus a margin depending on the amount of our debt to cash flow ratio as defined by the credit agreement and measured at the end of each quarter for prospective periods. Our obligations under the credit agreement are secured by a lien on substantially all of our assets, including a pledge of all of the common stock or partnership interest of each of our subsidiaries in which we own an 80% or more interest. The credit agreement contains operating and financial covenants, including requirements to maintain a certain debt to equity ratio and minimum leverage and debt service coverage ratios. In addition, the credit agreement includes customary affirmative and negative covenants, including covenants relating to transactions with affiliates, uses of proceeds, restrictions on subsidiaries, limitations on indebtedness, limitations on capital expenditures, limitations on mergers, acquisitions and sales of assets, limitations on investments, prohibitions on payment of dividends and stock repurchases, limitations on debt payments (including payment of subordinated indebtedness) and other distributions. The credit agreement also contains customary events of default, including events relating to changes in control of our company. On January 2, 2002, we agreed to acquire substantially all of the assets of Gentiva Health Services, Inc.'s specialty pharmaceutical services business (SPS). The terms of the asset purchase agreement provide that the purchase price to be paid to Gentiva is approximately $415 million, which is subject to adjustment as described in the agreement. The purchase price is payable 50% in cash and 50% in Accredo common stock. The number of shares of Accredo common stock to be issued will be equal to one-half of the purchase price divided by the average closing price for Accredo common stock for the 20 trading days ending on the second business day prior to the closing of the acquisition. However, - if this average is greater than $41.00 per share, the number of shares to be issued will be equal to one-half of the purchase price divided by $41.00, or 5,060,976 (assuming no adjustment to the purchase price); or - if this average is less than $31.00 per share, the number of shares to be issued will be equal to one-half of the purchase price divided by $31.00, or 6,693,548 (assuming no adjustment to the purchase price). We are exploring alternatives regarding financing and raising capital for the cash portion of the purchase price, including borrowing funds or issuing additional securities. We may use a $275 million credit facility to finance the cash portion of the purchase price and to provide for working capital needs and other general corporate purposes. This credit facility would replace the existing revolving credit facility. While we anticipate that our cash from operations, along with the short-term use of the existing revolving credit facility or the new credit facility described above will be sufficient to meet our internal operating requirements and growth plans for at least the next 12 months (assuming that cash collections and DSO rates from the SPS business, if acquired, remain at historical levels for that business), we expect that additional funds may be required in the future to successfully continue our growth beyond such period. We 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 us or, if obtained, will be sufficient for our needs. RISK FACTORS You should carefully consider the risks and uncertainties 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. [You should also review the risk factors specifically related to our proposed acquisition of the specialty pharmaceutical services business of Gentiva Health Services, Inc., which are included in Item 5 of this Form 10-Q.] If any of the following risks occur, our earnings, financial condition or business could be materially harmed, and the trading price of our common stock could decline, resulting in the loss of all or part of your investment. WE ARE HIGHLY DEPENDENT ON OUR RELATIONSHIPS WITH A LIMITED NUMBER OF BIOPHARMACEUTICAL SUPPLIERS AND THE LOSS OF ANY OF THESE RELATIONSHIPS COULD SIGNIFICANTLY IMPACT OUR ABILITY TO SUSTAIN OR GROW OUR REVENUES. We derive a substantial majority of our revenue and profitability from our relationships with Biogen, Genzyme, MedImmune and Genentech. The table below shows the concentration of our revenue derived from these relationships as a percentage of revenue for the periods indicated:
NINE MONTHS FISCAL YEAR ENDED ENDED ------------------------------------------------- March 31, 2002 JUNE 30, 2001 JUNE 30, 2000 JUNE 30, 1999 -------------- ------------- ------------- ------------- Biogen, Genzyme, MedImmune and Genentech 69% 72% 72% 73%
Our agreements with these suppliers are short-term and cancelable by either party without cause on 60 to 90 days prior notice. These agreements also generally limit our ability to handle competing drugs during and, in some cases, after the term of the agreement, but allow the supplier to distribute through channels other than us. Further, these agreements provide that pricing and other terms of these relationships be periodically adjusted for changed market conditions or required service levels. Any termination or adverse adjustment to any of these relationships could have a material adverse effect on a significant portion of our business, financial condition and results of operations. OUR ABILITY TO GROW COULD BE LIMITED IF WE DO NOT EXPAND OUR EXISTING BASE OF DRUGS OR IF WE LOSE PATIENTS. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The drugs that we currently sell are prescribed for Multiple Sclerosis, Gaucher Disease, Hemophilia and Autoimmune Disorders, Growth Hormone-Related Disorders, Respiratory Syncytial Virus and pulmonary arterial hypertension. Due to the small patient populations that use the drugs we handle, our future growth is highly dependent on expanding our base of drugs. Further, a loss of patient base or reduction in demand for any reason of the drugs we currently handle could have a material adverse effect on a significant portion of our business, financial condition and results of operation. OUR BUSINESS WOULD BE HARMED IF DEMAND FOR OUR PRODUCTS AND SERVICES IS REDUCED. Reduced demand for our products and services could be caused by a number of circumstances, including: - patient shifts to treatment regimens other than those we offer; - new treatments or methods of delivery of existing drugs that do not require our specialty products and services; - a recall of a drug; - adverse reactions caused by a drug; - the expiration or challenge of a drug patent; - competing treatment from a new drug or a new use of an existing drug; - the loss of a managed care or other payor relationship covering a number of high revenue patients; - the cure of a disease we service; or - the death of a high-revenue patient. THERE IS SUBSTANTIAL COMPETITION IN OUR INDUSTRY, AND WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY. The specialty pharmacy industry is highly competitive and is continuing to become more competitive. All of the drugs, supplies and services that we provide are also available from our competitors. Our current and potential competitors include: - other specialty pharmacy distributors; - specialty pharmacy divisions of wholesale drug distributors; - 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 from any of our suppliers deciding to pursue its own distribution and services and not outsource these needs to companies like us. 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. IF ANY OF OUR RELATIONSHIPS WITH MEDICAL CENTERS ARE DISRUPTED OR CANCELLED, OUR BUSINESS COULD BE HARMED. We have significant relationships with four medical centers that provide services primarily related to hemophilia, growth hormone-related disorders and respiratory syncytial virus. For the fiscal years ended June 30, 2000 and 2001 and the nine months ended March 31, 2002, we received approximately 12%, 4% and 4%, respectively, of our earnings before income taxes and extraordinary item from equity in the net income of unconsolidated joint ventures. We own 80% of one of our joint ventures with Children's Home Care, Inc. and the financial results of this joint venture are included in our consolidated financial results. This consolidated joint venture represented approximately 11% of our income before income taxes for the nine months ended March 31, 2002. Our agreements with medical centers have terms of between one and five years, and may be cancelled by either party without cause upon notice of between one and twelve months. Adverse changes in our relationships with those medical centers could be caused, for example, by: - changes caused by consolidation within the hospital industry; - changes caused by regulatory uncertainties inherent in the structure of the relationships; or - restrictive changes to regulatory requirements. Any termination or adverse change of these relationships could have a material adverse effect on our business, financial condition and results of operations. IF ADDITIONAL PROVIDERS OBTAIN ACCESS TO FAVORABLY PRICED DRUGS WE HANDLE, OUR BUSINESS COULD BE HARMED. We are not eligible to participate directly in the federal pricing program of the Public Health Service, commonly known as PHS, which allows hospitals and hemophilia treatment centers to obtain discounts on clotting factor. Increased competition from hospitals and hemophilia treatment centers may reduce our profit margins. OUR ACQUISITION AND JOINT VENTURE STRATEGY MAY NOT BE SUCCESSFUL, WHICH COULD CAUSE OUR BUSINESS AND FUTURE GROWTH PROSPECTS TO SUFFER. As part of our growth strategy, we continue to evaluate joint venture and acquisition opportunities, but we cannot predict or provide assurance that we will complete any future acquisitions or joint ventures. Acquisitions and joint ventures involve many risks, including: - difficulty in identifying suitable candidates and negotiating and consummating acquisitions on attractive terms; - difficulty in assimilating the new operations; - increased transaction costs; - diversion of our management's attention from existing operations; - dilutive issuances of equity securities that may negatively impact the market price of our stock; - increased debt; and - increased amortization expense related to intangible assets that would decrease our earnings. We could also be exposed to unknown or contingent liabilities resulting from the pre-acquisition operations of the entities we acquire, such as liability for failure to comply with health care or reimbursement laws. FLUCTUATIONS IN OUR QUARTERLY FINANCIAL RESULTS MAY CAUSE OUR STOCK PRICE TO DECLINE. Our results of operations may fluctuate on a quarterly basis, which could adversely affect the market price of our common stock. Our results may fluctuate as a result of: - lower prices paid by Medicare or Medicaid for the drugs that we sell, including lower prices resulting from recent revisions in the method of establishing average wholesale price ("AWP"); - below-expected sales or delayed launch of a new drug; - price and term adjustments with our drug suppliers; - increases in our operating expenses in anticipation of the launch of a new drug; - product shortages; - inaccuracies in our estimates of the costs of ongoing programs; - the timing and integration of our acquisitions; - changes in governmental regulations; - the annual renewal of deductibles and co-payment requirements that affect patient ordering patterns; - our provision of drugs to treat seasonal illnesses, such as respiratory syncytial virus; - physician prescribing patterns; and - general political and economic conditions. OUR BUSINESS WOULD BE HARMED IF THE BIOPHARMACEUTICAL INDUSTRY CEASES RESEARCH, DEVELOPMENT AND PRODUCTION OF THE TYPES OF DRUGS THAT ARE COMPATIBLE WITH THE SERVICES WE PROVIDE. Our business is highly dependent on continued research, development, manufacturing and marketing expenditures of biopharmaceutical companies, and the ability of those companies to develop, supply and generate demand for drugs that are compatible with the services we provide. Our business would be materially and adversely affected if those companies stopped outsourcing the services we provide or failed to support existing drugs or develop new drugs. Our business could also be harmed if the biopharmaceutical industry undergoes any of the following developments: - supply shortages; - adverse drug reactions; - drug recalls; - increased competition among biopharmaceutical companies; - an inability of drug companies to finance product development because of capital shortages; - a decline in product research, development or marketing; - a reduction in the retail price of drugs from governmental or private market initiatives; - changes in the Food and Drug Administration ("FDA") approval process; or - governmental or private initiatives that would alter how drug manufacturers, health care providers or pharmacies promote or sell products and services. OUR BUSINESS COULD BE HARMED IF THE SUPPLY OF ANY OF THE PRODUCTS THAT WE DISTRIBUTE BECOMES SCARCE. The biopharmaceutical industry is susceptible to product shortages. Some of the products that we distribute, such as IVIG and blood-related products, are collected and processed from human donors. Accordingly, the supply of these products is highly dependent on human donors and their availability has been constrained from time to time. An industry wide recombinant factor VIII product shortage has existed for some time, as a result of the manufacturers being unable to increase production to meet rising global demand. Future availability of product is unclear and we are not certain when the manufacturers will return to normal product allocations. If these products, or any of the other drugs that we distribute, are in short supply for long periods of time, our business could be harmed. IF SOME OF THE DRUGS THAT WE PROVIDE LOSE THEIR "ORPHAN DRUG" STATUS, WE COULD FACE MORE COMPETITION. Our business could also be adversely affected by the expiration or challenge to the "orphan drug" status that has been granted by the FDA to some of the drugs that we handle. When the FDA grants "orphan drug" status, it will not approve a second drug for the same treatment for a period of seven years unless the new drug is chemically different or clinically superior. The "orphan drug" status applicable to drugs that we handle expires as follows: - Cerezyme(R) expired May 2001; - AVONEX(R) expires May 2003; and - Tracleer(TM) expires October 2008. The loss of orphan drug status or approval of new drugs, notwithstanding orphan drug status, could result in competitive drugs entering the market, which could harm our business. For example, despite the orphan drug status of AVONEX(R), the FDA recently approved a competitive drug called Rebif, which we do not currently expect to handle. RECENT INVESTIGATIONS INTO REPORTING OF AVERAGE WHOLESALE PRICES COULD REDUCE OUR PRICING AND MARGINS. Many government payors, including Medicare and Medicaid, pay us directly or indirectly at the drug's average wholesale price (or AWP) or at a percentage off AWP. We have also contracted with a number of private payors to sell drugs at AWP or at a percentage off AWP. AWP for most drugs is compiled and published by a private company, First DataBank, Inc. In February 2000, First DataBank published a Market Price Survey of 437 drugs, which was significantly lower than the historic AWP for a number of the clotting factor and IVIG products that we sell. Various federal and state government agencies have been investigating whether the reported AWP of many drugs, including some that we sell, is an appropriate or accurate measure of the market price of the drugs. As reported in the Wall Street Journal, there are also several whistleblower lawsuits pending against various drug manufacturers. These government investigations and lawsuits involve allegations that manufacturers reported artificially inflated AWP prices of various drugs to First DataBank. Bayer Corporation, one of the Company's suppliers of clotting factor, recently agreed to pay $14 million in a settlement with the federal government and 45 states regarding these charges. Bayer also entered into a 5 year corporate integrity agreement with the government, in which Bayer agreed to provide average selling prices of its drugs to the government. In a separate action involving alleged inflated pricing, TAP Pharmaceutical Products agreed to pay federal and state governments $875 million to settle charges associated with the marketing of Lupron. A number of state Medicaid agencies have revised their payment methodology as a result of the Market Price Survey. The Centers for Medicare and Medicaid Services ("CMMS") had also announced that Medicare intermediaries should calculate the amount that they pay for certain drugs by using the lower prices on the First DataBank Market Price Survey. However, the proposal to include clotting factor in the lower Medicare pricing was withdrawn. Instead, CMMS has announced that it will seek legislation that would establish payments to cover the administrative costs of suppliers of clotting factor as a supplement to lower AWP pricing for factor. On September 21, 2001, the United States House Subcommittees on Health and oversight & Investigations held hearings to examine how Medicare reimburses providers for the cost of drugs. In conjunction with that hearing, the U.S. General Accounting office issued its Draft Report recommending that Medicare establish payment levels for part-B prescription drugs and their delivery and administration that are more closely related to their costs, and that payments for drugs be set at levels that reflect actual market transaction prices and the likely acquisition costs to providers. We cannot predict the eventual results of the government investigations, lawsuits and the changes made by First DataBank. If reduced average wholesale prices for the drugs that we sell are ultimately adopted as the standard by which we are paid by government payors or private payors, this could have a material adverse effect on our business, financial condition and results of operation, including reducing the pricing and margins on certain of our products. OUR BUSINESS COULD BE HARMED BY CHANGES IN MEDICARE OR MEDICAID. Changes in the Medicare, Medicaid or similar government programs or the amounts paid by those programs for our services may adversely affect our earnings. For example, these programs could revise their pricing based on new methods of calculating the AWP for drugs we handle. For the fiscal years ended June 30, 2000 and 2001 and the nine months ended March 31, 2002, we estimate that approximately 18%, 19%, and 20% respectively of our gross patient service revenues 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 affect our business, financial condition and results of operations. OUR BUSINESS WILL SUFFER IF WE LOSE RELATIONSHIPS WITH PAYORS. We are highly dependent on reimbursement from non-governmental payors. For the fiscal years ended June 30, 2000 and 2001 and the nine months ended March 31, 2002, we derived approximately 82%, 81% and 80% respectively of our gross patient service revenue from non-governmental payors (including self-pay), which included 5%, 4% and 3%, respectively for those periods, from sales to private physician practices whose ultimate payor is typically Medicare. In fiscal year 2001 and the nine months ended March 31, 2002, one private payor, Aetna, Inc. and affiliates accounted for approximately 16% of the Company's revenue. Many payors seek to limit the number of providers that supply drugs to their enrollees. For example, we were selected by Aetna, Inc. as one of three providers of injectible medications. From time to time, payors with whom we have relationships require that we and our competitors bid to keep their business, and there can be no assurance that we will be retained or that our margins will not be adversely affected when that happens. The loss of a payor relationship, for example, our relationship with Aetna (which is terminable on 90 days notice), or an adverse change in the financial condition of a payor like Aetna, 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. WE RELY HEAVILY ON A SINGLE SHIPPING PROVIDER, AND OUR BUSINESS WOULD BE HARMED IF OUR RATES ARE INCREASED OR OUR PROVIDER IS UNAVAILABLE. Almost all of our revenues result from the sale of drugs we deliver to our patients and principally all of our products are shipped by a single carrier, FedEx. We depend heavily on these outsourced shipping services for efficient, cost effective delivery of our product. The risks associated with this dependence include: - any significant increase in shipping rates; - strikes or other service interruptions by our primary carrier, FedEx, or by another carrier that could affect FedEx; or - spoilage of high cost drugs during shipment, since our drugs often require special handling, such as refrigeration. DISRUPTIONS IN COMMERCIAL ACTIVITIES SUCH AS THOSE FOLLOWING THE SEPTEMBER 2001 TERRORIST ATTACKS ON THE U.S. MAY ADVERSELY IMPACT OUR RESULTS OF OPERATIONS, OUR ABILITY TO RAISE CAPITAL OR OUR FUTURE GROWTH. Our operations have been and could again be harmed by terrorist attacks on the U.S. For example, transportation systems and couriers that we rely upon to deliver our drugs have been and could again be disrupted, thereby causing a decrease in our revenues. In addition, we may experience a rise in operating costs, such as costs for transportation, courier services, insurance and security. We also may experience delays in payments from payors, which would harm our cash flow. The U.S. economy in general may be adversely affected by terrorist attacks or by any related outbreak of hostilities. Any such economic downturn could adversely impact our results of operations, impair our cost of or ability to raise debt or equity capital or impede our ability to continue growing our business. OUR BUSINESS COULD BE HARMED IF PAYORS DECREASE OR DELAY THEIR PAYMENTS TO US. Our profitability depends on payment from governmental and non-governmental payors, and we could be materially and adversely affected by cost containment trends in the health care industry or by financial difficulties suffered by non-governmental payors. Cost containment measures affect pricing, purchasing and usage patterns in health care. Payors also influence decisions regarding the use of a particular drug treatment and focus on product cost in light of how the product may impact the overall cost of treatment. Further, some payors, including large managed care organizations and some private physician practices, have recently experienced financial trouble. The timing of payments and our ability to collect from payors also affects our revenue and profitability. If we are unable to collect from payors or if payors fail to pay us in a timely manner, it could have a material adverse effect on our business and financial condition. IF WE ARE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY, OUR BUSINESS WILL BE HARMED. Our rapid growth over the past several years has placed a strain on our resources, and if we cannot effectively manage our growth, our business, financial condition and results of operations could be materially and adversely affected. We have experienced a large increase in the number of our employees, the size of our programs and the scope of our operations. our ability to manage this growth and be successful in the future will depend partly on our ability to retain skilled employees, enhance our management team and improve our management information and financial control systems. WE COULD BE ADVERSELY AFFECTED BY AN IMPAIRMENT OF THE SIGNIFICANT AMOUNT OF GOODWILL ON OUR FINANCIAL STATEMENTS. Our formation and our acquisitions of Southern Health Systems, Inc., Hemophilia Health Services, Inc., Sunrise Health Management, Inc., Pharmacare Resources, Inc., NCL Management, Inc., BioPartners in Care, Inc. and the specialty pharmacy businesses of Home Medical of America, Inc. resulted in the recording of a significant amount of goodwill on our financial statements. The goodwill was recorded because the fair value of the net assets acquired was less than the purchase price. We also expect to record a significant amount of goodwill from the proposed acquisition of the SPS business from Gentiva. 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. 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 March 31, 2002, we had goodwill, net of accumulated amortization, of approximately $128.8 million, or 35% of total assets and 60% of stockholders' equity. Since our growth strategy may involve the acquisition of other companies, we may record additional goodwill in the future. The possible write-off of this goodwill could negatively impact our future earnings. We will also be required to allocate a portion of the purchase price of any acquisition to the value of non-competition agreements, patient base and contracts that are acquired. The amount allocated to these items could be amortized over a fairly short period. As a result, our earnings and the market price of our common stock could be negatively impacted. WE RELY ON A FEW KEY EMPLOYEES WHOSE ABSENCE OR LOSS COULD ADVERSELY AFFECT OUR BUSINESS. We depend on a few key executives, and the loss of their services could cause a material adverse effect to our company. We do not maintain "key person" life insurance policies on any of those executives. As a result, we are not insured against the losses resulting from the death of our key executives. Further, we must be able to attract and retain other qualified, essential employees for our technical operating and professional staff, such as pharmacists. If we are unable to attract and retain these essential employees, our business could be harmed. WE MAY NEED ADDITIONAL CAPITAL TO FINANCE OUR GROWTH AND CAPITAL REQUIREMENTS, WHICH COULD PREVENT US FROM FULLY PURSUING OUR GROWTH STRATEGY. In order to implement our growth strategy, we will need substantial capital resources and will incur, from time to time, short- and long-term indebtedness, the terms of which will depend on market and other conditions. We cannot be certain that existing or additional financing will be available to us on acceptable terms, if at all. As a result, we could be unable to fully pursue our growth strategy. Further, additional financing may involve the issuance of equity securities that would reduce the percentage ownership of our then current stockholders. OUR INDUSTRY IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND NONCOMPLIANCE BY US OR OUR SUPPLIERS COULD HARM OUR BUSINESS. The marketing, sale and purchase of drugs and medical supplies is extensively regulated by federal and state governments, and if we fail or are accused of failing to comply with laws and regulations, we could suffer a material adverse effect on our business, financial condition and results of operations. our business could also be materially and adversely affected if the suppliers or 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, or HIPAA, created new violations for fraudulent activity applicable to both public and private health care benefit programs and prohibits inducements to Medicare or Medicaid eligible patients. The potential sanctions for violations of these laws range from significant fines, to exclusion from participation in the Medicare and Medicaid programs, to criminal sanctions. Although some "safe harbor" regulations attempt to clarify when an arrangement will not violate the Anti-Kickback Law, our business arrangements and the services we provide may not fit within these safe harbors. Failure to satisfy a safe harbor requires analysis of whether the parties intended to violate the Anti-Kickback Law. The finding of a violation could have a material adverse effect on our business. - The Department of Health and Human Services recently issued regulations implementing the Administrative Simplification provision of HIPAA concerning the maintenance and transmission and security of electronic health information, particularly individually identifiable information. The new regulations, when effective, will require the development and implementation of security and transaction 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, or wrongful disclosure of confidential patient information could result in the imposition of administrative or criminal sanctions, including exclusion from the Medicare and state Medicaid programs. In addition, if we choose to distribute drugs through new distribution channels such as the Internet, we will have to comply with government regulations that apply to those distribution channels, which could have a material adverse effect on our business. - The Ethics in Patient Referrals Act of 1989, as amended, commonly referred to as the "Stark Law," prohibits physician referrals to entities with which the physician or their immediate family members have a "financial relationship." 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. - Pharmacies and pharmacists must obtain state licenses to operate and dispense drugs. Pharmacies must also obtain licenses in some states to operate and provide goods and services to residents of those states. If we are unable to maintain our licenses or if states place burdensome restrictions or limitations on non-resident pharmacies, this could limit or affect our ability to operate in some states which could adversely impact our business and results of operations. - Federal and state investigations and enforcement actions continue to focus on the health care industry, scrutinizing a wide range of items such as joint venture arrangements, referral and billing practices, product discount arrangements, home health care services, dissemination of confidential patient information, clinical drug research trials and gifts for patients. - The False Claims Act encourages private individuals to file suits on behalf of the government against health care providers such as us. Such suits could result in significant financial sanctions or exclusion from participation in the Medicare and Medicaid programs. THE MARKET PRICE OF OUR COMMON STOCK MAY EXPERIENCE SUBSTANTIAL FLUCTUATIONS FOR REASONS OVER WHICH WE HAVE LITTLE CONTROL. Our common stock is traded on the Nasdaq National Market. Since our common 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; - overall volatility of the stock market; - 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 our results of operations and general economic, political and market conditions, may adversely affect the market price of our common stock. SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD DISCOURAGE A CHANGE IN CONTROL, EVEN IF AN ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Our certificate of incorporation, our bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to the impact of financial market risk is currently not significant. our primary financial market risk exposure consists of interest rate risk related to interest income from our short term investments in money market and high quality short term debt securities with maturities of twelve months or less that we intend to hold to maturity. We have invested and expect to continue to invest a substantial portion of our excess cash in such securities. Generally, if the overall average return on such securities had decreased 10% from the average return during the nine months and quarter ended March 31, 2002, then our interest income would have decreased, and pre-tax income would have decreased approximately $84,000 and $4,000 respectively for those periods. This amount was determined by considering the impact of a hypothetical change in interest rates on our interest income. Actual changes in rates may differ from the hypothetical assumptions used in computing this exposure. In prior periods, we have used derivative financial instruments to manage our exposure to rising interest rates on our variable-rate debt, primarily by entering into variable-to-fixed interest rate swap agreements. During the quarter, we did not have an outstanding balance on our revolving line of credit nor any outstanding interest rate swap agreements. Therefore, we did not have an exposure to financial market risk associated with our revolving line of credit or any derivative financial instruments during the quarter. However, we have accessed our revolving line of credit since the end of the quarter without entering into any variable-to-fixed interest rate swap agreements. Rising interest rates could expose us to financial market risk associated with any future outstanding debts on the line of credit that are not hedged by an interest rate swap agreement. PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION. On January 2, 2002, the Company announced that it had entered into an agreement with Gentiva Health Services, Inc. to purchase the SPS business of Gentiva for $415,000,000, subject to adjustment as set forth in the asset purchase agreement. The purchase price is to be paid in an equal combination of cash and the Company's common stock, with the stock portion of the purchase price being subject to a price collar set forth in the asset purchase agreement. The acquisition is scheduled to close in the second quarter of 2002 and is contingent upon approval by the shareholders of each company and approval by the applicable federal regulatory agencies. Accredo proposes to acquire substantially all of the assets of the SPS business of Gentiva. The SPS business to be acquired by Accredo includes: - the distribution of drugs and other biological and pharmaceutical products and professional support services for individuals with chronic diseases, such as hemophilia, primary pulmonary hypertension, autoimmune deficiencies and growth disorders, - the administration of antibiotics, chemotherapy, nutrients and other medications for patients with acute or episodic disease states, - marketing and distribution services for pharmaceutical, biotechnology and medical service firms, and - clinical support services for pharmaceutical and biotechnology firms. Following the closing of the acquisition, Accredo intends to separate and reorganize the chronic and acute portions of the SPS business. While Gentiva treated IVIG, Synagis(R), Cerezyme(R) and growth hormone as part of its acute business, Accredo will consider these drugs as part of the chronic business which it will continue to operate. Excluding the drugs mentioned above, Accredo intends to assess strategic options for the portion of the SPS business which relates to the administration of medications for acute diseases because this business is inconsistent with Accredo's strategy and focus. RISK FACTORS RELATED TO THE PROPOSED ACQUISITION You should carefully consider the risks and uncertainties associated with this transaction that we describe below before investing in Accredo. The risks and uncertainties described below are NOT the only risks and uncertainties that could develop regarding the proposed acquisition of the SPS business. other risks and uncertainties associated with this transaction that we have not predicted or evaluated could also affect our company. You should also review the risk factors related to Accredo's business generally, which are included in Item 2 of this Form 10-Q. 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. IF ACCREDO'S PROPOSED ACQUISITION OF THE SPECIALTY SERVICES BUSINESS OF GENTIVA DOES NOT OCCUR, ACCREDO WILL NOT BENEFIT FROM THE EXPENSES IT HAS INCURRED IN THE PURSUIT OF THE ACQUISITION. Accredo's planned acquisition of the specialty services business, or SPS business, of Gentiva may not be completed. The asset purchase agreement may be terminated for material adverse effects in either Accredo or the SPS business, failure to obtain regulatory approvals, identified consents, and other reasons, many of which are beyond the control of Accredo or Gentiva. In the event of a termination of the asset purchase agreement because either Gentiva or Accredo has breached its representations, warranties, covenants or agreements, or because its stockholders have voted against the acquisition, the party in breach or whose stockholders voted against the transaction has agreed to pay the costs and expenses actually incurred in connection with the acquisition by the other party, up to an aggregate of $2.5 million. Accredo will have incurred substantial expenses, and may have to reimburse the costs and expenses of Gentiva, for which no ultimate benefit will have been received by Accredo. ACCREDO MAY INCUR ADDITIONAL DEBT WHICH MAY LIMIT ITS FINANCIAL FLEXIBILITY. Accredo is exploring its alternatives regarding financing and raising capital for the cash portion of the purchase price, including borrowing the funds or issuing additional securities. Accredo may incur an additional $227 million of indebtedness in order to consummate the acquisition of the SPS business. After giving effect to the acquisition of the SPS business, including the issuance of the stock consideration, if Accredo borrows the cash portion of the acquisition consideration, as of March 31, 2002, Accredo would have had approximately $227 million of total debt and a total debt to total capitalization ratio of 36%. Accredo may also incur additional debt in the future, including in connection with other acquisitions. While Accredo would also have additional assets and cash flow, the level of Accredo's debt could have several important effects on the company's future operations, including, among others: - A significant portion of Accredo's cash flow from operations will be dedicated to the payment of principal and interest on the debt and will not be available for other purposes; - Covenants in Accredo's existing debt arrangements and anticipated covenants related to the debt that Accredo intends to incur to finance the cash portion of the acquisition consideration will require Accredo to meet financial tests, and may impose other limitations that may limit Accredo's flexibility in planning for and reacting to changes in its business, including possible acquisition opportunities; - Accredo's ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate and other purposes may be limited; - Accredo may be at a competitive disadvantage to similar companies that have less debt; and - Accredo's vulnerability to adverse economic and industry conditions may increase. ACCREDO MAY ISSUE ADDITIONAL SECURITIES WHICH COULD DILUTE YOUR OWNERSHIP OF ACCREDO COMMON STOCK. Accredo may issue additional shares of common stock or other securities to finance the cash portion of the purchase price. In addition, Accredo may undertake additional transactions in the future to simplify and restructure its capital structure, which may include, as part of these efforts, additional issuances of equity securities in exchange for current indebtedness or indebtedness incurred in order to complete the acquisition. The issuance of additional shares of common stock or securities convertible into common stock may be dilutive to the holders of Accredo common stock. THE FAILURE TO INTEGRATE SUCCESSFULLY ACCREDO AND THE SPS BUSINESS ACQUIRED FROM GENTIVA MAY PREVENT ACCREDO FROM ACHIEVING THE ANTICIPATED POTENTIAL BENEFITS OF THE ACQUISITION AND MAY ADVERSELY AFFECT ACCREDO'S BUSINESS. Accredo will face significant challenges in consolidating functions, integrating the procedures, operations and product lines of the SPS business in a timely and efficient manner, and retaining key personnel of the SPS business. The integration of Accredo and the SPS business will be complex and will require substantial attention from management. The diversion of management attention and any difficulties encountered in the transition and integration process could have a material adverse effect on the revenues, level of expenses and operating results of Accredo. ACCREDO MAY NOT BE ABLE TO BENEFIT FROM THE ACUTE PORTION OF THE SPS BUSINESS. Accredo has not historically distributed the drugs represented by the acute portion of the SPS business of Gentiva, except for IVIG, Synagis(R), Cerezyme(R) and growth hormone. Following the acquisition, Accredo will treat these four drugs as part of its chronic business, but otherwise Accredo does not intend to distribute the drugs represented by the acute portion of the SPS business. Accredo intends to assess strategic options related to the acute portion of the SPS business following the closing of the acquisition. Accredo may not be able to find an available or acceptable strategic alternative for the acute business, and may have to sell the business for less than its fair value or to shut down the acute business which could cause Accredo to incur additional expenses. For these reasons, Accredo has not assigned any value to the acute portion of the SPS business it is acquiring for financial purposes. In addition, Accredo's assessment of the strategic alternatives for the acute portion of the SPS business or the actions required to shut down the acute business could divert management time and company resources which could be better served elsewhere. FOLLOWING THE ACQUISITION OF THE SPS BUSINESS, GENTIVA MAY BE UNABLE TO INDEMNIFY ACCREDO FOR LIABILITIES. The asset purchase agreement provides that Gentiva will indemnify Accredo, after the sale of the SPS business, for losses suffered or incurred by Accredo and its affiliates arising from the retained liabilities of Gentiva, breaches of Gentiva's representations, warranties, covenants or agreements under the asset purchase agreement or agreements delivered pursuant thereto, failure to deliver good, valid and marketable title to the assets of the SPS business, and specified tax liabilities of Gentiva, including those related to Gentiva's split off from olsten Corporation. However, Gentiva may not be able to fulfill its indemnification obligations. Should any significant payment be required, Gentiva may not have sufficient funds and may not be able to obtain the funds to satisfy its potential indemnification obligations to Accredo. Accredo may suffer impairment of assets or have to bear a liability for which it is entitled to indemnification, but which it is unable to collect. ACCREDO'S COMMON STOCK PRICE MAY BE ADVERSELY AFFECTED BY FUTURE SALES OF ACCREDO COMMON STOCK. According to the terms of the asset purchase agreement, Accredo could be obligated to issue up to 6.7 million shares, plus additional shares for adjustments to the purchase price in accordance with the asset purchase agreement. Assuming the issuance of the 5.1 million shares based on the recent closing price of Accredo common stock, upon completion of the acquisition, Accredo will have outstanding approximately 31.3 million shares of common stock. The shares issued by Accredo are to be distributed to Gentiva stockholders following the acquisition, resulting in an increase of approximately 19.4% in the common stock available for resale on the market. The sale of these additional shares could result in downward pricing pressure on the Accredo common stock. PRODUCT SHORTAGES MAY CONTINUE TO ADVERSELY AFFECT REVENUE GROWTH. Gentiva has historically reported that its revenue growth was negatively impacted by some product shortages of recombinant coagulation therapy, which is used in the treatment of hemophilia, as well as by Bayer Corporation's decision in 1999 to begin directly distributing Prolastin(R), an intravenous therapy used in the treatment of the hereditary disorder Alpha 1 Antirypsin Deficiency. These drugs affected by product shortages accounted for approximately 14% of the revenues of the SPS business for the year ended December 31, 2001. While Accredo considered these factors when evaluating the acquisition of the SPS business, continuing shortages of these products and new product shortages could materially and adversely affect Accredo's ability to grow revenues. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 10.1 Employment Agreement dated as of January 7, 2002 between Accredo Health, Incorporated and Steve Fitzpatrick 10.2 Employment Agreement dated as of January 21, 2002 between Accredo Health, Incorporated and Barbara H. Biehner (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. May 15, 2002 Accredo Health, Incorporated /s/ David D. Stevens -------------------- David D. Stevens Chairman of the Board and Chief Executive officer Exhibit Index
Exhibit Number Description of Exhibits ------- ----------------------- 10.1 Employment Agreement dated as of January 7, 2002 between Accredo Health, Incorporated and Steve Fitzpatrick 10.2 Employment Agreement dated as of January 21, 2002 between Accredo Health, Incorporated and Barbara H. Biehner