-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AO/+Snw9IkcEJyA4vScVlmpYUrV3ur5uy2Chuno/d1UxJekA8DU4mKXpi5lbJaFB Y+7DyuW2jQiffLFtrVX21w== 0000847935-06-000012.txt : 20061109 0000847935-06-000012.hdr.sgml : 20061109 20061109155209 ACCESSION NUMBER: 0000847935-06-000012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061109 DATE AS OF CHANGE: 20061109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLION HEALTHCARE INC CENTRAL INDEX KEY: 0000847935 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-DRUGS PROPRIETARIES & DRUGGISTS' SUNDRIES [5122] IRS NUMBER: 112962027 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-17821 FILM NUMBER: 061202045 BUSINESS ADDRESS: STREET 1: 1660 WALT WHITMAN ROAD SUITE 105 CITY: MELVILLE STATE: NY ZIP: 11747 BUSINESS PHONE: 631-870-5100 MAIL ADDRESS: STREET 1: 1660 WALT WHITMAN ROAD SUITE 105 CITY: MELVILLE STATE: NY ZIP: 11747 FORMER COMPANY: FORMER CONFORMED NAME: CARE GROUP INC DATE OF NAME CHANGE: 19920703 10-Q 1 d10q.htm FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2006
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 0-17821
 
ALLION HEALTHCARE, INC.
(Exact Name of registrant as specified in its charter)
 
 
Delaware
  
11-2962027
  
 
(State or other jurisdiction of
incorporation or organization)
 
  
(I.R.S. Employer
Identification No.)
 
  
 
1660 Walt Whitman Road, Suite 105, Melville, NY 11747
(Address of principal executive offices)
 
Registrant’s telephone number: (631) 547-6520
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x  Yes ¨  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer  ¨
Accelerated Filer  x
Non-accelerated filer  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨  Yes x  No
 
As of November 3, 2006 there were 16,203,666 shares of the Registrant’s common stock, $.001 par value, outstanding.  


 
TABLE OF CONTENTS
 

PART I. FINANCIAL INFORMATION
 
 
 
    Item 1: Financial Statements:
 
3
4
5
6
15
26
    Item 4: Controls and Procedures
26
 
 
PART II. OTHER INFORMATION
 
    Item 1: Legal Proceedings
27
    Item 1A: Risk Factors
27
30
30
30
    Item 5: Other Information
30
    Item 6: Exhibits
30

 



ALLION HEALTHCARE, INC. AND SUBSIDIARIES
 
Item 1. FINANCIAL STATEMENTS
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
  
At September 30, 2006
(UNAUDITED) 
  
At December 31, 2005 
(RESTATED - See Note 2)
  
ASSETS
    
     
CURRENT ASSETS:
    
   
 
Cash and cash equivalents
  
$
17,485,458
  
$
3,845,037
  
Short term investments and securities held for sale
    
5,742,430
    
23,000,553
  
Accounts receivable (net of allowance for doubtful accounts of $593,500 in 2006 and $282,824 in 2005)
    
19,312,928
    
14,640,304
  
Inventories
    
4,426,136
    
3,228,225
  
Prepaid expenses and other current assets
    
743,489
    
762,466
  
Total current assets
    
47,710,441
    
45,476,585
  
 
Property and equipment, net
    
957,853
    
671,396
  
Goodwill
    
37,676,152
    
19,739,035
  
Intangible assets
    
35,700,842
    
20,314,866
  
Other assets
    
90,014
    
87,123
  
Total Assets
  
$
122,135,302
  
$
86,289,005
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
    
   
 
CURRENT LIABILITIES:
    
   
 
Accounts payable and accrued expenses
  
$
19,032,153
  
$
17,205,977
  
Notes payable-subordinated
    
695,642
    
675,000
  
Other current
    
57,198
    
107,379
 
Total current liabilities
    
19,784,993
    
17,988,356
  
LONG TERM LIABILITIES:
    
   
 
Notes payable - subordinated
    
—
   
682,710
  
Deferred income taxes
    
685,798
    
153,000
  
Other
    
117,140
    
121,710
  
Total liabilities
    
20,587,931
    
18,945,776
  
COMMITMENTS & CONTINGENCIES
    
   
 
STOCKHOLDERS’ EQUITY
    
   
 
Preferred stock, $.001 par value, shares authorized 20,000,000; issued and outstanding 0 at September 30, 2006 and 
    December 31, 2005
    
—
   
—
 
Common stock, $.001 par value; shares authorized 80,000,000; issued and outstanding 16,203,666 at September 30,
    2006 and 12,956,382 at December 31, 2005.
    
16,204
    
12,956
  
Additional paid-in capital
    
111,540,740
    
80,228,664
  
Accumulated deficit
    
(10,127,166
)
  
(12,936,944
)
Accumulated other comprehensive income
    
117,593
    
38,553
  
Total stockholders’ equity
    
101,547,371
    
67,343,229
  
Total liabilities and stockholders’ equity
  
$
122,135,302
  
$
86,289,005
  
 
See notes to condensed consolidated financial statements.


ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
   
Three months ended
September 30,
  
Nine months ended
September 30,
  
     
2006
    
2005
    
2006
    
2005
  
                       
(RESTATED -See Note 2
 ) 
Net sales
 
$
58,349,080
  
$
33,926,592
  
$
151,605,962
  
$
85,261,440
  
Cost of goods sold
   
49,971,384
    
28,108,735
    
129,267,507
    
71,671,766
  
Gross profit
   
8,377,696
    
5,817,857
    
22,338,455
    
13,589,674
  
Operating expenses:
                          
Selling, general and administrative expenses
   
7,085,838
    
5,160,666
    
19,639,477
    
12,596,577
  
Operating income
   
1,291,858
    
657,191
    
2,698,978
    
993,097
  
Interest income (expense)
   
168,560
    
259,154
    
946,378
    
(1,265,419
)
Other income
   
—
   
—
   
102
    
(1,133,215
) 
    Income (loss) from continuing operations before taxes
   
1,460,418
    
916,345
    
3,645,458
    
(1,405,537
)
Provision for taxes
   
445,419
    
—
   
835,680
    
—
 
Income (loss) before discontinued operations
   
1,014,999
    
916,345
    
2,809,778
    
(1,405,537
)
Loss from discontinued operations
   
—
   
(7,355
)
  
—
   
(17,905
)
Net income (loss)
  
$
1,014,999
  
$
908,990
  
$
2,809,778
  
$
(1,423,442
) 
Deemed dividend on preferred stock
    
—
   
—
   
—
   
1,338,047
 
    Net income (loss) available to common shareholders
  
$
1,014,999
  
$
908,990
  
$
2,809,778
    
($2,761,489
)
                           
Basic earnings (loss) per common share:
                          
    Earnings (loss) from continuing operations
 
$
0.06
  
$
0.07
  
$
0.18
    
($0.42
)
Loss from discontinued operations
   
—
   
—
   
—
   
—
 
Earnings (loss) per share
 
$
0.06
  
$
0.07
  
$
0.18
    
($0.42
)
                           
Diluted earnings (loss) per common share:
                          
    Earnings (loss) from continuing operations
 
$
0.06
  
$
0.06
  
$
0.17
    
($0.42
)
Loss from discontinued operations
   
—
   
—
   
—
   
—
 
Earnings (loss) per share
 
$
0.06
  
$
0.06
  
$
0.17
    
($0.42
)
                           
Basic weighted average of common shares outstanding
   
16,203,666
    
12,635,160
    
15,865,714
    
6,636,738
  
Diluted weighted average of common shares outstanding
   
17,023,879
    
14,921,283
    
16,954,924
    
6,636,738
  
 
See notes to condensed consolidated financial statements.


ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 
  
Nine months ended
September 30, 
  
 
  
2006 
  
2005 
  
CASH FLOWS FROM OPERATING ACTIVITIES:
  
 
  
(RESTATED -See Note 2
 ) 
Net income
  
$
2,809,778
  
$
(1,423,442
) 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
    
   
 
Depreciation and amortization
    
2,732,798
    
1,276,608
  
Deferred rent
    
30,015
    
4,395
  
Provision for doubtful accounts
    
482,949
    
55,000
  
Amortization of debt discount on acquisition notes
    
12,932
    
51,253
  
Tax benefit realized from the exercise of employee stock options
    
302,882
    
—
 
Non-cash stock compensation expense
    
210,985
    
—
 
Mandatory redeemable warrants
    
—
   
1,133,215
 
Non-cash interest expense
    
—
   
966,000
  
Deferred Income Taxes
    
532,798
    
—
 
Loss on disposition of property and equipment
    
411
    
—
 
Changes in operating assets and liabilities:
    
   
 
Accounts receivable
    
(5,155,573
)
  
(3,677,851
)
Inventories
    
(88,418
)
  
(56,610
)
Prepaid expenses and other current assets
    
(194,722
)
  
(605,067
)
Accounts payable and accrued expenses
    
2,376,589
   
1,238,929
  
Net cash provided by (used in) operating activities:
    
4,053,424
    
(1,037,570
)
 
CASH FLOWS USED IN INVESTING ACTIVITIES:
    
   
 
Purchase of property and equipment
    
(505,910
)
  
(219,285
)
Purchases of short term securities
    
(73,846,899
)
  
(28,812,000
)
Sales of short term securities
    
91,184,062
   
—
 
Proceeds from disposition of property and equipment
    
100
   
—
 
Payments for acquisition of NAHH, net of cash acquired of $88,808
    
(16,614
)
  
(5,267,534
)
Payments for acquisition of SPI
    
(300
)
  
(5,043,522
)
Payments for acquisition of Oris’s Assets
    
(325,640
)
  
(1,303,655
)
Payments for acquisition of PMW’s Assets
    
—
   
(8,925,622
)
Payments for acquisition of Priority’s Assets
    
(1,394,381
)
  
—
 
Payments for acquisition of Maiman’s Assets
    
(5,810,062
)
  
—
 
Payments for acquisition of H&H’s Assets
    
(4,736,840
)
  
—
 
Payments for acquisition of Whittier’s Assets
    
(15,821,596
)
  
—
 
Payments for acquisition of St. Judes’s Assets
    
(9,381,919
)
  
—
 
Net cash used in investing activities
    
(20,655,999
)
  
(49,571,618
)
 
CASH FLOWS FROM FINANCING ACTIVITIES:
    
   
 
Net proceeds from sale of Preferred Stock
    
—
   
103,554
  
Proceeds from line of credit
    
—
   
43,250,071
  
Repayment of line of credit
    
—
   
(43,250,216
)
Net proceeds from IPO
    
—
   
53,661,692
  
Net proceeds from secondary public offering
    
28,852,195
    
—
 
Proceeds from exercise of employee stock options and warrants
    
2,153,395
    
330,538
  
Notes Payable and Mandatory Warrants from acquisitions
    
—
   
(3,034,543
)
Repayment of capital leases and long term debt
    
(762,594
)
  
(4,948,176
)
Proceeds from notes payable
    
—
   
3,500,000
  
Net cash provided by financing activities
    
30,242,996
    
49,612,920
  
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
13,640,421
    
(996,268
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
3,845,037
    
6,979,630
  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  
$
17,485,458
  
$
5,983,362
  
 
See notes to condensed consolidated financial statements.


NOTE 1 ORGANIZATION AND DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION
 
(a) Allion Healthcare, Inc. (the “Company” or “Allion”) was originally incorporated in 1983 under the name The Care Group Inc. In 1999, the Company changed its name to Allion Healthcare, Inc. The Company is a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. The Company operates primarily under its trade name MOMS Pharmacy.
 
(b) The condensed consolidated financial statements include the accounts of Allion and its subsidiaries. The condensed consolidated balance sheet as of September 30, 2006 and the condensed consolidated statements of operations for the three and nine months ended September 30, 2006 and 2005, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2006 and 2005, are unaudited and have been prepared by the Company. The unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required to be presented for complete financial statements. The accompanying financial statements reflect all adjustments (consisting only of normal recurring items), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The accompanying condensed consolidated balance sheet at December 31, 2005 has been derived from audited financial statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2005 as filed with the Securities and Exchange Commission (the “SEC”). The Company believes that the disclosures provided are adequate to make the information presented not misleading.
 
The financial statements and related disclosures have been prepared with the assumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company believes that the disclosures provided are adequate to make the information presented not misleading. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto included in the Annual Report on Form 10-K/A for the year ended December 31, 2005.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States require the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the year ending December 31, 2006 or any other interim period.
 
NOTE 2 RESTATEMENT OF FINANCIAL STATEMENTS
 
The Company recently received a comment letter from the SEC’s Division of Corporation Finance (“Staff”) relating to a routine review of Allion’s Form 10-K/A for the 2005 fiscal year and Form 10-Q for the quarter ended March 31, 2006.  In the course of responding to the Staff’s comments, the Company reviewed the accounting treatment for certain warrants considered derivatives under Emerging Issue Task Force No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  Specifically, in February 2005, the Company issued warrants for 351,438 shares of common stock in connection with its acquisition of Specialty Pharmacies, Inc., half of which were redeemed as required under the terms of the warrants upon the Company’s initial public offering (“IPO”) in June 2005 and the other half of which became non-redeemable as a result of the IPO. Although the Company appropriately classified these warrants as liabilities when issued as required by EITF 00-19, the warrants that became non-redeemable as a result of the IPO became reclassified as equity at that time and should have been revalued at fair value prior to that reclassification with any increase in value charged to other income (expense). 
 
On November 6, 2006, after discussion with the Company’s independent registered public accounting firm, BDO Seidman, LLP, and consultation with management and the Board of Directors, the Company concluded that the financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month period ended September 30, 2005 and the fiscal year ended December 31, 2005 should be restated to reflect the fair value adjustment of redeemable warrants that became non-redeemable upon the completion of the Company’s IPO. The fair value of the warrants was approximately $1.5 million and will be recorded as a non-cash charge to other expense in the restated financial statements for the three-month and six-month periods ended June 30, 2005. This expense is a one time charge to the income statement and does not affect operating income.
 
6

Below are summary financial tables comparing the originally reported financials to the restated financials for the nine-month period ended September 30, 2005. The restatement also affected the three-month and six-month periods ended June 30, 2005 and the fiscal year ended December 31, 2005, which will be reported in a separately filed 10Q/A and 10K/A.
 
The following table reports the items in the condensed consolidated statements of operations for the nine months ended September 30, 2005.
 
(in thousands of dollars, except per share data)
Nine Months Ended
     
September 30, 2005
     
As Previously
    
     
Reported
  
As Restated
   
Net sales
$85,261
 
$85,261
   
Gross profit
$13,590
 
$13,590
   
Operating income
$993
 
$993
   
Other income (expense)
$317
  
($1,133)
   
Discontinued operations
($18)
  
($18)
   
Deemed dividend on preferred stock
($1,338)
  
($1,338)
   
Net loss available to common shareholders
($1,312)
  
($2,761)
   
Basic and diluted loss per common share
($0.20)
  
($0.42)
   
Basic and diluted weighted average shares
6,637
  
6,637
 
The following table reports the items in the condensed consolidated balance sheet as of September 30, 2005 that were affected by the restatement.
 
(in thousands of dollars)
Balance Sheet at
         
September 30, 2005
         
(Unaudited)
         
 As Previously
  
As
         
Reported
  
Restated
   
Additional paid in capital
    
$78,592
 
$80,042
   
    Accumulated deficit
    
($11,865)
  
($13,315)

The following table reports the items in the condensed consolidated statement of cash flows as of September 30, 2005 that were affected by the restatement.
 
(in thousands of dollars)
  
Cash Flow for
         
Nine Months Ended
         
September 30, 2005
         
As
   
         
Previously
  
As
         
Reported
  
Restated
   
Net income (loss)
    
$27
 
($1,423)
   
    Mandatory redeemable warrants
    
($317)
 
$1,133

 
NOTE 3 EARNINGS PER SHARE
 
The Company presents earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings per Share”. All per share amounts have been calculated using the weighted average number of shares outstanding during each period. Diluted earnings per share are adjusted for the impact of common stock equivalents using the treasury stock method when the effect is dilutive. There were no shares of preferred stock convertible into common stock outstanding at September 30, 2006 and 2005, respectively. Options and warrants to purchase approximately 2,140,828 and 2,845,658 shares of common stock were outstanding at September 30, 2006 and 2005, respectively. Options and warrant common shares were not included in the computation of diluted earnings per share for the nine month period ended September 30, 2005 because the effect would be anti-dilutive. The diluted shares outstanding for the three and nine month period ended September 30, 2006 were 17,023,879 and 16,954,924, respectively.
 

 
NOTE 4 CASH AND CASH EQUIVALENTS
 
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. The carrying amount of cash approximates its fair value. Our short-term securities are generally government obligations and are carried at amortized cost, which approximates fair market value. The gross unrealized gain at September 30, 2006 was $75,163 and is recorded as a component of accumulated other comprehensive income. There were no short term securities included in cash and cash equivalents at December 31, 2005. Cash and cash equivalents consist of the following at September 30, 2006:
 
Cash
$ 7,509,434
Short-term securities
9,976,024
Total
$17,485,458
 
NOTE 5 SHORT TERM INVESTMENTS
 
Investments in short term securities include available for sale securities, which are carried at amortized cost. Due to the short term nature of these investments, the amortized cost approximates fair market value. The gross unrealized gain at September 30, 2006 and December 31, 2005 was $42,430 and $38,553, respectively, and is recorded as a component of accumulated other comprehensive income. All of these investments mature within 12 months and consist of $5.7 million of auction rate securities at September 30, 2006.
 
NOTE 6 SECONDARY PUBLIC OFFERING
 
On January 26, 2006, the Company along with certain selling stockholders completed a secondary public offering of its common stock. The Company sold 1,800,000 shares of its common stock and participating stockholders sold 2,636,454 shares of common stock at a price of $12.83 per share less an underwriting discount and commission of $0.71 per share. In addition, the Company granted the underwriters an option, exercisable until February 27, 2006, to purchase up to an additional 665,468 shares at the secondary public offering price, less an underwriting discount and commission of $0.71 per share. On January 27, 2006, the underwriters exercised their over-allotment option. The Company received net proceeds of $21.8 million and $8.1 million from the secondary public offering and from the exercise of the over-allotment option, respectively, less expenses incurred of $929,000. The Company did not receive any proceeds from the sale of shares by the participating stockholders.
 
NOTE 7 ACQUISITIONS
 
On March 13, 2006, MOMS Pharmacy of Brooklyn, Inc. (“MOMS of Brooklyn”), a New York corporation and wholly owned subsidiary of the Company purchased certain assets of H.S. Maiman Rx, Inc. (“Maiman”), a Brooklyn, New York pharmacy. Under the terms of the asset purchase agreement between MOMS of Brooklyn and Maiman, MOMS of Brooklyn acquired selected assets, including Maiman’s customer list of HIV/AIDS patients and inventory, for the following:
 
 
•
$4,853,491 of cash paid, including $128,491 of direct acquisition costs paid;
 
 
•
$525,000 additional payments; and
 
 
•
$431,571 cash paid for inventories.
 
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the New York City HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
 
On April 6, 2006, Medicine Made Easy (“MME”), a California corporation and wholly owned subsidiary of the Company, purchased certain assets of the HIV business of H&H Drug Stores, Inc. (“H&H”), a Glendale, California based pharmacy doing business as Western Drug, for the following:
 
 
•
$3,746,162 cash paid, including $66,162 of direct acquisition costs paid (total acquisition costs have been estimated at $165,000 - $98,838 remains accrued at September 30, 2006);
 
 
•
$920,000 additional payments; and
 
 
•
$70,678 cash paid for inventories.
 
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the Los Angeles metropolitan HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
 
On May 1, 2006, MME purchased substantially all of the assets of Whittier Goodrich Pharmacy, Inc. (“Whittier”), a Los Angeles, California based specialty pharmacy, and its two shareholders, for the following:
 
 
•
$15,221,047 cash paid (of which $1,081,757 remained in escrow at September 30, 2006 pending completion of certain conditions), including $221,047 of direct acquisition costs paid (total acquisition costs have been estimated at $225,000 - $3,953 remains accrued at September 30, 2006); and
 
 
•
$607,244 cash paid for inventories.
 
 
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the Los Angeles, California HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
 
On July 14, 2006, MOMS of Brooklyn purchased certain assets of the HIV business of St. Jude Pharmacy & Surgical Supply Corp. (“St. Jude”), a Brooklyn, New York pharmacy, for the following:
 
 
•
$9,381,919 cash paid, including $48,586 of direct acquisition costs paid (total acquisition costs have been estimated at $155,000 - $106,414 remains accrued at September 30, 2006)and $666,667 paid on each of August 14, 2006 and September 14, 2006 based on St. Jude providing certain transitional services to MOMS of Brooklyn relating to the acquired assets; and
 
 
•
$666,667 payable on October 14, 2006 subject to St. Jude providing certain transitional services to MOMS of Brooklyn relating to the acquired assets.
 
The amount allocated to goodwill is reflective of the benefit the Company expects to realize from expanding its presence in the New York City HIV/AIDS market. The acquisition was recorded by allocating the purchase price to the assets acquired, including intangible assets, based on their estimated fair values at the acquisition date. The excess cost over the net amounts assigned to the fair value of the assets acquired is recorded as goodwill. The results of operations from the acquisition are included in Allion’s consolidated operating results as of the date the assets were acquired.
 
The goodwill recorded as the result of the Maiman, H&H, Whittier, and St. Jude acquisitions is expected to be deductible for tax purposes.
 
The following tables describe the allocation of purchase price for these four acquisitions:
 
Purchase Price Paid for Maiman
      
Cash paid
  
$
4,725,000
  
Additional payments
    
525,000
  
Inventories
    
431,571
  
Direct acquisition costs
    
128,491
  
Total purchase price
    
5,810,062
  
less: net tangible assets
    
(431,571
)
 
  
$
5,378,491
  
Preliminary Allocation of Purchase Price for Maiman*
      
Referral list (15 year life)
  
$
2,101,021
  
Non compete (5 year life)
    
25,000
  
Workforce (part of goodwill)
    
120,158
  
Goodwill
    
3,132,312
  
 
  
$
5,378,491
  
 


Purchase Price Paid for Whittier
  
 
  
Cash paid
  
$
15,000,000
  
Inventories
    
607,244
  
Direct acquisition costs
    
225,000
  
Total purchase price
    
15,832,244
  
less: net tangible assets
    
(700,906
)
 
  
$
15,131,338
  
Preliminary Allocation of Purchase Price for Whittier*
      
Referral list (15 year life)
  
$
9,210,470
  
Non compete (5 year life)
    
841,904
  
Workforce (part of goodwill)
    
167,905
  
Goodwill
    
4,911,059
  
   
$
15,131,338
  

Purchase Price Paid for St. Jude
  
 
  
Cash paid
  
$9,333,333
  
Additional payment due
  
666,667
  
Direct acquisition costs
  
155,000
  
 
  
$
10,155,000
  
Preliminary Allocation of Purchase Price for St. Jude*
      
Referral list (15 year life)
  
$
3,000,000
  
Non compete (5 year life)
    
275,000
  
Goodwill
    
6,880,000
  
   
$
10,155,000
  
* Allocation of purchase price is subject to change based on finalization of independent valuation.
 
In 2005, the Company acquired Specialty Pharmacies, Inc. (“SPI”) on February 28, 2005 pursuant to a stock purchase agreement and certain assets of Frontier Pharmacy & Nutrition, Inc., d/b/a PMW Pharmacy (“PMW”) on August 5, 2005 and Priority Pharmacy, Inc. (“Priority”) on December 9, 2005 pursuant to an asset purchase agreement. The following pro forma results were developed assuming the acquisitions of SPI, PMW, Priority, Maiman, H&H, Whittier, and St. Jude occurred on January 1, 2005. The pro forma results do not purport to represent what our results of operations actually would have been if the transactions set forth above had occurred on the date indicated or what our results of operations will be in future periods. The financial results for the periods prior to the acquisition were based on audited or reviewed financial statements, where required, or internal financial statements as provided by the sellers.

 
  
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
 
  
2006 
  
2005 
  
2006 
  
2005 
  
Revenue
  
$59,051,885
  
$58,322,622
  
$175,936,311
  
$172,406,062
  
Net income (loss)
    
1,006,002
    
907,534
    
3,206,600
    
(1,065,207
)
Earnings (loss) per common share:
                          
Basic
  
$
0.06
  
$
0.07
  
$
0.20
  
$
0.16
  
Diluted
  
$
0.06
  
$
0.06
  
$
0.19
  
$
0.16
  
 
On June 30, 2005, Oris Health, Inc, a newly-formed California corporation and wholly-owned subsidiary of the Company, acquired, pursuant to an asset purchase agreement dated May 19, 2005, all right, title and interest in and to certain intellectual property and other assets owned, leased or held for use by Oris Medical System, Inc. (“Oris”) a development stage company incorporated in Washington, including an assignment of Oris’ license to use Ground Zero Software, Inc.’s computer software program known as LabTracker—HIV™, and Oris System, an electronic prescription writing system. Pursuant to the terms of an earn-out formula set forth in the asset purchase agreement, Oris and Ground Zero may receive up to an additional $40,000,000 in the aggregate, paid on a quarterly basis, based on the net number of HIV patients of physician customers utilizing the LabTracker—HIV™ software or the Oris System to fill their prescriptions at MOMS Pharmacy or an affiliate of MOMS Pharmacy. During the third quarter of 2006, we serviced 786 total patients that were monitored under LabTracker and/or Oris software. The reduction of 397 patients from the 1,169 previously reported is due principally to the removal of one clinic relationship that resulted from an acquisition. Patients from this clinic had previously been counted because it was believed that the clinic had a LabTracker contract in place at the time of acquisition. The Company subsequently learned that the LabTracker contract was not executed and therefore the clinic should not be included in calculating the number of patients served under LabTracker and/or Oris. The Company continues to treat these patients and they are included in the overall patient counts for the third quarter 2006.


During the third quarter of 2006, the number of patients monitored under the LabTracker and/or Oris software and covered under the Oris earn-out agreement increased by 46 patients from the second quarter of 2006. The Company has made earn-out payments according to the asset purchase agreement in respect to 316 patients since the Company acquired Oris Medical System, Inc. Oris’ and Ground Zero’s rights to these additional payments terminate 40 months after the closing of the acquisition and, under certain circumstances set forth in the asset purchase agreement, portions of these additional payments may be made in stock of the Company. Earn-out payments are recorded quarterly as earned. Earn-out payments made to Oris in reference to patients served from existing clinics will be allocated to the clinic list and amortized over a fixed 15 year period beginning from when Oris was acquired, and earn-out payments made to Oris in reference to patients served from new clinics will be expensed. Earn-out payments made to Ground Zero in reference to patients served from both new and existing clinics will be allocated to the exclusive LabTracker license agreement and will be amortized over its remaining life. Oris does not qualify as a business so the transaction was accounted for as the acquisition of certain assets and liabilities of Oris.
 
Purchase Price Paid for Oris’ Intangible Assets
  
 
  
Cash paid
  
$1,000,000
  
Earn out obligation
    
302,000
  
Operating expenses paid to seller
    
250,000
  
Employee severance payments
    
72,520
  
Direct acquisition costs
    
129,435
  
Total Purchase Price
    
1,753,955
  
less: net tangible assets
    
(29,000
)
 
  
$
1,724,955
  
Allocation of Purchase Price for Oris’ Intangible Assets
      
License agreement—LabTracker—exclusive rights (40 month life)
  
$
1,242,834
  
Clinic List (15 year life—from date of purchase)
    
196,000
  
Computer software (3 year life)
    
86,121
  
Non compete (40 month life)
    
200,000
  
 
  
$
1,724,955
  
 
NOTE 8 CONTINGENCIES - LEGAL PROCEEDINGS
 
On March 9, 2006, we alerted the staff of the SEC’s Division of Enforcement to the issuance of our press release of that date announcing our intent to restate our financial statements for the periods ended June 30, 2005 and September 30, 2005 relating to the valuation of warrants as disclosed in Note 13. On March 13, 2006, we received a letter from the Division of Enforcement notifying us that the Division of Enforcement had commenced an informal inquiry and requested that we voluntarily produce certain documents and information. In that letter, the SEC also stated that the informal inquiry should not be construed as an indication that any violations of law have occurred. We are cooperating fully with the Division of Enforcement’s inquiry.

Oris Medical Systems Inc. v. Allion Healthcare, Inc., et al., Superior Court of California, San Diego County, Action No. GIC 870818. Oris Medical Systems ("OMS") filed a complaint against Allion Healthcare, Inc. ("Allion"), Oris Health, Inc.("Oris Health") and Mom's Pharmacy, Inc. ("Mom's") on August 14, 2006, purporting to allege claims for breach of contract, breach of the implied covenant of good faith and fair dealing, specific performance, accounting, fraud, negligent misrepresentation, rescission, conversion and declaratory relief, allegedly arising out of a May 19, 2005 asset purchase agreement between Oris Health and Mom's on the one hand, and OMS on the other hand. Allion, Oris Health, and Mom's will vigorously defend against the claims and are considering any appropriate cross-claims against OMS, its majority shareholder Pat Iantorno, and/or any other appropriate third parties. 

We are involved from time to time in legal actions arising in the ordinary course of our business. Other than as set forth above, we currently have no pending or threatened litigation that we believe will result in an outcome that would materially adversely affect our business. Nevertheless, there can be no assurance that future litigation, to which the Company may become a party, will not have a material adverse effect on our business.


NOTE 9 STOCK-BASED COMPENSATION PLAN
 
The Company maintains stock option plans that include both incentive and non-qualified options reserved for issuance to key employees, including officers and directors. All options are issued at fair market value at the grant date and vesting terms vary according to the plans. The plans allow for the payment of option exercises through the surrender of previously owned mature shares based on the fair market value of such shares at the date of surrender.
 
Prior to January 1, 2006, the Company followed Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations in accounting for its employee stock-based compensation. Under APB No. 25, compensation expense was recorded if, on the date of grant, the market price of the underlying stock exceeded its exercise price. As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123” (“SFAS No. 148”), the Company had retained the accounting prescribed by APB No. 25 and presented the disclosure information prescribed by SFAS No. 123 and SFAS No. 148.
 
Had compensation expense for stock option grants issued been determined under the fair value method of SFAS No. 123, the Company’s net income (loss) and EPS for the three and nine-month periods ended September 30, 2005 would have been:

 
  
Three Months Ended
September 30, 2005 
  
Nine Months Ended
September 30, 2005 
  
           
(RESTATED) 
  
Net income (loss) available to common shareholders
  
$
908,990
  
$
(2,761,489
)
Stock-based compensation cost
    
66,039
   
291,741
 
Pro-forma net income (loss) available to common shareholders
  
$
842,951
  
$
(3,053,230
)
               
Reported basic EPS
    
0.07
    
(0.42
)
Reported diluted EPS
    
0.06
    
(0.42
)
               
Pro-forma basic EPS
    
0.07
    
(0.46
)
Pro-forma diluted EPS
    
0.06
    
(0.46
)
 
Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment”, which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their fair values and over the requisite service period. For the three and nine months ended September 30, 2006, the Company recorded non-cash compensation expense in the amount of $129,934 and $210,985, respectively, relating to stock options. The Company elected to utilize the modified-prospective application method, whereby compensation expense is recorded for all awards granted after January 1, 2006 and for the unvested portion of awards granted prior to this date. Accordingly, prior period amounts have not been restated.
 
On June 28, 2006 the Board of Director’s approved a comprehensive option grant to substantially all of the Company’s employees issuing a total of 455,000 options that vest annually in equal installments over a period of five years. The fair value for options was determined using the Black-Scholes valuation model and the straight-line attribution approach using the following weighted average assumptions:
 
Risk-free interest rate
5.23%
Dividend yield
0.00%
Volatility factor
44.81%
Weighted average expected life
6.5 years
 
The risk-free interest rate used in the Black-Scholes valuation model is based on the market yield currently available in U.S. Treasury securities with equivalent maturities. We have not declared or paid any dividends and do not currently expect to do so in the future. The expected term of options represents the period during which our stock-based awards are expected to be outstanding and was determined based on contractual terms of our stock-based awards and vesting schedules. Expected volatility is based on market prices of traded shares for comparable entities within our industry.
 
The Company’s stock price volatility and option lives involve management’s best estimates, both of which impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option.


A summary of stock option activity for the nine-months ended September 30, 2006 is presented below:
 
Options
  
Shares 
  
Weighted Average
Exercise Price 
  
Weighted Average
Remaining
Contractual Term
(in years) 
  
Aggregate
Intrinsic
Value 
  
Outstanding at January 1, 2006
    
1,452,000
  
$
3.21
          
Granted
    
455,000
    
8.11
          
Exercised
    
(420,417
)
  
2.97
          
Forfeited or expired
    
(49,583
)
  
6.19
          
Outstanding at September 30, 2006
    
1,437,000
  
$
4.73
    
6.3
  
$
1,754,375
  
Exercisable at September 30, 2006
    
801,278
  
$
2.47
    
4.3
  
$
1,754,375
  
 
The total intrinsic value of options exercised during the three and nine-months ended September 30, 2006 was $1,110 and $4,128,621 respectively.
 
A summary of the status of the Company’s non-vested shares for the nine months ended September 30, 2006 is as follows:
 
 
Non-vested Shares
  
Shares 
  
Weighted Avg.
Grant Date
Fair Value 
  
Non vested at January 1, 2006
    
341,805
  
$
1.64
  
Granted
    
455,000
    
4.29
  
Vested
    
(111,500
)
  
2.39
  
Forfeited
    
(49,583
)
  
1.62
  
Non vested at September 30, 2006
    
635,722
  
$
3.51
  
 
As of September 30, 2006, there was $1,738,092 of total unrecognized compensation cost, net of estimated forfeitures, related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted-average period of 3.0 years. The total fair value of shares vested during the three and nine-months ended September 30, 2006 was $129,934 and $210,985, respectively, which was recorded as part of selling, general and administrative expenses.
 
NOTE 10 CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
 
The Company provides prescription medications to its customers in the United States through its ten distribution centers. Credit losses relating to customers historically have been minimal and within management’s expectations.
 
At December 31, 2005 and September 30, 2006, the Company maintained the majority of its cash and short term investments with two financial institutions. Such cash balances, at times, may exceed FDIC limits. The Company has not experienced any losses in such accounts.
 
For the nine month periods ended September 30, 2006 and 2005, federal and state third-party reimbursement programs represented approximately 86% and 87% of total sales, respectively. Federal and state third-party reimbursement programs represented approximately 86% and 87% of total sales for the three month periods ended September 30, 2006 and 2005, respectively. At September 30, 2006 and December 31, 2005, the Company had an aggregate outstanding receivable from federal and state agencies of approximately $16,750,982 and $11,736,073, respectively.
 
NOTE 11 MAJOR SUPPLIERS
 
During the nine months ended September 30, 2006 and 2005, the Company purchased approximately $94,801,000 and $68,787,000, respectively, from one major supplier. During the three months ended September 30, 2006 and 2005, the Company purchased approximately $34,727,000 and $26,841,000, respectively, from one major supplier. Amounts due to this supplier at September 30, 2006 and December 31, 2005 were approximately $13,782,000 and $12,358,000, respectively.
 
In September 2003, the Company signed a five-year agreement with a drug wholesaler that requires certain minimum purchases. If the Company does not meet the minimum purchase commitments as set forth in the agreement, the Company will be charged a prorated amount of 0.20% of the balance remaining on the term of the Agreement. The agreement also provides that the Company’s minimum purchases during the term of the agreement will be no less than $400,000,000. The Company has purchased approximately $262,970,000 from this drug wholesaler since the beginning of the term of this agreement and believes it will be able to meet its minimum purchase obligations under this agreement.

 
NOTE 12 SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES
 
Interest paid on credit facilities, notes and capital leases for the nine months ended September 30, 2006 and 2005 was $49,083 and $532,479, respectively. During 2005, the Company completed two acquisitions of assets by paying part of the consideration paid in notes payable. For the nine months ended September 30, 2005, the balance of the notes was $1,375,000. The Company incurred an obligation of $666,667 to acquire the assets of St. Jude, which was subsequently paid on October 14, 2006.
 
NOTE 13 RELATED PARTY TRANSACTION
 
In March 2005, when West Bank agreed to extend the maturity of its loan until September 2005, Mr. Pappajohn, one of the Company’s outside directors, agreed to keep his guaranty in place through September 2005. As consideration for continuing his guaranty, in April 2005 the Company issued to Mr. Pappajohn warrants to purchase 100,000 shares of common stock exercisable at a price equal to our IPO price per share. The fair value of the warrants was $753,000 as calculated using the Black Scholes model and was recorded as interest expense in June 2005 when the West Bank facility was repaid with proceeds from the IPO.
 
NOTE 14 RECENT ACCOUNTING PRONOUNCEMENTS
 
On July 13, 2006, Financial Accounting Standards Board (“FASB”) Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109,” was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Management is in the process of evaluating the effects of this guidance which is effective for fiscal years beginning after December 15, 2006.
 
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to U.S. GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.
 
NOTE 15 SUBSEQUENT EVENTS
 
On October 4, 2006, the Company entered into an employment agreement, effective as of October 1, 2006, with each of Michael P. Moran, the Chief Executive Officer and President, and James G. Spencer, the Chief Financial Officer (collectively, the “Employment Agreements,” and each of Messrs. Moran and Spencer, the “Executive”). Mr. Moran’s and Mr. Spencer’s annual base salaries under their Employment Agreements are $350,000 and $290,000, respectively, subject to increases from time to time in the sole discretion of the compensation committee. In addition, the Employment Agreements provide that the Executive may be awarded performance bonuses on an annual basis, commencing with a bonus that may be awarded for the 2006 fiscal year, as determined by the board of directors or compensation committee; provided, that the bonus for any year cannot exceed 40% of the Executive’s base salary for that year. The Executive is also entitled to participate in any employee benefit plans which the Company may from time to time have in effect for all or most of its senior employees. The Company will also provide each Executive with an automobile allowance of $800 per month.
 
In addition, for a minimum of two years following the date of his Employment Agreement, the Company agreed to reimburse Mr. Spencer for travel and living expenses incurred by him in traveling from his residence in Maryland to Melville, New York or any other location where the Company offices are moved. The Company also agreed that if at any time reimbursement for such expenses is characterized by the Internal Revenue Service as compensation to Mr. Spencer, the Company will pay him an additional amount equal to the tax paid by Mr. Spencer on such compensation so that the amount retained by Mr. Spencer after payment of taxes on such amount equals the tax imposed on the reimbursement of payments. Furthermore, if Mr. Spencer relocates his residence at any time, he will be reimbursed for relocation expenses.
 
The Employment Agreements provide for an initial term of one year and automatically renew for successive one-year periods unless notice of non-renewal is provided in writing by either party at least ninety (90) days before the end of the then-current term. The Employment Agreements may also be earlier terminated by the Company with or without Cause (as defined in the Employment Agreements), by the Executive with or without Good Reason (as defined in the Employment Agreements and including a Change in Control), or upon the Executive’s death or disability as further described in the Employment Agreements. Upon a termination by the Company for Cause, by the Executive without Good Reason or upon a notice of non-renewal by the Executive, the Executive is entitled to received accrued but unpaid salary through the termination date, cash in lieu of any accrued but unused vacation through the termination date and any benefits accrued or payable to the Executive under the Company’s benefit plans (collectively the “Accrued Benefits”). Upon a termination by the Executive for Good Reason or by the Company without Cause, or upon a notice of non-renewal by the Company, the Executive is entitled to receive certain termination benefits in addition to Accrued Benefits, including continuation of his then-current salary through the expiration of the then-current term, a lump sum payment equal to each Executive’s initial base salary set forth above and, with respect to Mr. Spencer, accelerated vesting of all options if Mr. Spencer terminates his agreement upon a Change in Control.
 

Pursuant to the Employment Agreements, the Executives are subject to confidentiality provisions as well as certain non-compete and non-solicitation obligations during the term of employment with the Company and for a one-year period following termination of employment. Notwithstanding the foregoing, if the Employment Agreement is terminated by the Company without Cause, by the Executive for Good Reason or upon a notice of non-renewal by the Company with respect to Mr. Spencer, the Executive will no longer be bound by a restriction preventing him from directly or indirectly engaging, participating, assisting or investing in any competing business.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
RESTATEMENT
 
As discussed more fully in Note 2 to the condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report, we are restating our previously reported condensed consolidated financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month period ended September 30, 2005 and our fiscal year ended December 31, 2005. This Form 10-Q reflects the restatement of the nine-month period ended September 30, 2005.
 
This discussion and analysis (MD&A) should be read in conjunction with the restated financial statements and notes appearing elsewhere in this Report and our 2005 Form 10-K/A, as will be amended to reflect the restatement of our financial statements for our fiscal year ended December 31, 2005 noted above.
 
FORWARD-LOOKING STATEMENTS
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and notes thereto included in Item 1 of Part I of this Quarterly Report. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The forward-looking statements included herein and any expectations based on such forward-looking statements are subject to risks and uncertainties and other important factors that could cause our actual results to differ materially from the results contemplated by the forward-looking statements, including, but not limited to:
 
 
•
The effect of regulatory changes, including but not limited to, the Medicare Prescription Drug Improvement and Modernization Act of 2003;
 
 
•
The reduction of reimbursement rates for primary services provided by government and other third-party payers;
 
 
•
Changes in reimbursement policies and possible other potential reductions in reimbursements by other state agencies and our ability to qualify for preferred reimbursement programs in California and New York;
 
 
•
Changes in Average Wholesale Price, or AWP, for the prescriptions we fill, which could reduce reimbursement for the drugs we dispense and negatively affect our financial results, including the impact of a proposed settlement in a class action case involving First DataBank, an AWP reporting service;
 
 
•
Our ability to market our customized packaging system and the acceptance of such system by healthcare providers and patients;
 
 
•
Our ability to adapt our operational, financial and management controls, reporting systems and procedures to the demands of a larger business, including the demands of integrating our acquisitions;
 
 
•
Our ability to manage our growth with a limited management team;
 
 
•
The availability of appropriate acquisition candidates and/or our ability to successfully complete and integrate acquisitions;
 
 
•
The effect of the restatement of our previously issued financial statements; and
 
 
•
Our unresolved comments with the SEC, and the ongoing informal SEC inquiry.
 
 
 
These and other risks and uncertainties are discussed in detail in our 2005 Annual Report on Form 10-K/A and in Part II Item 1A. Risk Factors of this Quarterly Report, and should be reviewed carefully. All forward-looking statements included or incorporated by reference in this Quarterly Report on Form 10-Q are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statements. Stockholders are cautioned not to place undue reliance on such statements.
 
OVERVIEW
 
We are a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. We sell HIV/AIDS medications, ancillary drugs and nutritional supplies under our trade name MOMS Pharmacy. We work closely with physicians, nurses, clinics and AIDS Service Organizations, or ASO’s, and with government and private payors, to improve clinical outcomes and reduce treatment costs for our patients. Most of our patients rely on Medicaid and other state-administered programs, such as the AIDS Drug Assistance Program, or ADAP, to pay for their HIV/AIDS medications. The following discussion and analysis provides information that our management believes is relevant to an assessment and understanding of our results of operations and financial condition.
 
We operate our business as a single segment configured to serve key geographic areas most efficiently. As of September 30, 2006, we operated ten distribution centers that are located strategically in California (6 separate locations), New York (2 separate locations), Florida and Washington to serve major metropolitan areas in which high concentrations of HIV/AIDS patients reside. In discussing our results of operations, we address changes in the net sales contributed by each of these distribution centers because we believe this provides a meaningful indication of the historical performance of our business.
 
In March 2005, we decided to cease operating our Austin, Texas distribution center as of June 30, 2005. A significant portion of the operations of our Austin, Texas distribution center was dedicated to serving organ transplant and oncology patients, and consistent with our strategy of focusing on the HIV/AIDS market, we decided not to continue this business. We did not record any material expense associated with the discontinuance of these operations and the closing of our Austin, Texas facility. In 2005, our Austin, Texas distribution center contributed approximately $1.5 million of net sales to our financial results. As a result of our decision to discontinue our Texas operations, we have presented the results of the Texas distribution center as “discontinued operations.” As required by generally accepted accounting principles, we have restated prior periods to reflect the presentation of the Texas facility as “discontinued operations,” so that period-to-period results are comparable.
 
On December 8, 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003, or the MMA, was signed into law. This legislation made significant structural changes to the Federal Medicare program, including providing for a Medicare prescription drug benefit. Under the MMA, Medicare Part D prescription drug plans, or PDPs, were selected by the Centers for Medicare & Medicaid Services, or CMS, through a competitive bidding process so that beneficiaries would have a choice between at least two plans in the area in which they live. CMS announced the results of its bidding process and the selected PDPs through a press release on September 23, 2005.
 
Effective January 1, 2006, Medicaid coverage of prescription drugs for Medicaid beneficiaries who are also eligible for Medicare were shifted to the Medicare program. These enrollees are referred to as “dual eligibles.” In general, dual eligibles are persons (1) who have low income qualifying them for Medicaid benefits and (2) who also qualify for Medicare because they have chronic illnesses and disabilities, or they are over age 65. Previously, dual eligibles filled their prescriptions through their state Medicaid programs. Medicaid drug coverage ended for people who were eligible for Medicare on December 31, 2005. Previously Medicare helped pay for basic healthcare services, like physician and hospital care, while Medicaid filled gaps and covered certain supplies, like prescription drugs, not covered by Medicare.
 
In connection with the implementation of the MMA, all dual eligibles had the opportunity to enroll in a PDP that administers the Medicare drug benefit and pays providers like us for providing drugs under the program. Dual eligibles that did not voluntarily pick a PDP plan were enrolled automatically in a plan. This change in payor requires us to seek payment for our dual eligible patients from their PDP instead of the government. We have contracts in place with multiple PDPs in each of the markets we serve. However, we may not have a negotiated agreement with all of the PDPs in which our patients are enrolled. As a result, we may lose patients who are enrolled in a PDP with whom we do not have a contract . In addition, if patients move to a PDP with whom we do not have an agreement, we may not be able to provide services to them in the future. In some cases, we have to accept a lower reimbursement rate from the PDPs than we previously received under Medicaid. Some PDPs do not cover all the drugs and services we previously provided to our dual eligible patients. A combination of a lower reimbursement rate and different coverage has negatively impacted our earnings and resulted in lower net sales and a lower gross profit to us for the dual eligible patients we serve.
 
The key components of our financial results are our net sales, gross profit and operating expenses.
 
Net Sales. We sell HIV/AIDS prescriptions, ancillary medications, and nutritional supplies. As of September 30, 2006, approximately 86% of our net sales came from payments from Medicaid, Medicare (including Medicare Part D) and ADAP. These are all highly regulated government programs that are subject to frequent changes and cost containment measures. We continually monitor changes in reimbursement for HIV/AIDS medications.

 
Gross Profit. Our gross profit reflects net sales less the cost of goods sold. Cost of goods sold is the cost of pharmaceutical products we purchase from wholesalers. The amount that we are reimbursed by government and private payors has historically increased as the price of the pharmaceuticals we purchase has increased. However, as a result of cost containment initiatives prevalent in the healthcare industry, private and government payors have reduced reimbursement rates, which prevent us from recovering the full amount of any price increases.
 
North American Home Health Supply, Inc. (“NAHH”), which we acquired on January 4, 2005, has historically reported higher gross margins than our historical business. The higher gross margin for NAHH is due to a product mix that is reimbursed at higher amounts than the HIV/AIDS medications we sell. The purchasers of these higher margin products are primarily not HIV/AIDS patients.
 
While we believe that we now have a sufficient revenue base to continue to operate profitably given our anticipated operating and other expenses, our business remains subject to uncertainties and potential changes, as discussed below that could result in losses. In particular, changes to reimbursement rates (including Part D), unexpected increases in operating expenses, difficulty integrating acquisitions or declines in the number of patients we serve or the number of prescriptions we fill could adversely affect our future results. See also the discussion regarding AWP under “Recent Developments” below.
 
Operating Expenses. Our operating expenses are made up of both variable and fixed costs. Variable costs increase as net sales increase. Our principal variable costs are labor and delivery. Fixed costs do not vary directly with changes in net sales. Our principal fixed costs are facilities, equipment and insurance.
 
We have grown our business by acquiring other specialty pharmacies and expanding our existing business. We expect to continue to make acquisitions and to continue to expand our existing business. Since the beginning of 2003, we have acquired seven specialty pharmacies in California and two specialty pharmacies in New York. We also generate internal growth primarily by increasing the number of patients we serve and filling more prescriptions per patient.
 
CRITICAL ACCOUNTING POLICIES
 
Our critical accounting policies affect the amount of income and expense we record in each period as well as the value of our assets and liabilities and our disclosures regarding contingent assets and liabilities. In applying these critical accounting policies, we must make estimates and assumptions to prepare our financial statements that, if made differently, could have a positive or negative effect on our financial results. We believe that our estimates and assumptions are both reasonable and appropriate, in light of applicable accounting rules. However, estimates involve judgments with respect to numerous factors that are difficult to predict and are beyond management’s control. As a result, actual amounts could differ materially from estimates.
 
Management believes that the following accounting policies represent “critical accounting policies,” which the SEC defines as those that are most important to the portrayal of a company’s financial condition and results of operations and require management’s most difficult, subjective, or complex judgments, often because management must make estimates about uncertain and changing matters.
 
Revenue Recognition. Net sales refer to our sales of medications and nutritional supplements to patients and are reported net of contractual allowances to patients, government and private payors and others in the period when delivery to our patients is completed. Any customer can initiate the filling of prescriptions by having a doctor call in prescriptions to our pharmacists, faxing over a prescription, or mailing prescriptions to one of our facilities. Once we have verified that the prescriptions are valid and have received authorization from a customer’s insurance company or state insurance program, the pharmacist then fills the prescriptions and ships the medications to the customers through our outside delivery service, an express courier service, postal mail, or the patient picks up the prescription at the pharmacy. We served 15,086 patients in the month of September 2006. In our Form 10-Q for the period ended June 30, 2006, we inadvertently misstated the number of patients served in June 2006 as 16,556 due to a reporting error in the software system used by Whittier at the time of acquisition. The correct number of patients served during the month of June 2006 was 15,187. This correction does not affect our previously reported financial results for the second quarter of 2006. Whittier has since been converted to the same pharmacy platform as our other locations. The decline in patients served from June 2006 to September 2006 is due to the number of business days in the month which were 22 and 20, respectively. In October 2006, we served approximately 15,527 patients.
 
As of September 1, 2004, as part of the passage of the State of California budget, reimbursement rates for pharmacy services provided under Medi-Cal were reduced. Under the reduced reimbursement rate, prescriptions are reimbursed at the Average Wholesale Price, or AWP, less 17%, and the provider is paid a $7.25 dispensing fee. The previous reimbursement rate was AWP less 10% with a $4.05 dispensing fee. Effective January 1, 2005, California approved a three year HIV/AIDS Pharmacy Pilot Program that funds an additional $9.50 fee per prescription for qualified pharmacies that participate in the program. The payments are retroactive and apply to services rendered since September 1, 2004. We own two of the ten pharmacies that have qualified for the pilot program in California.

 
In New York, reimbursement rates for pharmacy services provided under Medicaid were reduced in September 2004. Under the reduced reimbursement rate, prescriptions were reimbursed at the AWP less 12.75% plus a dispensing fee of $3.50 for brand name drugs and AWP less 16.5% plus a dispensing fee of $4.50 for generic drugs.   Despite this reduction, approved specialized HIV pharmacies were reimbursed at  a more favorable pre-reduction reimbursement rate of AWP less 12% plus a dispensing fee of $3.50 for brand name drugs and $4.50 for generic drugs. Reimbursement rates for pharmacy services provided under Medicaid were reduced further effective July 2006.  Under the new reimbursement rate, prescriptions are reimbursed at the AWP less 13.25% plus a dispensing fee of $3.50 for brand name drugs and AWP less 20% plus a dispensing fee of $4.50 for generic drugs. Approved specialized HIV pharmacies will continue to be reimbursed at AWP less 12% plus the same dispensing fees. The legislation authorizing the more favorable reimbursement rate is effective until further legislation changes it.  We have been notified by the Department of Health in New York that we qualify for the specialized HIV pharmacy reimbursement and we have recognized the expected revenues.  The first payment under this reimbursement program was received in April 2006.  Our continuing qualification for specialized HIV pharmacy reimbursement is dependent upon our recertification by the Department of Health in New York as an approved specialized HIV pharmacy. At this time, we have submitted all required paperwork to the state for recertification and are awaiting notification that we continue to qualify as a specialized HIV pharmacy. We were previously certified through September 2006.
 
We began recognizing revenue related to premium reimbursement in June 2005 and September 2005 following notification by the states of New York and California, respectively that certain of our pharmacies had qualified to participate in these programs. Both states provided for retroactive payment of prescriptions dating back to September 2004. No revenues were recorded for premium reimbursement prior to our receipt of notification from the appropriate governing state agency that we had qualified to participate in these premium reimbursement programs. Thus, for our three licensed pharmacies that qualified to participate in one of these programs, we reviewed our internal records and estimated the expected premium reimbursement for the then-current period and retroactive payments to be received for prior periods. These estimated retroactive premium reimbursement amounts were then recorded as revenue. Because these are estimates, the actual amounts for retroactive premium reimbursement may differ and an adjustment may be required when payments are received.
 
Premium reimbursement for eligible prescriptions dispensed in the current period are recorded as a component of net sales in the period in which the patient receives the medication. Prescriptions are filled as described above, once we have verified that the prescriptions are valid and have received authorization from a customer’s state insurance program. We have begun to receive regular payments for premium reimbursement which are paid in conjunction with the regular reimbursement amounts due through the normal payment cycle for the California pilot program and have received annual payment under the New York program beginning in April 2006.
 
Allowance for Doubtful Accounts. We are reimbursed for the medications we sell by government and private payors. The net sales and related accounts receivable are recorded net of payor contractual discounts to reflect the estimated net billable amounts for the products delivered. We estimate the allowance for contractual discounts on a payor-specific basis, given our experience or interpretation of the contract terms if applicable. However, the reimbursement rates are often subject to interpretation that could result in payments that differ from our estimates. Additionally, updated regulations and contract negotiations occur frequently, necessitating our continual review and assessment of the estimation process. While management believes the resulting net carrying amounts for accounts receivable are fairly stated at each quarter-end and that we have made adequate provision for uncollectible accounts based on all available information, no assurance can be given as to the level of future provisions for uncollectible accounts, or how they will compare to the levels experienced in the past.
 
Intangible Asset Impairment. In assessing the recoverability of our intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If we determine that impairment indicators are present and that the assets will not be fully recoverable, their carrying values are reduced to estimated fair value. Impairment indicators include, among other conditions, cash flow deficits, a historic or anticipated decline in net sales or operating profit, adverse legal or regulatory developments, accumulation of costs significantly in excess of amounts originally expected to acquire the asset, and a material decrease in the fair value of some or all of the assets. Changes in strategy and/or market conditions could significantly impact these assumptions, and thus we may be required to record impairment charges for these assets. In our intangible asset impairment analysis, we follow Statement of Financial Accounting Standards (“SFAS”) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”).
 
Goodwill and Other Intangible Assets. In accordance with SFAS No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets associated with acquisitions that are deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Such impairment tests require the comparison of the fair value and carrying value of reporting units. Measuring fair value of a reporting unit is generally based on valuation techniques using multiples of sales or earnings, unless supportable information is available for using a present value technique, such as estimates of future cash flows.


We assess the potential impairment of goodwill and other indefinite-lived intangible assets annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an interim impairment review include the following:
 
 
•
Significant underperformance relative to expected historical or projected future operating results;
 
 
•
Significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and
 
 
•
Significant negative industry or economic trends.
 
If we determine through the impairment review process that goodwill has been impaired, we record an impairment charge in our consolidated statement of income. Based on our impairment review process, we have not recorded any impairment during the period ended September 30, 2006.
 
Recent Accounting Pronouncements
 
On July 13, 2006, FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109,” was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Management is in the process of evaluating the effects of this guidance which is effective for fiscal years beginning after December 15, 2006.
 
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to U.S. GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.

RECENT DEVELOPMENTS
 
Government payors, including ADAP, Medicaid and Medicare Part D programs, which account for most of our net sales, pay us directly or indirectly for the medications we provide at average wholesale price, or AWP, or at a percentage of AWP. Private payors with whom we may contract also reimburse us for medications at AWP or at a percentage of AWP.   Federal and state government attention has focused on the validity of using AWP as the basis for Medicaid and Medicare Part D payments for HIV/AIDS medications, and most state Medicaid programs now pay substantially less than AWP for the prescription drugs we dispense.
 
Drug pricing and the validity of AWP continues to be a focus of litigation and governmental investigations.  The case of New England Carpenters Health Benefits Fund, et al. v. First DataBank, et al., Civil Action No. 1:05-CV-11148-PBS (D. Mass.), is a civil class action brought against the most widely used reporter and publisher of the AWP, First DataBank ("FDB").  As part of a recently announced proposed settlement in the case, FDB has agreed to reduce the reported AWP of over 8,000 specific pharmaceutical products by four percent (4%).  At this time, the final resolution of the case is still unknown, and any settlement terms must be approved and ordered by the court. We cannot predict the outcome of this case or, if the settlement is approved, the precise timing of any of the proposed AWP reductions. The proposed settlement, if approved, is likely to reduce the price paid to us for medications we dispense, and this would have a material adverse effect on our results of operations. We cannot be certain that any attempts by us to mitigate those effects would be successful.
 
The proposed settlement in this case may also result in the elimination of AWP as a pricing benchmark altogether, and our reimbursement from government and private payors may be based on less favorable pricing benchmarks in the future.
Whatever the outcome of the FDB case, we believe that government and private payors will continue to evaluate pricing benchmarks other than AWP as the basis for prescription drug reimbursements.  We are unable to evaluate the overall financial impact that the transition to any such alternative benchmark may have on our company.


RESULTS OF OPERATIONS
 
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
 
The following table sets forth the net sales and operating data for each of our distribution regions for the nine months ended September 30, 2006 and 2005:

 
  
Nine Months Ended
September 30, 
  
 
  
2006 
  
2005 
  
 
Distribution Region
  
Net Sales 
  
Prescriptions 
  
Patient
Months 
  
Net Sales 
  
Prescriptions 
  
Patient
Months 
  
California (1)(2)(3)(4)
  
$
101,184,619
    
434,760
    
91,522
  
$
49,888,113
    
239,601
    
52,825
  
New York (5)(6)
  
$
46,141,102
    
174,771
    
26,486
  
$
31,918,058
    
121,054
    
17,141
  
Florida
  
$
1,470,183
    
7,994
    
1,095
  
$
1,593,657
    
9,847
    
1,164
  
Seattle (1)
  
$
2,810,058
    
15,218
    
2,706
  
$
1,861,612
    
11,549
    
1,986
  
Total
  
$
151,605,962
    
632,743
    
121,809
  
$
85,261,440
    
382,051
    
73,116
  
(1)
California & Seattle operations for the nine months ended September 30, 2005 include seven months of contribution from SPI.
 
(2)
California operations for the nine months ended September 30, 2006 included nine months contribution from SPI, PMW and Priority. Additionally, it included five and one half months contribution from H&H and five months contribution from Whittier.
 
(3)
California operations for the nine months ended September 30, 2006 include $858,457 of retroactive premium reimbursement for prior periods in 2005 and 2004. For the nine months ended September 30, 2005, operations includes $158,547 of retroactive premium reimbursement for prior periods in 2004.
 
(4)
For the six month period ended June 30, 2006, we reported patient months for California operations of 60,668. We identified an error in the reporting system used by Whittier and the corrected number of patient months for the California operations for the six month period ended June 30, 2006 is 58,037. This correction does not affect our previously reported financial results for the six months ended June 30, 2006. Whittier was subsequently converted to our pharmacy platform in September 2006.
 
(5)
New York operations for the nine months ended September 30, 2006 include six and one half months of contribution from Maiman and two and one half months contribution from St. Jude.
 
(6)
New York operations for the nine months ended September 30, 2006 include $58,105 of retroactive premium reimbursement for prior periods in 2005. For the nine months ended September 30, 2005, operations include $99,183 of retroactive premium reimbursement for prior periods in 2004.
 
The prescription and patient month data has been presented to provide additional data about operations. A prescription typically represents a 30-day supply of medication for an individual patient. “Patient months” represents a count of the number of months during a period that a patient received at least one prescription. If an individual patient received multiple medications during each month of a nine month period, a count of nine would be included in patient months irrespective of the number of medications filled in each month.
 
NET SALES
 
Net sales for the nine months ended September 30, 2006 increased to $151,605,962 from $85,261,440 for the nine months ended September 30, 2005, an increase of 77.8%. The increase in net sales for the nine months ended September 30, 2006 as compared to the same period in 2005 is primarily attributable to the Company’s acquisitions. During the nine months ended September 30, 2006, we owned SPI, PMW, and Priority for nine months. We owned Maiman for six and one half months, H&H for five and one half months, and Whittier for five months. Increases in net sales for the nine months ended September 30, 2006 were partially offset by the implementation of MMA, which resulted in lower reimbursement rates for our dual eligible patients.
 
In 2004 revenue was reduced by reductions in reimbursement rates in California and New York for the last four months of the year. However, in 2005, we qualified for a pilot program in California and for additional reimbursement in New York under specialized reimbursement for HIV pharmacies. Both states’ programs also provided for retroactive payment of prescriptions dating back to September 2004. In the second and third quarters of 2005, we began recognizing revenue relating to premium reimbursement in New York and California, respectively, under each state’s program for qualified pharmacies. These revenues are estimated at the time service is provided and accrued to the extent that payment has not been received. For the nine month periods ended September 30, 2006 and September 30, 2005, we recorded $916,562 and $257,730 of retroactive premium reimbursement related to prior periods in 2005 and 2004, respectively.
 
As of September 30, 2006, we had an outstanding balance of $932,731 of accrued revenue relating to premium reimbursement in New York and California including retroactive payments for prior periods. Based on discussions with each state agency, we believe we will receive payment for these accrued revenues.


GROSS PROFIT
 
Gross profit was $22,338,455 and $13,589,674 for the nine months ended September 30, 2006 and 2005, respectively, and represents 14.7% and 15.9% of net sales, respectively. Excluding the $916,562 related to the retroactive premium reimbursement (in net sales) from prior periods, the adjusted gross margin for the nine months ended September 30, 2006 would have been 14.2%. Similarly, the adjusted gross margin for the period ended September 30, 2005 is 15.7% (excluding the $257,730 related to the retroactive premium reimbursement from prior periods). Our adjusted gross margin for the nine months ended September 30, 2006 decreased 1.4% as compared with the gross margin for the nine months ended September 30, 2005 primarily due to lower reimbursement on patients that moved from state Medicaid programs to Medicare Part D and the increased focus on lower margin HIV business as the higher margin NAHH business becomes a smaller portion of the overall business.
 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
Selling, general and administrative expenses were $19,639,477 and $12,596,577 for the nine months ended September 30, 2006 and 2005, respectively, and represented 13.0% and 14.8% of net sales, respectively. The decrease in selling, general and administrative expenses as a percentage of net sales is primarily due to operating efficiencies related to labor and other resources as prescription volumes increase. The increase in selling, general and administrative expenses of $7,042,900 for the nine months ended September 30, 2006 as compared to the same period in 2005 was primarily due to the acquisitions of SPI, PMW, Priority, Maiman, H&H, Whittier and St. Jude. These acquisitions represented approximately $4.8 million of the increase. In addition to the increases in expenses related to the acquisitions, the following increases were associated with our historical businesses:
Components of Selling, General and Administrative Expense 
Change ($) 
Labor Expense
653,468
Sarbanes Oxley Compliance Expense
230,265
Non-Cash Stock Compensation Expense
210,985
Vacation Accrual for Employee Vacation Carryover *
116,000
Rent & Facilities
73,550
 
* We recognized approximately $116,000 of non-recurring compensation relating to vacation accruals for employees that were allowed to carry over vacation as part of the standardization of benefits across locations.
 
Included in selling, general & administrative expenses for the nine month period ended September 30, 2006 was $388,813 of legal, accounting and printing expenses relating to the informal SEC inquiry and the restatement of financial statements for three and six month periods ended June 30, 2005 and the three and nine month periods ended September 30, 2005. The financial statements were restated to correct the omission of a non-cash interest expense relating to warrants to purchase 100,000 shares of our common stock that were issued to John Pappajohn, one of our outside directors, in April 2005 in connection with the extension of a guarantee on our West Bank credit facility, and warrants to purchase 40,000 shares of our common stock that were issued to Crestview Capital Master, LLC in May 2005 in connection with the issuance of subordinated notes. The total non-cash interest expense for both issuances of warrants was approximately $966,000.
 
Included in selling, general & administrative expenses for the nine month period ended September 30, 2005 was $150,000 of compensation expense to one of the former owners of the San Francisco pharmacy acquired in the first quarter of 2005. We accrued an additional $150,000 per quarter for a one-year period through March 2006, as long as this former owner remained employed with Allion. In March 2006, we paid this former owner the contingent compensation of $600,000 for fulfilling the employment obligation.
 
Included in selling, general & administrative expenses for the nine month period ended September 30, 2006 is $407,949 of bad debt expense compared to $55,000 for the same period in 2005. The year over year increase for the nine months ended September 30, 2006 is primarily due to the increased receivables relating to acquisitions and NAHH that the company does not expect to collect.
 
OPERATING INCOME
 
Operating income was $2,698,978 and $993,097 for the nine months ended September 30, 2006 and 2005, respectively and represents 1.8% and 1.2% of net sales, respectively. The increase in operating income is attributable to an increase in gross profit of $8,748,781 million and a decrease in selling, general and administrative expenses as a percent of net sales of 1.8%.


OTHER INCOME (EXPENSE)
 
Interest income was $946,378 and interest expense was $1,265,419 for the nine months ended September 30, 2006 and 2005, respectively. The decrease in interest expense is primarily attributable to our repayment of short term loans under our revolving credit facility during the second quarter of 2005 with proceeds from the IPO and the non-recurrence in 2006 of $966,000 of non-cash expense recorded in June 2005 related to the fair value of warrants issued in connection with the private placement of subordinated notes and to a director in exchange for the guarantee of a credit facility. Interest income for the nine months ended September 30, 2006 is due primarily to our investment in short-term securities and other investment of cash.
 
Other income was $102 and other expense was $1,133,215 for the nine months ended September 30, 2006 and 2005, respectively. The other expense recorded in the nine months ended September 30, 2005 related to the fair value adjustment of redeemable warrants that became non-redeemable upon the completion of our IPO. The fair value adjustment resulted in an additional charge to other expense of $1,133,215 from what had previously been recorded.
 
PROVISION FOR TAXES
 
We recorded a provision for taxes in the amount of $835,680 for the nine months ended September 30, 2006. The provision relates primarily to state income tax and federal alternative minimum tax that would have been payable before income tax deductions relating to stock based compensation which created a taxable loss and to deferred taxes which related to tax-deductible goodwill. The benefit of the stock based compensation deduction was credited to additional paid in capital as the grant of these options was originally booked through additional paid in capital. We did not record any provision for income taxes for the nine months ended September 30, 2005.
 
NET INCOME (LOSS)
 
For the nine months ended September 30, 2006, we recorded net income of $2,809,778 as compared to a net loss of $2,761,489 for the comparable period in the prior year. The increase in net income is primarily attributable to revenue growth, increased gross profit and interest income as opposed to interest expense.
 
THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
 
The following table sets forth the net sales and operating data for each of our distribution regions for the three months ended September 30, 2006 and 2005:

 
  
Three Months Ended
September 30, 
  
 
  
2006 
  
2005 
  
Distribution Region
  
Net Sales 
  
Prescriptions 
  
Patient
Months 
  
Net Sales 
  
Prescriptions 
  
Patient
Months 
  
California (1)(2)(3)
  
$
37,943,846
   
162,147
    
33,485
  
$
21,620,159
    
99,616
    
20,714
  
New York (4)(5)
    
18,843,123
    
71,633
    
10,940
    
10,979,492
    
39,762
    
5,657
  
Florida
    
574,174
    
2,861
    
409
    
459,463
    
2,756
    
333
  
Seattle
    
987,937
    
5,076
    
910
    
867,478
    
4,890
    
850
  
Total
  
$
58,349,080
    
241,717
    
45,744
  
$
33,926,592
    
147,024
    
27,554
  
(1)  
California operations for the three months ended September 30, 2006 include three months contribution from PMW, Priority, H&H and Whittier. For the three months ended September 30, 2005, operations include one and one half months of contribution from PMW.

(2)  
California operations for the three months ended September 30, 2005 include $683,353 of retroactive premium reimbursement related to prior periods in 2005 and 2004.

(3)  
For the three month period ended June 30, 2006, we reported patient months for California operations of 34,938. We identified an error in the reporting system used by Whittier and the corrected number of patient months for the California operations for the three month period ended June 30, 2006 is 32,307. This correction does not affect our previously reported financial results for the three months ended June 30, 2006. Whittier was subsequently converted to our pharmacy platform in September 2006.
 
(4)  
New York operations for the three months ended September 30, 2006 include three months contribution from Maiman and two and one half months contribution from St. Jude.
 
(5)  
New York operations for the three months ended September 30, 2006 include $70,613 of retroactive premium reimbursement related to prior periods in 2006 and 2005. For the three months ended September 30, 2005, operations include $114,152 of retroactive premium reimbursement related to prior periods in 2005 and 2004.
 

The prescription and patient month data has been presented to provide additional data about operations. A prescription typically represents a 30-day supply of medication for an individual patient. “Patient months” represents a count of the number of months during a period that a patient received at least one prescription. If an individual patient received multiple medications during each month of a three month period, a count of three would be included in patient months irrespective of the number of medications filled in each month.
 
NET SALES
 
Net sales for the three months ended September 30, 2006 increased to $58,349,080 from $33,926,592 for the three months ended September 30, 2005, an increase of 72.0%. The increase in net sales for the three months ended September 30, 2006 as compared to the same period in 2005 is primarily attributable to the Company’s acquisitions. During the three months ended September 30, 2006, we owned PMW, Priority, Maiman, H&H and Whittier for three months. We owned St. Jude for one and one half months. Increases in net sales for the three months ended September 30, 2006 were partially offset by the implementation of MMA, which resulted in lower reimbursement rates for our dual eligible patients.
 
Net sales for the three months ended September 30, 2006 includes $70,613 of premium reimbursement recorded for prior periods in 2006 & 2005. Net sales for the three months ended September 30, 2005 includes $797,505 of premium reimbursement recorded for prior periods in 2005 and 2004.
 
GROSS PROFIT
 
Gross profit was $8,377,696 and $5,817,857 for the three months ended September 30, 2006 and 2005, respectively, and represents 14.4% and 17.1% of net sales, respectively. Excluding the $70,613 related to the retroactive premium reimbursement (in net sales) from prior periods, the adjusted gross margin for the nine months ended September 30, 2006 would have been 14.3%. Similarly, the adjusted gross margin for the period ended September 30, 2005 is 15.2% (excluding the $797,505 related to the retroactive premium reimbursement from prior periods). Our adjusted gross margin for the three months ended September 30, 2006 decreased 0.9% as compared with the gross margin for the three months ended September 30, 2005 primarily due to lower reimbursement on patients that moved from state Medicaid programs to Medicare Part D and the increased focus on lower margin HIV business as the higher margin NAHH business becomes a smaller portion of the overall business.
 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
Selling, general and administrative expenses were $7,085,838 and $5,160,666 for the three months ended September 30, 2006 and 2005, respectively, and represented 12.1% and 15.2% of net sales, respectively. The increase in selling, general and administrative expenses of $1,925,172 for the three months ended September 30, 2006 as compared to the same period in 2005 was primarily due to the acquisitions of PMW, Priority, Maiman, H&H, Whittier and St. Jude. These acquisitions represented approximately $1.9 million of the increase. In addition to the increases in expenses related to the acquisitions, the following increases were associated with our historical businesses:
 
Components of Selling, General and Administrative Expense
  
Change ($) 
Non-Cash Stock Compensation Expense
  
129,934
 
Included in selling, general & administrative expenses for the three month period ended September 30, 2006 was $100,000 of legal expenses relating to the informal SEC inquiry regarding the restatement of financial statements for three and six month periods ended June 30, 2005 and the three and nine month periods ended September 30, 2005. The financial statements were restated to correct the omission of a non-cash interest expense relating to warrants to purchase 100,000 shares of our common stock that were issued to John Pappajohn, one of our outside directors, in April 2005 in connection with the extension of a guarantee on our West Bank credit facility, and warrants to purchase 40,000 shares of our common stock that were issued to Crestview Capital Master, LLC in May 2005 in connection with the issuance of subordinated notes. The total non-cash interest expense for both issuances of warrants was approximately $966,000.
 
Included in selling, general & administrative expenses for the three month period ended September 30, 2006 was $265,448 of bad debt expense compared to $30,000 for the same period in 2005. This expense was recorded to provide for uncollectible receivables primarily relating to NAHH receivables that we do not expect to collect.

 
OPERATING INCOME
 
Operating income was $1,291,858 and $657,191 for the three months ended September 30, 2006 and 2005, respectively and represents 2.2% and 1.9% of net sales, respectively. The increase in operating income is attributable to an increase in gross profit of $2,559,839 and a decrease in selling, general and administrative expenses as a percent of net sales of 3.1%.
 
OTHER INCOME (EXPENSE)
 
Interest income was $168,560 and $259,154 for the three months ended September 30, 2006 and 2005, respectively. The decrease in interest income is attributable to our increased use of cash to finance acquisitions during 2006 rather than investing those cash amounts. Interest income is due primarily to our investment in short-term securities and other investment of cash.
 
PROVISION FOR TAXES
 
We recorded a provision for taxes in the amount of $445,419 for the three months ended September 30, 2006. The provision relates primarily to state income tax and federal alternative minimum tax that would have been payable before income tax deductions relating to stock based compensation which created a taxable loss and deferred taxes which related to tax-deductible goodwill. The benefit of the stock based compensation deduction was credited to additional paid in capital as the grant of these options was originally booked through additional paid in capital. We did not record any provision for income taxes for the three months ended September 30, 2005.
 
NET INCOME (LOSS)
 
For the three months ended September 30, 2006, we recorded net income of $1,014,999 as compared to a net income of $908,990 for the comparable period in the prior year. The increase in net income is primarily attributable to revenue growth, gross profit, and a decrease in operating expenses as a percentage of net sales.
 
LIQUIDITY AND CAPITAL RESOURCES
 
As of September 30, 2006, we had approximately $23,227,888 in cash and short term investments.
 
On June 22, 2005, we completed an IPO of our common stock. We sold 4,000,000 shares of our common stock at a price of $13.00 per share, less underwriting discounts and commissions of $0.91 per share. In addition, we granted the underwriters an option, exercisable until July 21, 2005, to purchase up to an additional 600,000 shares at the IPO price to cover over-allotments. On July 8, 2005, the over-allotment option was exercised at $13.00 per share, less underwriting discounts and commissions of $0.91 per share. We received proceeds net of underwriters’ discounts and commissions of $48.4 million from the IPO and $7.3 million from the exercise of the over-allotment option, less expenses incurred of $2.1 million. We used a portion of the IPO proceeds to repay approximately $12 million of our debt on June 27, 2005.
 
On January 25, 2006, we completed the sale of 5,101,922 common shares in a secondary offering at the price of $12.83 per share, less an underwriting discount, for total net proceeds of $61,857,488. There were 2,465,468 shares sold by us (including 665,468 shares through the over-allotment exercised by the underwriters after the offering) and 2,636,454 shares sold by certain selling stockholders. We received total proceeds, net of expenses of $28,852,195 from the sale of our shares and did not receive any proceeds from the sale of shares by the selling stockholders. In addition, for the period ended September 30, 2006, we received gross proceeds of $2,150,395 from exercise of options, $1,777,413 of which was from the exercise price of options and warrants to purchase 574,000 shares of our common stock that were sold as part of the secondary offering.
 
Since the completion of the initial and secondary public offerings, until September 30, 2006, we have completed six specialty pharmacy acquisitions, which have used approximately $54.1 million of our IPO and secondary offering proceeds.
 
Accounts receivable increased $5.1 million in the nine months ended September 30, 2006 from December 31, 2005. This increase is primarily due to revenue growth in the business, both from historical operations and from acquisitions. Revenue growth from the acquisitions of Priority, Maiman, H&H, Whittier and St. Jude resulted in $6.0 million of the increase in outstanding receivables during the period.

 
On April 21, 2006, we allowed our credit facility agreement with GE HFS Holdings, Inc. f/k/a Heller Healthcare Finance (‘GE”) to expire; however, we are continuing to accrue for the management fee to maintain the credit line open.  The GE credit facility provided the ability for us to borrow up to a maximum of $6,000,000, based on our accounts receivable.
 
Operating Requirements
 
Our primary liquidity need is cash to purchase the medications that we require to fill prescriptions. Our largest vendor, AmerisourceBergen, requires payment within 31 days of delivery of the medications to us. We are reimbursed by third-party payors, on average, within 30 days after a prescription is filled and a claim is submitted in the appropriate format.
 
Our operations provided $4,053,424 of cash over the nine month period ended September 30, 2006, while our operations used $1,037,570 of cash during the same period in 2005. The change was primarily a result of an increase in net income to $2,809,778 for the nine months ended September 30, 2006 from a loss of $1,423,442 for the same period in 2005.
 
We have a five-year purchase agreement with AmerisourceBergen which we entered into in September 2003, which requires certain minimum purchases. It provides payment terms up to 31 days. If we do not meet the aggregate minimum purchase commitment of $400,000,000 under our agreement with AmerisourceBergen by the end of the five-year term, we may be charged 0.2% of the un-purchased volume commitment. We have purchased approximately $262,969,544 under this agreement and we believe we will be able to meet our minimum purchase obligations under this agreement. Pursuant to the terms of this agreement, AmerisourceBergen has a subordinated security interest in all of our assets.
 
Long-Term Requirements
 
We expect that the cost of additional acquisitions will be our primary long-term funding requirement. In addition, as our business grows, we anticipate that we will need to invest in additional capital equipment, such as the machines we use to create the MOMSPak for dispensing medication to our patients. We also may be required to expand our existing facilities or to invest in modifications or improvements to new or additional facilities. If our business operates at a loss in the future, we will also need funding for such losses.
 
As the result of our initial and secondary public offerings, we believe that our cash balances are sufficient to provide us with the capital required to fund our working capital needs and operating expense requirements for at least the next 12 months. Although, we currently believe that we have sufficient capital resources to meet our anticipated working capital and capital expenditure requirements beyond the next twelve months, unanticipated events and opportunities may make it necessary for us to return to the public markets or establish new credit facilities or raise capital in private transactions in order to meet our capital requirements.
 
CONTRACTUAL OBLIGATIONS
 
At September 30, 2006, our contractual cash obligations and commitments over the next five years were as follows:
 
 
  
Payments due by Period 
  
 
  
Total 
  
Less than
1 year 
  
1-3 years 
  
4-5 years 
  
More than
5 years 
  
Long-Term Debt Obligation (1)
  
$
695,642
  
$
695,642
  
$
—
 
$
—
 
$
—
 
Capital Lease Obligations (1)
    
112,602
    
54,369
    
58,233
    
—
   
—
 
Operating Leases
    
1,766,937
    
632,017
    
890,385
    
244,535
    
—
 
Purchase Commitments (2)
    
137,030,456
    
42,530,456
    
94,500,000
    
—
   
—
 
Total
  
$
139,605,637
  
$
43,912,484
  
$
95,448,618
  
$
244,535
  
$
—
 
(1)
Interest payments on these amounts will be approximately $31,247 over the next three years.
 
(2)
If we fail to satisfy the minimum purchase obligation under our purchase agreement with AmerisourceBergen, we would be required to pay an amount equal to 0.2% of the un-purchased commitments at the end of the five-year term of the contract.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
We do not have any off-balance sheet arrangements.


Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Interest Rate Sensitivity. We have limited exposure to financial market risks, including changes in interest rates. At September 30, 2006, we had cash and cash equivalents of approximately $17.5 million and short-term investments of approximately $5.7 million. Cash and cash equivalents consisted of demand deposits, money market accounts, and government obligations. Short term investments consist of auction rate securities with maturities of one year or less. These investments are classified as available for sale and are considered short term, because we expect to sell them within 12 months. These investments are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates continue to rise, the value of short-term investments would decrease. We may sell these investments prior to maturity, and therefore, we may not realize the full value of these investments. We currently hold no derivative instruments and do not earn foreign-source income. We expect to invest only in short-term, investment grade, interest-bearing instruments and thus do not expect future interest rate risk to be significant. The interest rates on outstanding notes payable are not subject to change with changes in market interest rates. We have not hedged against our interest rate risk exposure for our cash, investments or the notes payable. As a result, our interest income will increase from increasing interest rates and our interest income will decrease from declining rates.
 
Item 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
As previously disclosed in our annual report for the period ended December 31, 2005, we identified a material weakness relating to the valuation of warrants that were issued in the period ended June 30, 2005. As a result, we subsequently restated our second and third quarter 2005 financial statements as set forth in amendments to our quarterly reports for those periods on Form 10-Q/A. We have worked with our independent auditor and external SOX 404 consultant to review valuation techniques for options and warrants. As a result, we instituted checklists and processes during the first quarter of 2006 that we believe will strengthen our ability to identify and value option and warrant grants. As a result of the restatement, we have adjusted our valuation models and techniques and will continue to use these techniques for future option or warrant grants. There were no warrants issued in the three months ended September 30, 2006. In June 2006, the Board of Directors approved a comprehensive option grant to substantially all of our employees issuing a total of 455,000 options that vest annually in equal installments over a period of five years. As part of this grant, we tested the procedures, systems and checklists implemented to rectify the material weakness found in the second quarter of 2005 around the valuation of options and warrants and determined that these controls as they relate to the valuation of options were effective as of June 30, 2006. No options were granted in the three months ended September 30, 2006.
 
During the quarter ended September 30, 2006, management identified a software error in the computer system used by Whittier prior to September 2006, which led to an overstatement in the count of unique patients served. As a result, the number of patients served in the quarter ended June 30, 2006 and number of patient months for the same period were overstated in our Form 10-Q for the second quarter of 2006. Therefore, we have provided updated numbers in this report based on an analysis of the system and prescription data. However, this error in the former computer system at Whittier did not affect the financial reporting aspects of the system or our previously reported financial results for the quarter ended June 30, 2006. In September 2006, we moved Whittier to the operating system used by the rest of the company.
 
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2006.
 
Changes in Internal Control over Financial Reporting
We implemented the Great Plains accounting system as of January 1, 2006. Existing internal controls have been reevaluated in the context of this implementation and have been updated accordingly. There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.


ALLION HEALTHCARE, INC. AND SUBSIDIARIES
PART II OTHER INFORMATION
 
Item 1.
LEGAL PROCEEDINGS
 
On March 9, 2006, we alerted the staff of the SEC’s Division of Enforcement to the issuance of our press release of that date announcing our intent to restate our financial statements for the periods ended June 30, 2005 and September 30, 2005. On March 13, 2006, we received a letter from the Division of Enforcement notifying us that the Division of Enforcement had commenced an informal inquiry and requested that we voluntarily produce certain documents and information. In that letter, the SEC also stated that the informal inquiry should not be construed as an indication that any violations of law have occurred. We are cooperating fully with the Division of Enforcement’s inquiry.
 
Oris Medical Systems Inc. v. Allion Healthcare, Inc., et al., Superior Court of California, San Diego County, Action No. GIC 870818.  Oris Medical Systems ("OMS") filed a complaint against Allion Healthcare, Inc. ("Allion"), Oris Health, Inc.("Oris Health") and Mom's Pharmacy, Inc. ("Mom's") on August 14, 2006, purporting to allege claims for breach of contract, breach of the implied covenant of good faith and fair dealing, specific performance, accounting, fraud, negligent misrepresentation, rescission, conversion and declaratory relief, allegedly arising out of a May 19, 2005 asset purchase agreement between Oris Health and Mom's on the one hand, and OMS on the other hand. Allion, Oris Health, and Mom's will vigorously defend against the claims and we are considering any appropriate cross-claims against OMS, its majority shareholder Pat Iantorno, and/or any other appropriate third parties. 
 
In addition to the matters noted above, we are involved from time to time in legal actions arising in the ordinary course of our business. Other than as set forth above, we currently have no pending or threatened litigation that we believe will result in an outcome that would materially affect our business. Nevertheless, there can be no assurance that future litigation to which we become a party will not have a material adverse effect on our business.
 
Item 1A.
RISK FACTORS
 
Information regarding risk factors appears in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements,” in Part I - Item 2 of this Form 10-Q and in Part I - Item 1A of our Annual Report on Form 10-K/A for the year ended December 31, 2005. The following information sets forth material changes from the risk factors previously disclosed in our Annual Report on Form 10-K/A.
 
We have decided to restate our financial statements for certain periods to record a fair value adjustment for warrants that were reclassified from a liability to equity and cannot predict the consequences the restatement will have on our financial results in the future.
 
During the third quarter of 2006, we received a comment letter from the Staff of the SEC’s Division of Corporation Finance relating to a routine review of our Form 10-K/A for the fiscal year ended December 31, 2005 and Form 10-Q for the quarter ended March 31, 2006. In the course of reviewing the Staff’s comments, we reviewed the accounting treatment for certain warrants considered derivatives under Emerging Issue Task Force No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” Specifically, in February 2005, we issued warrants for 351,438 shares of common stock in connection with our acquisition of Specialty Pharmacies, Inc., half of which were redeemed as required under the terms of the warrants upon our IPO in June 2005 and the other half of which became non-redeemable as a result of our IPO. As a result of this review, on November 6, 2006, our board of directors, after discussion with management and our independent registered public accounting firm, BDO Seidman LLP, concluded that we should restate our financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month period ended September 30, 2005 and the fiscal year ended December 31, 2005 to include a non-cash charge of approximately $1.5 million to other expense, and that the financial statements for such periods should no longer be relied upon. In addition, the recognition of this charge will cause a reclassification in subsequent periods within stockholders’ equity between additional paid in capital and the accumulated deficit.
 
Although we appropriately classified these warrants as liabilities when issued as required by EITF 00-19, the warrants that became non-redeemable as a result of the IPO became reclassified as equity at that time and should have been revalued at fair value prior to that reclassification with any increase in value charged to other income (expense). This restatement is a non-cash expense for the periods indicated and a one-time charge that does not affect our operating income.
 
The financial statements included in our Form 10-Q for the quarter ended September 30, 2006 reflect the restated financial statements for the nine months ended September 30, 2005. We are currently in the process of preparing amended periodic reports as soon as possible to include the restated financial statements for the other affected periods; however, we could experience delays in filing the amended periodic reports. The filing of our amended periodic reports to reflect the restatement may not resolve the SEC’s comments, and it is possible that in the future we may be required to further restate our financial statements. Any such restatements could be costly and time consuming, and they could have a material adverse effect on our previously reported results of operations and financial condition. Considerable legal and accounting expenses related to this matter have already been incurred to date and significant expenditures may continue to be incurred in the future. The above and similar matters could divert management’s attention from other business concerns and may have a material adverse impact on our business.
27
 
We have an open comment letter from the Staff of the SEC’s Division of Corporation Finance as well as an unrelated, ongoing informal inquiry by the SEC’s Enforcement Division, and depending on the length, scope and results of the comment letter process and/or informal inquiry, our business, financial condition and results of operations could experience a material adverse impact.
 
We currently have outstanding comments from the Staff at the SEC’s Division of Corporation Finance in connection with the Staff’s routine review of our Form 10-K/A for the 2005 fiscal year and Form 10-Q for the quarter ended March 31, 2006. We have undertaken the restatement of our financial statements for the three-month and six-month periods ended June 30, 2005, the nine-month perioed ended September 30, 2005 and fiscal year ended December 31, 2005 in response to certain of the Staff’s comments, and we are working to resolve the remaining comments with the Staff as soon as possible. However, notwithstanding the restatement and our additional responses, the SEC may have further comments on our restated financial statements or otherwise, and the SEC may raise new issues. In addition, we may be required to adjust and further modify our restated financial results for the periods in question. Such adjustments and modifications, if any, may have a material adverse effect on the financial results set forth in those reports. In addition, we have provided certain information to the SEC’s Enforcement Division in connection with its informal inquiry; however, we are unable to predict whether they will issue additional requests for information or whether the inquiry will result in any adverse action. If we are ultimately required to pay significant amounts and/or take significant corrective actions, our costs could significantly increase and our results of operations and financial condition could be materially adversely affected. In addition, the potential risks associated with the informal inquiry could negatively impact the perception of our company by investors and others, which could adversely affect the price of our securities, our access to capital markets and/or our borrowing costs.
 
Furthermore, we are likely to continue incurring significant expenses in connection with responding to the Staff’s outstanding comments as well as the SEC’s informal inquiry, and these increased expenses could negatively impact our financial results. Our senior management has devoted a significant amount of time and effort to responding to the comments and informal inquiry, as well as on the restatement of our financial statements. As a result, if our senior management is unable to devote sufficient time in the future toward managing our existing business operations and executing our growth strategy, we may not be able to remain competitive and our revenues and gross profit may decline.

Changes in average wholesale price (AWP) or other industry pricing benchmarks could adversely affect the reimbursement we receive for drugs we dispense and as a result, negatively impact our financial condition and results of operations.
 
Government payors, including the AIDS Drug Assistance Program, Medicaid and Medicare Part D programs, which account for most of our net sales, pay us directly or indirectly for the medications we provide at average wholesale price, or AWP, or at a percentage of AWP. Private payors with whom we may contract also reimburse us for medications at AWP or at a percentage of AWP.   Federal and state government attention has focused on the validity of using AWP as the basis for Medicaid and Medicare Part D payments for HIV/AIDS medications, and most state Medicaid programs now pay substantially less than AWP for the prescription drugs we dispense.
 
Drug pricing and the validity of AWP continues to be a focus of litigation and governmental investigations.  The case of New England Carpenters Health Benefits Fund, et al. v. First DataBank, et al., Civil Action No. 1:05-CV-11148-PBS (D. Mass.), is a civil class action brought against the most widely used reporter and publisher of AWP, First DataBank, or FDB.  As part of a recently announced proposed settlement in the case, FDB has agreed to reduce the reported AWP of over 8,000 specific pharmaceutical products by four percent.  At this time, the final resolution of the case is still unknown, and any settlement terms must be approved and ordered by the court.  We cannot predict the outcome of this case or, if the settlement is approved, the precise timing of any of the proposed AWP reductions. If approved, the proposed settlement is likely to reduce the price paid to us for medications we dispense, and this would have a material adverse effect on our results of operations.
 
The proposed settlement in this case may also result in the elimination of AWP as a pricing benchmark altogether, and our reimbursement from government and private payors may be based on less favorable pricing benchmarks in the future, which would have a negative impact on our net sales.
 
Whatever the outcome of the FDB case, we believe that government and private payors will continue to evaluate pricing benchmarks other than AWP as the basis for prescription drug reimbursements.  We are unable to evaluate the overall financial impact that the transition to an alternative benchmark may have on our company.
 
Due to these and other uncertainties, we can give no assurance that the short-term or long-term impact of changes to industry pricing benchmarks will not have a material adverse effect on our financial condition and result of operations in future periods.


Our revenues could be adversely affected if our patients who are “dual-eligible” under the Medicare Modernization Act cease to use our services or if prescription drug plans, or PDPs, reduce reimbursement rates.
 
Beginning January 1, 2006, under Part D of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or the MMA, we began being reimbursed by PDPs, and not Medicaid, for the prescription drugs we provide to our dual eligible patients. Reimbursement rates for these patients are less favorable than the rates we received from Medicaid and result in lower gross margins for our dual eligible patients. In September 2006, we serviced 3,046 patients under Medicare Part D or approximately 20.2% of our patients. Our earnings have been negatively impacted from the movement of patients from Medicaid to a Medicare Part D plan. If a higher number of our patients become eligible under MMA, there is a risk that our gross margins will decline further and negatively impact earnings. Additional risks that could affect financial performance include:
 
 
•
The possibility that the reimbursement rates we currently receive from the PDPs for our services could be reduced;
 
 
•
Regulations that strictly limit our ability to market to our current and new patients, which may limit our ability to maintain and grow our current patient base;
 
 
•
The possibility that Part D may not continue to cover all the medications needed for persons with HIV/AIDS, including our patients;
 
 
•
The possibility that our contracts with PDPs could be terminated if we fail to comply with the terms and conditions of such contracts.
 
If we do not continue to qualify for preferred reimbursement programs in California and New York, our net sales could decline.
 
We have qualified for additional reimbursement rates under a California pilot program for HIV/AIDS pharmacies that is effective until January 1, 2008 and have qualified as a specialty HIV pharmacy in New York and are eligible to receive preferred reimbursement rates for HIV/AIDS medications for the time being.
 
As of September 1, 2004, reimbursement rates for pharmacy services provided under Medi-Cal, the Medicaid reimbursement program administered in California, were reduced as part of the passage of the State of California budget. On September 28, 2004, California approved an HIV/AIDS Pharmacy Pilot Program bill that funds an additional $9.50 fee per prescription for qualified and participating HIV pharmacies through January 1, 2008, unless extended.
 
In New York, reimbursement rates for pharmacy services provided under Medicaid were reduced in September 2004. Reimbursement rates for pharmacy services provided under Medicaid were reduced further effective July 2006. Approved specialized HIV pharmacies will continue to be reimbursed at the higher reimbursement rate that was in place before the 2004 reimbursement reduction. The legislation authorizing the more favorable reimbursement rate is effective until further legislation changes it.  We have been notified by the Department of Health in New York that we qualify for the specialized HIV pharmacy reimbursement; however, our continuing qualification for specialized HIV pharmacy reimbursement is dependent upon our recertification by the Department of Health in New York as an approved specialized HIV pharmacy. We have submitted all required paperwork to the state for recertification and are awaiting notification that we continue to qualify as a specialized HIV pharmacy. We were previously certified through September 2006. There can be no assurance that we will obtain our recertification in New York.
 
There can be no assurance that the California or New York legislatures will not change these programs in a manner adverse to us or will not terminate early or elect not to renew these programs. If either of these programs are not renewed or are terminated early, our net sales and profit could be adversely affected. Additionally, if either California or New York permits additional companies to take advantage of these additional reimbursement programs, our competitive advantage in these states could be adversely impacted.
 
Our revenues could be adversely affected if new HIV/AIDS drugs or combination therapies are developed and prescribed to our patients if the reimbursement rate is less than the pricing received for the current drug therapy our patients receive.
 
On July 12, 2006, Bristol-Myers Squibb Company and Gilead Sciences, Inc. announced the U.S. Food and Drug Administration (FDA) granted approval of ATRIPLA™ for the treatment of HIV-1 infection in adults. ATRIPLA is the first-ever once-daily single tablet regimen (STR) for HIV intended as a stand-alone therapy or in combination with other antiretrovirals. The product combines SUSTIVA® manufactured by Bristol-Myers Squibb, and Truvada® manufactured by Gilead Sciences. There is a risk that the reimbursement rate for ATRIPLA™ may be less than reimbursement rate for the combination of the component drugs. The number of total prescriptions received by our patients who use ATRIPLA™ may decline resulting in reduced average revenues and a decrease in dispensing fees per patient.

 
If we fail to manage our growth or implement changes to our reporting systems effectively, our business could be harmed.
 
If we are unable to manage our growth effectively, we could incur losses. How we manage our growth will depend, among other things, on our ability to adapt our operational, financial and management controls, reporting systems and procedures to the demands of a larger business, including the demands of integrating our acquisitions. To manage the growth and increasing complexity of our business, we may make modifications to or replace computer and other reporting systems, including those that report on our financial results and on which we are substantially dependent. We may incur significant financial and resource costs as a result of any such modifications or replacements, and our business may be subject to transitional difficulties. The difficulties associated with any such implementation, and any failure or delay in the system implementation, could negatively affect our internal control over financial reporting and harm our business and results of operations. In addition, we may not be able to successfully hire, train and manage additional sales, marketing, customer support and pharmacists quickly enough to support our growth. To provide this support, we may need to open additional offices, which will result in additional burdens on our systems and resources and require additional capital expenditures.
 
Item 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.
 
Item 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
 
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.
 
Item 5.
OTHER INFORMATION
 
None.
 
Item 6.
EXHIBITS
 
(a)

Exhibit No.
 
Exhibit Description.
   
10.1
Asset Purchase Agreement, dated as of July 14, 2006, by and among MOMS of Brooklyn, Inc., St. Jude Pharmacy & Surgical Supply Corp., Millie Chervin and Mitchell Chervin (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated and filed on July 14, 2006).
   
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
   
31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
   
32.1
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. §1350.


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.
 
Date: November 9, 2006
 

 
ALLION HEALTHCARE, INC.
     
 
By:
/S/ JAMES G. SPENCER
   
James G. Spencer
   
Secretary, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)



EXHIBIT INDEX

Exhibit No.
Exhibit Description.
   
10.1
Asset Purchase Agreement, dated as of July 14, 2006, by and among MOMS of Brooklyn, Inc., St. Jude Pharmacy & Surgical Supply Corp., Millie Chervin and Mitchell Chervin (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated and filed on July 14, 2006).
   
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
   
31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
   
32.1
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. §1350.
EX-31.1 2 dex31-1.htm CERTIFICATION OF CEO CERTIFICATION OF CEO
Exhibit 31.1
 
CERTIFICATION
 
I, Michael P. Moran, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Allion Healthcare, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
   
Date: November 9, 2006
/s/ Michael Moran
 
Michael P. Moran
 
Chief Executive Officer and President
EX-31.2 3 dex31-2.htm CERTIFICATION OF CFO CERTIFICATION OF CFO
Exhibit 31.2
 
CERTIFICATION
 
I, James G. Spencer, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Allion Healthcare, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
   
Date: November 9, 2006
/s/ James G. Spencer
 
James G. Spencer
 
Chief Financial Officer, Treasurer and Secretary
EX-32.1 4 dex32-1.htm CERTIFICATION OF CEO AND CFO CERTIFICATION OF CEO AND CFO
Exhibit 32.1
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the quarterly report of Allion Healthcare, Inc. on Form 10-Q for the period ended September 30, 2006 as filed with the Securities and Exchange Commission on November 9, 2006, each of the undersigned, in the capacities and on the dates indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:
 
(i) The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(ii) The information contained in the report fairly presents, in all material respects, the financial condition and results of operations of Allion Healthcare, Inc.
 
Dated: November 9, 2006

 
/s/ Michael P. Moran
 
Michael P. Moran
 
Chief Executive Officer
 
 
/s/ James G. Spencer
 
James G. Spencer
 
Chief Financial Officer
-----END PRIVACY-ENHANCED MESSAGE-----