Item 1. Business.
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. As of December 31, 2007, we owned and operated 11 specialty pharmacies in four states, and in December 2007 we serviced 15,610 patients. We work closely with physicians, nurses, clinics, AIDS Services Organizations, or ASOs, and 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. Billing requirements for these programs are complex. We are one of a limited number of providers that has qualified for certain HIV/AIDS premium reimbursement programs under legislation enacted in California and New York.
We operate our business as a single segment configured to serve key geographic areas most efficiently. All of our revenues are attributed to sales of our products in the United States. Our revenues were $246.7 million, $209.5 million, and $123.1 million for the fiscal years ended December 31, 2007, 2006 and 2005, respectively. Our net income was $3.3 million and $3.2 million for the years ended December 31, 2007 and 2006, respectively, and we recorded a net loss of $1.0 million for the fiscal year ended December 31, 2005. Our total assets were $126.6 million, $121.6 million and $86.3 million at December 31, 2007, 2006 and 2005, respectively. We believe that the combination of services we offer to patients, healthcare providers and payors makes us an attractive source of specialty pharmacy and disease management services, contributes to better clinical outcomes and reduces overall healthcare costs. Our services include the following:
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Specialized MOMSPak prescription packaging that helps reduce patient error associated with complex multi-drug regimens, which require multiple drugs to be taken at varying doses and schedules;
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Reimbursement experience which assists patients and healthcare providers with complex reimbursement processes and optimizes collection of payment;
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Arrangement for the timely delivery of medications in a discreet and convenient manner as directed by our patients or their physicians;
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Specialized pharmacists who consult with patients, physicians, nurses and ASOs to provide education, counseling, treatment coordination, clinical information and compliance monitoring; and
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Information systems and prescription automation solutions that make the provision of clinical data and the transmission of prescriptions more efficient and accurate.
According to the World Health Organization, or the WHO, and the Joint United Nations Programme on HIV/AIDS, or UNAIDS, as many as two million individuals living in the United States as of the end of 2005 were infected with HIV/AIDS. Of this number, between 400,000 and 500,000 were receiving HIV/AIDS medications, according to the Cleveland Journal of Medicine. Our distribution centers are located in or near metropolitan areas in those states - New York, California, Florida, New Jersey and Washington - where a majority of HIV/AIDS patients live in the United States, according to the Centers for Disease Control and Prevention, or the CDC.
We have grown our business primarily by acquiring other specialty pharmacies and expanding our existing business. We have generated our internal growth primarily by increasing the number of patients we serve and filling more prescriptions per patient. In addition, our business has grown as the price of HIV/AIDS medications has increased. Since 2003, we have acquired seven specialty pharmacies in California and two specialty pharmacies in New York. We will continue to evaluate acquisition opportunities as they arise, especially other specialty pharmacies that have established relationships with HIV/AIDS patients, clinics and hospitals. On December 10, 2007, we opened a satellite pharmacy in Oakland, California. We will continue to consider acquisitions and satellite locations in both our existing markets and in markets where we do not currently have operations.
Recent Events
On March 13, 2008, we signed a definitive merger agreement to acquire 100% of the stock of Biomed America, Inc., or Biomed, for aggregate consideration of approximately $117.8 million. Biomed is a leading provider of specialized biopharmaceutical medications and services to chronically ill patients. Under the definitive merger agreement, we will pay Biomed stockholders an aggregate of $48.0 million in cash and issue a total of 9.35 million shares of common and preferred stock valued at approximately $51.4 million. We will also assume up to $18.4 million of Biomed’s debt. In addition, we
may make an earn-out payment in 2009 if Biomed achieves certain financial performance benchmarks during the first 12 months after closing. We expect to pay the purchase price with funds from a new senior credit facility, available cash and newly issued common stock and preferred stock. The closing will be subject to government approval and is expected to close within 60 days.
HIV/AIDS
Human Immunodeficiency Virus, commonly known as HIV, is the virus that causes Acquired Immune Deficiency Syndrome, commonly known as AIDS. The demographic profile of HIV/AIDS patients has shifted since the disease was first diagnosed in 1981. Most HIV/AIDS patients now live in the inner-city of major metropolitan areas and are dependent on government programs to pay for the medications used to treat HIV/AIDS. From 1981 to 2005, approximately 40,000 people per year were diagnosed with AIDS in the United States, according to the CDC. A UNAIDS/WHO report estimates that 46,000 additional people became infected with HIV in North America in 2007.
The current standard of care for the treatment of HIV/AIDS involves complex treatment regimens of multiple drugs, or multi-drug regimens, that consist of predominantly oral medications taken by a patient multiple times a day, typically outside a clinical setting. Anti-retroviral drugs are medications for the treatment of infection by retroviruses, primarily HIV. Different classes of anti-retroviral drugs act at different stages of the HIV life cycle. Combinations of several (typically three or four) anti-retroviral drugs are known as Highly Active Anti-Retroviral Therapy. The number of medications and varying dosages and schedules often confuse and overwhelm patients. As a result, many patients lose confidence in their ability to adhere to their drug regimens and simply stop taking their HIV/AIDS medications, while others lose track of which doses they have taken or inadvertently miss a dose. Alcohol and illicit drug use are also factors causing non-compliance. Poor adherence or even slight or occasional deviations from a prescribed regimen can reduce the potency of therapy and lead to viral resistance. Once resistance has developed in a patient, success rates of other HIV medications are often limited, particularly if the patient’s adherence issues are not resolved, and treatment options become greatly limited. Studies reported by the AIDS Research Institute on adherence within the HIV/AIDS population have shown that if a patient does not take at least 95% of his or her medication doses as prescribed, the medication may become ineffective or the patient may develop drug resistance to the medication. Given the ability of HIV to mutate rapidly in the absence of anti-retroviral medication, taking a multi-drug regimen exactly as prescribed, without missing or reducing doses, is critical to effective treatment.
In the United States, HIV/AIDS-associated morbidity and mortality rates have declined significantly due to combination therapies, which combine multiple HIV drugs into a single medication. Before combination therapies, 48% of adults infected with HIV that were diagnosed with AIDS within 10 years of infection died after 10 years of infection, according to the U.S. Department of Health and Human Services. After increasing every year between 1987 and 1994 at an average annual rate of 16%, AIDS mortality in the United States leveled off in 1995 and has since decreased, according to the CDC. In 1995, 19% of people living with AIDS in the United States died, as compared to 4% in 2005, according to the CDC. While HIV/AIDS remains life threatening, healthcare providers increasingly treat HIV/AIDS more as a long-term chronic disease.
We are one of only a few specialty pharmacy and disease management service companies that primarily serve HIV/AIDS patients. Despite the special needs of the HIV/AIDS infected population, few national and regional pharmacies have focused on this patient population. Most of the pharmacies serving this market are local or small regional providers located in a single urban market. These pharmacies often do not have the resources or sophistication to provide the specialty pharmacy and disease management services required by patients, healthcare providers and payors to maximize adherence to the treatment regimen. We also believe that neither retail pharmacies nor mail order pharmacies offer the range of specialty pharmacy and disease management services we provide.
Our Products and Services
We offer specialty pharmacy and disease management services to assist patients, healthcare providers and payors in managing HIV/AIDS. We sell HIV/AIDS medications, ancillary drugs and nutritional supplies. Patients or physicians generally initiate the prescription process by contacting us on our toll-free telephone number, through our facsimile number or through our electronic prescription writer. Some clinics have medication drop-off boxes in which physicians also may leave prescriptions for us to fill. Additionally, a patient may direct his or her physician to call, fax or electronically transmit a prescription to us. If requested by a patient, one of our pharmacists may contact the patient’s physician directly to obtain prescription information. Our pharmacists are required to validate and verify the completeness of each prescription, answer questions and, if appropriate, help coordinate support and training for patients. As soon as we receive a prescription, we also seek approval for reimbursement from the payor. Once the prescription is verified and we have received authorization from the patient’s insurance company or state insurance program, the order is filled, shipped and delivered. Patients also have the option to pick up their medications at our pharmacies.
We have designed our services to meet the following challenges that are of particular importance to HIV/AIDS patients, healthcare providers and payors:
Adherence
Packaging. We have designed our services to improve patient adherence to complex multi-drug regimens. We dispense prescribed medications in a customized dose-by-dose package called a MOMSPak. We also dispense these medications in pre-filled pillboxes at the patient’s request. Our customized packaging provides increased convenience to the patient and enhances patient adherence to complex multi-drug regimens.
Increased attention has recently been paid to Medicaid fraud and the resale of HIV/AIDS medications on the black market. According to POZ, a leading HIV publication, the resale of unopened HIV medications on the black market has become a problem in New York. Additionally, some small pharmacies are reportedly repurchasing the medications they distribute to Medicaid patients. We believe the current problem is attributable to the availability of unopened HIV/AIDS medications. Our automated prescription packaging system requires us to open the original bottles before separating the medications into a MOMSPak, thereby reducing the likelihood of after-market resale of HIV/AIDS medications. Doctors can continue to write HIV medication prescriptions with less fear of becoming complicit in Medicaid fraud if medication bottles are opened before distribution.
Delivery. We arrange for delivery of medications as directed by our patients or their physicians in a discreet, convenient and timely manner. We believe that this increases patient adherence, as it eliminates the need to pick up medications at a local pharmacy.
Reimbursement Management
We have experience with the complex reimbursement processes of Medicaid and ADAP, which optimizes collection of payment. As a result, we are able to manage efficiently the process of checking reimbursement eligibility, receiving authorization, adjudicating claims and confirming receipt of payment.
We work with government and private payors to obtain appropriate reimbursement. Our billing and reimbursement specialists typically secure pre-approval from a payor before any shipment of medications and also review such issues as pre-certification or other prior approval requirements, lifetime limits, pre-existing condition clauses and the availability of special state programs. Because the majority of our prescriptions are adjudicated through electronic submission, we are reasonably certain at the time we ship medications that we will receive payment from the payor.
Due to the high cost and extended duration of the treatment of HIV/AIDS, the availability of adequate health insurance is an on-going concern for our patients and their families. We work closely with physicians and our patients to monitor coverage reductions or termination dates. Because of our ability to facilitate reimbursement from government and private payors, in many cases, we provide prescription medications to patients at lower initial out-of-pocket costs than they might obtain from other sources.
The two largest HIV/AIDS markets in the United States - California and New York - have established specialized Medicaid reimbursement for HIV/AIDS medications. In 2004, California approved a three-year HIV/AIDS Pharmacy Pilot Program, which we refer to as the California Pilot Program, which provides additional reimbursement for HIV/AIDS medications for up to ten qualified pharmacies. We own two of the ten pharmacies that qualified for this program. The California Pilot Program was recently extended as part of California’s 2007 budget process and is currently set to expire on June 30, 2008. In New York, we qualify for a higher reimbursement rate under the revised reimbursement rates of the state-mandated Medicaid program. Our continuing qualification for the higher reimbursement rate is dependent on recertification every two years by the New York State Department of Health as an approved specialized HIV pharmacy. We are certified through September 2008. If the legislation in California is not renewed or we are not recertified in New York as an approved HIV specialized pharmacy in the future, our revenue would be reduced and our profits could suffer.
Disease Management
The medications we distribute to our patients require timely delivery, may require temperature-maintained distribution, and very often require dosage monitoring. Our employees have developed expertise in HIV/AIDS drug treatment that allows them to provide customized care to our patients. By focusing on the HIV/AIDS community, we have been able to design our services to help patients better understand and manage their medication needs and schedules.
Upon initiating service, we work closely with the patient and the patient’s physician and other healthcare providers to implement multi-drug regimens and manage the following services:
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Programs to monitor dosage compliance and outcomes;
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Clinical information and consultation regarding the patient’s illness, medications being used and treatment regimens;
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Educational information on the patient’s illness, including advancements in research, technology and combination therapies;
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Assistance in setting realistic expectations for a patient’s therapy, including challenges with adherence, and with anticipated outcomes and side effects;
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Systems for inventory management and record keeping; and
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Assistance in coordinating treatment outside of the home or hospital setting.
We believe that these disease management services benefit government and private payors by helping our patients avoid costly episodes that can result from non-adherence to a prescribed care regimen. Improved patient adherence avoids costs for the payor by reducing the incidence of physician intervention, hospitalization and emergency room visits. Our staff works closely with patient care coordinators to routinely monitor the patient’s care regimen.
We also assist patients by helping with the formation of patient support groups, advocating legislation to advance the interests of the HIV/AIDS community, and participating in national and regional advocacy groups.
Information Systems and Prescription Automation Solutions
We have licensed and developed information systems that enable patients and healthcare providers to more effectively manage and treat HIV/AIDS. We believe the transmission of electronic prescriptions reduces confusion and potential medication errors. Our electronic prescription transmittal software enables healthcare providers to view their patients’ prescription histories, request new prescriptions or renew prescriptions online, thereby saving physicians and their staff time. We have also developed an interface between our pharmacy information system and the MOMSPak automated packaging system that allows for the efficient processing of prescriptions.
In July 2005, we acquired substantially all of the assets of Oris Medical Systems, Inc., or OMS. As a result of this acquisition, we obtained OMS’ rights to the LabTracker-HIV ™ software system, which enables healthcare providers to record, track and analyze the outcomes of HIV/AIDS treatment. OMS’ rights included a license of LabTracker from Ground Zero Software, Inc., or Ground Zero, the right to license LabTracker to pharmacy providers and the right to develop a pharmacy interface with LabTracker’s existing system. On April 2, 2007, Ground Zero formally notified us of the termination of the OMS license to use the LabTracker software.
Relationships with Pharmaceutical Companies
We actively pursue marketing and other business relationships with pharmaceutical manufacturers. We look to work with manufacturers of the leading HIV/AIDS medications to enhance their awareness of our services and to increase our opportunities to benefit from their significant sales teams and marketing efforts. The HIV/AIDS sales teams at pharmaceutical companies regularly make sales calls on the leading prescribers of HIV/AIDS medications. If these sales teams are aware of our products and services, they will be in a position to inform the leading prescribers about the benefits we offer, which can increase our visibility in the market.
We have entered into a specialized services agreement with Roche Laboratories Inc., or Roche, to receive product pricing discounts, and we have agreed to provide Roche with blind patient data with respect to FUZEON, an HIV medication manufactured by Roche. We believe that Roche has entered into this type of agreement with only a limited number of pharmacies. See Item 1. Business - Privacy and Confidentiality; Electronic Transactions and Security in this Annual Report for a discussion of the regulations pertaining to the sharing of such patient data under the Health Insurance Portability and Accountability Act of 1996, or HIPAA. Standards are provided under HIPAA regulations for removing all individually identifiable health information in order to produce de-identified data that may be transferred without obtaining the patient’s authorization. Although we have implemented certain privacy protections for the sharing of this data under HIPAA privacy regulations, we cannot assure you that we have complied with all of the HIPAA privacy requirements. Any failure to comply could subject us to enforcement actions, including civil and criminal penalties.
On November 8, 2007, we signed an exclusive distribution agreement with Galea Life Sciences for Nutraplete, the first therapeutic dietary supplement designed specifically for people living with HIV/AIDS. We intend to distribute Nutraplete at each of our pharmacy locations.
Marketing
We intend to expand our business in the major metropolitan markets where the majority of HIV/AIDS patients live and where we operate by enhancing our existing relationships and creating new relationships with HIV/AIDS clinics, hospitals and prescribing physicians through direct sales, outreach programs and community-based education programs. Our sales team markets to the leading prescribers of HIV/AIDS medications, and we actively pursue relationships with the largest HIV/AIDS clinics, ASOs, and other groups focused on HIV/AIDS. We provide our services under the trade name of MOMS Pharmacy.
We believe MOMS Pharmacy is a recognized brand name within the HIV/AIDS community. We have a website at www.momspharmacy.com, which contains educational material and information of interest for the community, to directly market our products to the HIV/AIDS community and service organizations. We do not intend our Internet address to be an active link in this Annual Report on Form 10-K, and the contents of our website are not a part of this Annual Report on Form 10-K.
Suppliers
We purchase from wholesale distributors the approximately 1,000 branded and generic prescription medications that we use to fill prescriptions for patients. In 2003, we entered into a five-year prime vendor agreement with AmerisourceBergen to provide us with the HIV/AIDS medications we sell. Pursuant to this agreement, we are obligated to purchase at least 95% of the medications we sell from AmerisourceBergen. As part of this agreement, we receive improved payment terms relative to the terms we could get from other pharmaceutical distributors. In addition, we have agreed to purchase minimum dollar amounts of medications from AmerisourceBergen over the five-year term of the agreement, which expires in September 2008. If we fail to meet these minimum purchase amounts, we would be required to make an additional payment equal to 0.2% of the unpurchased amount. We believe we have met our minimum purchase obligations under this agreement. Pursuant to the terms of a security agreement entered into in connection with the prime vendor agreement, AmerisourceBergen holds a subordinated security interest in all of our assets.
In the past, we depended on existing credit terms from AmerisourceBergen to meet our working capital needs between the times we purchase medications from AmerisourceBergen and when we receive reimbursement or payment from third party payors. If our position changes and again we have to rely on credit to meet working capital needs, we may become limited in our ability to continue to increase the volume of medications we need to fill prescriptions if we are unable to maintain adequate credit terms from AmerisourceBergen or, alternatively, if we are unable to obtain sufficient financing from third-party lenders.
Competition
Our industry is highly competitive, fragmented and undergoing consolidation, with many public and private companies focusing on different products or diseases. Each of our competitors provides a different mix of products and services than we do. Some of our current and potential competitors include:
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Specialty pharmacy distributors such as Medco Health Solutions, Inc., BioScrip, Inc. and Express Scripts, Inc.;
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Pharmacy benefit management companies such as Medco Health Solutions, Inc., Express Scripts, Inc. and CVS/Caremark Rx, Inc.;
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Specialty pharmacy divisions of national wholesale drug distributors;
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Hospital-based pharmacies;
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Retail pharmacies;
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Manufacturers that sell their products both to distributors and directly to clinics and physician offices; and
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Hospital-based care centers and other alternate-site healthcare providers.
Many of our existing and potential competitors have substantially greater financial, technical, marketing and distribution resources than we do. Additionally, many of these companies have greater name recognition and more established relationships with HIV/AIDS patients. Furthermore, these competitors may be able to adopt more aggressive pricing policies and offer customers more attractive terms than we can.
Third Party Reimbursement, Cost Containment and Legislation
We generate the majority of our net sales from patients who rely on Medicaid and ADAP for reimbursement, both of which are highly regulated government programs and are subject to frequent changes and cost containment measures. Medicaid is a state program partially funded by the federal government. Payments to pharmacies for Medicaid-covered
outpatient prescription drugs are set by the states. Federal reimbursement to states for the federal share of those payments is subject to a ceiling called the federal upper limit, or FUL. In recent years, Medicaid and ADAP have reduced reimbursement to providers.
Historically, many government payors, including Medicaid and ADAP programs, paid us directly or indirectly for the medications we dispense at average wholesale price, or AWP, or a percentage of AWP. Private payors with whom we may contract also reimburse us for medications at AWP or a percentage of AWP. Federal and state governmental attention has recently focused on the validity of using AWP as the basis for Medicaid medication payments, including payments for HIV/AIDS medications, and most state Medicaid programs now pay substantially less than AWP for the prescription drugs we dispense.
In January of 2006, the federal government enacted the Deficit Reduction Act of 2005, or the Reduction Act, which established average manufacturer price, or AMP, as the benchmark for prescription drug reimbursement in the Medicaid program, eliminating the previously used AWP standard. The Reduction Act also made changes to the FUL for multiple source drugs, such as generics. Effective January 1, 2007, for multiple source drugs, the FUL became 250% of the AMP. On July 6, 2007, the Centers for Medicare and Medicaid Services, or CMS, issued final regulations that (1) defined what will be considered a multiple source drug, and (2) defined AMP by identifying the categories of drug sales that would be used to calculate AMP. The final regulations also mandated that CMS publish AMPs reported to it by manufacturers on CMS’ website. The final regulations became effective October 1, 2007.
The first publication of AMP data and the resulting FULs was scheduled to occur in December of 2007. However, on December 19, 2007, the National Association of Chain Drug Stores, or NACDS, and the National Community Pharmacists Association, or NCPA, sought and were granted a preliminary injunction in U.S. District Court that halted CMS’ implementation of its AMP regulations and the posting of any AMP data. In their complaint, the two pharmacy groups allege that the AMP regulations go beyond what Congress intended when it passed the Social Security Act. Specifically, the lawsuit alleges that (1) in defining AMP, CMS included categories of drug sales that exceeded the plain language of the Social Security Act and (2) CMS’ definition of multiple source drugs is impermissibly broad and, in some respects, contrary to the Social Security Act. On March 14, 2008, CMS issued an interim final rule revising its definition of multiple source drug to address an issue raised in the NACDS/NCPA lawsuit. The preliminary injunction is still in effect.
We cannot predict the outcome of the NACDS/NCPA case. If the preliminary injunction is lifted and CMS is allowed to implement the AMP regulations, it could adversely impact our revenues. While there is no requirement that states use AMP to set payment amounts, we believe that the adoption of AMP will result in lower Medicaid reimbursement rates for medications we dispense. We continue to review the potential impact that the Reduction Act and the AMP regulations may have on our business and are not yet in a position to fully assess their impact on our business or profitability. However, the use of AMP in the FUL may have the effect of reducing the reimbursement rates for certain medications that we currently dispense or may dispense in the future. Further, states may elect to base all Medicaid pharmacy reimbursement on AMP instead of AWP. If the individual states make this decision, it may have the effect of reducing the reimbursement rates for certain medications that we currently dispense or may dispense in the future.
In New York, reimbursement rates for pharmacy services provided under Medicaid were reduced in September 2004, in July 2006, and again in July 2007. Under the new reimbursement rate effective July 1, 2007, prescriptions are reimbursed at AWP less 14% plus a $3.50 dispensing fee for brand name drugs and AWP less 25% plus a $4.50 dispensing fee for generic drugs. However, 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 for approved pharmacies 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 every two years by the Department of Health in New York as an approved specialized HIV pharmacy. We are currently certified through September 2008. There can be no assurance that we will obtain our recertification in New York in the future.
As of September 1, 2004, as part of the passage of the California state budget, reimbursement rates for pharmacy services provided under Medi-Cal, the Medicaid reimbursement program administered in California, were reduced. Under the new reimbursement rate, prescriptions are reimbursed at AWP less 17% plus a $7.25 dispensing fee. The previous reimbursement rate was AWP less 10% with a $4.05 dispensing fee. On September 28, 2004, California approved the California Pilot Program, which provides additional reimbursement for HIV/AIDS medications for up to ten qualified pharmacies. We own two of the ten pharmacies that qualified for this program. The California Pilot Program was recently extended as part of California’s 2007 budget process and is currently set to expire on June 30, 2008.
Cost containment initiatives are a primary trend in the U.S. healthcare industry. The increasing prevalence of managed care, centralized purchasing decisions, consolidation among and integration of healthcare providers, and competition for patients has affected and continues to affect pricing, purchasing, and usage patterns in healthcare. Efforts by payors to eliminate, contain or reduce costs through coverage exclusions, lower reimbursement rates, greater claims scrutiny, closed provider panels, restrictions on required formularies, mandatory use of generics, limitations on payments in certain therapeutic drug categories, claim delays or denials and other similar measures could erode our profit margins or materially harm the results of our operations. We can offer no assurance that payments under governmental and private third-party payor programs will be timely or will remain at rates similar to present levels.
Government Regulation
Marketing, repackaging, dispensing, selling and purchasing drugs is highly regulated and regularly scrutinized by state and federal government agencies for compliance with laws and regulations governing:
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Inducements for patient referrals;
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Manufacturer-calculated and -reported AWP and ASP amounts;
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Joint ventures and management agreements;
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Referrals from physicians with whom we have a financial relationship;
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Professional licensure;
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Repackaging, storing, and distributing prescription pharmaceuticals;
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Incentives to patients; and
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Product discounts.
The laws and regulations governing these issues are very complex and generally broad in scope, often resulting in differing interpretations and inconsistent court decisions. Compliance with laws continues to be a significant operational requirement for us. We believe that we currently comply in all material respects, and intend to continue to comply, with all laws and regulations with respect to our operations and conduct of business. However, the application of complex standards to the operation of our business creates areas of uncertainty, and there can be no assurance that all of our business practices would be interpreted by the appropriate regulatory agency to be in compliance in all respects with the applicable requirements. Any failure or alleged failure to comply with applicable laws and regulations could have a material adverse effect on our business.
Moreover, regulation of the healthcare industry frequently changes. We are unable to predict or determine the future course of federal, state and local regulation, legislation or enforcement or what additional federal or state legislation or regulatory initiatives may be enacted in the future relating to our business or the healthcare industry in general, or what effect any such legislation or regulation might have on us. We cannot provide any assurance that federal or state governments will not impose additional restrictions or adopt interpretations of existing laws that could have a material adverse effect on our business or financial position. Consequently, any future change, interpretation, violation or alleged violation of law or regulations could have a material adverse effect on our business. The following areas of government regulation particularly apply to our business.
Medicare Legislation (Medicare Prescription Drug, Improvement and Modernization Act, or MMA). On December 8, 2003, the MMA was signed into law. This complex legislation made many significant structural changes to the federal Medicare program, including, most notably, the establishment of a new Medicare Part D outpatient prescription drug program. Effective January 1, 2006 under the MMA, Medicaid coverage of prescription drugs for Medicaid beneficiaries who were also eligible for Medicare transitioned to the Medicare program. These beneficiaries, generally referred to as “dual eligibles,” are now enrolled in the Medicare Prescription Drug Programs, or PDPs. We have agreements with most of these PDPs to provide prescription drugs to dual eligible beneficiaries that are our patients. Typically, the PDPs provide a lower reimbursement rate than the rates we received from the Medicaid programs. In December 2007, approximately 20.3% of our patients received coverage under a PDP.
Medicare Part D may not continue to cover all medications we dispense for persons with HIV/AIDS. State Medicaid programs may, at their discretion, provide coverage for medications not covered by Medicare Part D, but we have no assurance that they will do so.
ADAP provides payment for certain items and services not covered by Medicare Part D. ADAP can cover Medicare PDP premiums, deductibles, coinsurance and co-pays. We work with the various state ADAP and Medicaid programs to ensure coverage of our drugs, when possible.
There may also be other provisions of the MMA legislation or the implementing regulations that may impact our business by decreasing our net sales or increasing our operational expenses. The continued impact of the MMA depends upon a variety of factors, including the nature of the implementing regulations.
We can provide no assurance that the impact of any future healthcare legislation or regulation will not adversely affect our business or profitability. There can be no assurance that payments under governmental and private third-party payor programs will be timely or will remain at rates similar to present levels.
Reform. The U.S. healthcare industry continues to undergo significant change. Future changes in the nature of the health system could reduce our net sales and profits. We cannot provide any assurance as to the ultimate content, timing or effect of any healthcare reform legislation including sweeping changes to the Medicaid or Medicare programs, nor is it possible at this time to estimate the impact on us of potential legislation or regulation, which may be material. Further, although we exercise care in structuring our operations to comply in all material respects with all applicable laws and regulations, we can offer no assurance that (i) government officials charged with responsibility for enforcing such future laws will not assert that we or certain transactions in which we are involved are in violation of such laws, or (ii) such future laws will ultimately be interpreted by the courts in a manner consistent with our interpretation. Therefore, future legislation and regulation and the interpretation thereof could have a material adverse effect on our business, financial condition and results of operations. The federal government and the health care industry are continually assessing access to and the cost of prescription medication, which leads to frequent initiatives. For example, in order to make prescription drugs less expensive and more accessible to the general public, legislation has been introduced in both the U.S. Senate and the House of Representatives to amend the federal Food, Drug and Cosmetic Act to allow the importation of pharmaceuticals from foreign countries. We are unable to predict whether or when this or similar legislative proposals will be enacted.
Prescription Drug Marketing Act. The federal Prescription Drug Marketing Act, or PDMA, exempts many drug and medical devices from federal labeling and packaging requirements, as long as they are not adulterated or misbranded and were prescribed by a physician. The PDMA also prohibits the sale, purchase or trade of drug samples that are not intended for sale or to promote the sale of the drug. Distributors must keep records of drug sample distributions and utilize proper storage and maintenance methods. To the extent that the PDMA applies to us, we believe that we comply with the documentation, record keeping and storage requirements.
Federal Food, Drug, and Cosmetic Act. The Food, Drug and Cosmetic Act, as amended by the PDMA, imposes requirements for the labeling, packaging and repackaging, dispensing, advertising and promotion of prescription medication, and also prohibits, among other things, the distribution of unapproved, adulterated or misbranded drugs. To the extent the Food, Drug and Cosmetic Act applies to us, we believe that we comply with a reasonable interpretation of the repackaging labeling, compounding, documentation, record-keeping and storage requirements. In the past, the Food and Drug Administration, or the FDA, has viewed particular combination packaging arrangements as constituting new drugs that must be tested and labeled in the packaged combination. On occasion, the FDA also has sought to apply drug compounding guidance to analogous arrangements. We believe that sufficient legal authority and pharmacy industry practice supports our position that our packaging of a combination of drugs prescribed by a physician does not require FDA approval or registration by us with the FDA as a manufacturer. However, the FDA may disagree with this interpretation, and we could be required to defend our position and possibly to alter our practices, although the FDA has never initiated such action against us. Finally, to the extent we engage in co-marketing arrangements with pharmaceutical manufacturers regulated by the FDA, we are required to maintain our independence to ensure that any reference to specific products used in combination does not constitute illegal off-label promotion in the view of the FDA.
Federal Controlled Substances Act. The Controlled Substances Act contains pharmacy registration, packaging and labeling requirements, as well as record-keeping requirements related to a pharmacy’s inventory and its receipt and disposition of all controlled substances. Each state has also enacted similar legislation governing pharmacies’ handling of controlled substances. We maintain federal and state controlled substance registrations for each of our facilities, where applicable, and follow procedures intended to comply with all such record keeping requirements.
Federal Mail Order Provisions. Federal law imposes standards for the labeling, packaging, repackaging, advertising and adulteration of prescription drugs, and the dispensing of controlled substances and prescription drugs. The U.S. Postal Service and the Federal Trade Commission regulate mail order sellers, requiring us to maintain truth in advertising, a reasonable supply of drugs to fill orders, the consumer’s right to a refund if an order cannot be filled within 30 days, and in certain cases, child-resistant packaging. To the extent applicable, we believe we substantially comply with these requirements.
Pharmacy Drug Use Review Law. Federal law requires that states offering Medicaid prescription drug benefits implement a drug use review program. The program requires “before and after” drug use reviews and the use of certain
approved compendia and peer-reviewed medical literature as the source of standards for such drug use reviews. States offering Medicaid prescription drug benefits must develop standards, relating to patient counseling and record-keeping, for pharmacies. These standards also apply to non-resident pharmacies. We believe our pharmacists monitor these requirements, provide the necessary patient counseling and maintain the appropriate records.
Anti-Kickback Laws. We are subject to various laws that regulate our relationships with referral sources such as physicians, hospitals and other providers of healthcare services. Under the government payment programs for healthcare services, including Medicare, Medicaid, and ADAP, the federal government enforces the federal statute that prohibits the offer, payment, solicitation or receipt of any remuneration to or from any person or entity, directly or indirectly, overtly or covertly, in cash or in kind, to induce or in exchange for the referral of patients covered by the programs. This federal anti-kickback law also prohibits the purchasing, leasing, ordering, or arranging for or recommending the lease, purchase or order of any item, good, facility or service covered by the government payment programs. Violations by individuals or entities are punishable by criminal fines, civil penalties, imprisonment or exclusion from participation in reimbursement programs, such as Medicaid. States also have similar laws proscribing kickbacks, some of which are not limited to services for which government-funded payment may be made.
Anti-kickback laws are very broad in scope and are subject to modifications and variable interpretations. In an effort to clarify the federal anti-kickback law, the Department of Health and Human Services, or DHHS, has adopted a set of “safe harbor” rules, which specify various payment practices that are protected from civil or criminal liability. A practice that does not fall within a safe harbor is not necessarily unlawful, but may be subject to scrutiny and challenge. Failure to satisfy the requirements of a safe harbor requires an analysis of whether the parties intended to violate the anti-kickback law. In the absence of an applicable safe harbor, a violation of the anti-kickback law may occur even if only one purpose of a payment arrangement is to induce patient referrals or purchases or to induce the provision of a prescription drug reimbursable by a federal healthcare program such as Medicaid. Anti-kickback laws have been cited as a partial basis, along with the state consumer protection laws discussed below, for investigations and multi-state settlements relating to financial incentives provided by drug manufacturers to retail pharmacies in connection with pharmaceutical marketing programs. States have adopted similar safe harbors to their anti-kickback laws. We review our business practices regularly to comply with the federal anti-kickback law and similar state laws. We have a variety of relationships with referral sources such as physicians, clinics and hospitals. As we grow, we may pursue additional arrangements with such parties. Where applicable, we will attempt to structure these relationships to fit into the appropriate safe harbor; however, it is not always possible to meet all of the requirements of a safe harbor. While we believe that our relationships comply with the anti-kickback laws, if we are found to violate any of these laws, we could suffer penalties, fines, or possible exclusion from participation in federal and state healthcare programs, which could reduce our net sales and profits.
Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, or HIPAA. Among other things, HIPAA broadened the scope of the DHHS Secretary’s power to impose civil monetary penalties on healthcare providers and added an additional category to the list of individuals and entities that may be excluded from participating in any federal healthcare program like Medicaid. HIPAA encourages the reporting of healthcare fraud by allowing reporting individuals to share in any recovery made by the government, and requires the DHHS Secretary to create new programs to control fraud and abuse and conduct investigations, audits and inspections. HIPAA also defined new healthcare fraud crimes, including expanding the coverage of previous laws to include, among other things:
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Knowingly and willfully attempting to defraud any healthcare benefit program (including government and private commercial plans); and
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Knowingly and willfully falsifying, concealing, or covering up a material fact or making any materially false or fraudulent statements in connection with claims and payment for healthcare services by a healthcare benefit plan (including government and private commercial plans).
We believe that our business arrangements and practices comply with these HIPAA provisions. However, a violation could subject us to penalties, fines, or possible exclusion from Medicaid, which could reduce our net sales or profits.
OIG Fraud Alerts and Advisory Opinions. The Office of Inspector General, or OIG, of DHHS periodically issues Fraud Alerts and Advisory Opinions identifying certain questionable arrangements and practices that it believes may implicate the federal fraud and abuse laws. In a December 1994 Special Fraud Alert relating to “prescription drug marketing schemes,” the OIG stated that investigation may be warranted when a prescription drug marketing activity involves the provision of cash or other benefits to pharmacists in exchange for such pharmacists’ performance of marketing tasks in the course of their pharmacy practice, including, for example, sales-oriented “educational” or “counseling” contacts or physician or patient outreach where the value of the compensation is related to the business generated. We believe that we have structured our business arrangements to comply with federal fraud and abuse laws. However, if we are found to have
violated any of these laws, we could suffer penalties, fines or possible exclusion from the Medicaid or other government programs, which could adversely affect our net sales and profitability.
State Unfair and Deceptive Trade Practices and Consumer Protection Laws. State laws regulating unfair and deceptive trade practices and consumer protection statutes have been used as bases for the investigations and multi-state settlements relating to pharmaceutical industry promotional drug programs in which pharmacists are provided incentives to encourage patients or physicians to switch from one prescription drug to another. We do not participate in any such programs. A number of states involved in these consumer-protection-driven enforcement actions have requested that the FDA exercise greater regulatory oversight in the area of pharmaceutical promotion activities by pharmacists. We cannot determine whether the FDA will act in this regard or what effect, if any, FDA involvement would have on our operations.
The Stark Law. The federal Stark Law prohibits physicians from making a referral for certain health items or services if they, or their family members, have a financial relationship with the entity receiving the referral. Furthermore, no bill may be submitted for reimbursement in connection with a prohibited referral. Violations are punishable by civil monetary penalties on both the person making the referral and the provider rendering the service. Such persons or entities are also subject to exclusion from federal healthcare programs such as Medicaid. In 1995, CMS published final regulations under the Stark Law, known as Stark I, which provided some guidance on interpretation of the scope and exceptions of the Stark Law as they apply to clinical laboratory services. In addition, CMS released Phase I of the Stark II final regulations, which became effective in large part on January 4, 2002, and which covers additional health services, including outpatient prescription drugs, describes the parameters of the statutory exceptions in more detail and sets forth additional exceptions for physician referrals and physician financial relationships. Phase II of the Stark II final regulations became effective on July 26, 2004. Phase II clarifies portions of Phase I, addresses certain exceptions to the Stark Law not addressed in Phase I, and creates several new exceptions. The Phase II regulations include new provisions relating to indirect ownership and indirect compensation relationships between physicians and entities offering designated health services. These provisions are complex and have rarely been interpreted by the courts. CMS released Phase III regulations on September 5, 2007. Phase III responds to the comments on Phase II addressing the entire regulatory scheme and providing further clarification.
The Stark Law applies to our relationships with physicians and physician referrals for our products and services. A number of states have enacted similar referral prohibitions, which may cover financial relationships between entities and healthcare practitioners other than physicians as well. We believe we have structured our relationships to comply with the Stark Law and the Phase II and III regulations, as well as the applicable state provisions similar to the Stark Law. However, if our practices are found to violate the Stark Law or a similar state prohibition, we may be subject to sanctions or required to alter or discontinue some of our practices, which could reduce our net sales or profits.
Beneficiary Inducement Prohibition. The federal Civil Monetary Penalty Law prohibits the offering of remuneration or other inducements to beneficiaries of federal healthcare programs to influence the beneficiaries’ decision to seek specific governmentally reimbursable items or services, or to choose a particular provider. The federal Civil Monetary Penalty Law and its associated regulations exclude items provided to patients to promote the delivery of preventive care. However, permissible incentives do not include cash or cash equivalents. From time to time, we loan some items at no charge to our patients to assist them with adhering to their drug therapy regimen. Although these items are not expressly listed as excluded items in the statute and regulations, we nevertheless believe that our provision of these items does not violate the Civil Monetary Penalty Law and regulations, in part because we do not believe that providing these items is likely to influence patient choice of goods or services. A determination that we violated the statute or regulations, however, could result in sanctions that reduce our net sales or profits.
False Claims; Insurance Fraud Provisions. We are also subject to federal and state laws prohibiting individuals or entities from knowingly and willfully making claims for payment to Medicare, Medicaid, or other third-party payors that contain false or fraudulent information. These laws provide for both criminal and civil penalties, including exclusion from federal healthcare programs such as Medicaid, and require repayment of previously collected amounts. The federal False Claims Act contains a provision encouraging private individuals to file suits on behalf of the government against healthcare providers for making false claims. Federal false claims actions may be based on underlying violations of the anti-kickback or self-referral prohibitions as well. State law also proscribes fraudulent acts against third-party payors, including the ADAP and Medicaid programs. The Reduction Act provides a financial incentive for states to enact false claims acts that establish liability to the state for the submission of false or fraudulent claims to the state’s Medicaid program. If a state false claims act is determined to meet certain enumerated requirements, the state is entitled to an increase of ten percentage points in its share of any amounts recovered under a state action brought under such a law. Healthcare providers who submit claims that they knew or should have known were false, fraudulent, or for items or services that were not provided as claimed, may be excluded from Medicaid, required to repay previously collected amounts, and subject to substantial civil monetary penalties. We believe we are in material compliance with federal and state false claims laws.
The Reduction Act requires employers to provide their employees, contractors and agents with “detailed” information about the federal False Claims Act, administrative remedies for false claims, related state laws and whistleblower protections available under federal and state laws. We have provided this information as required by applicable laws and regulations.
Government Investigations. The government increasingly examines arrangements between healthcare providers and potential referral sources to determine whether they are designed to exchange remuneration for patient care referrals. Investigators are increasingly willing to look behind formalities of business transactions to determine the underlying purpose of payments. Enforcement actions have increased over the years and are highly publicized. The pharmaceutical industry continues to garner much attention from federal and state governmental agencies. The OIG has emphasized its continuing focus on pharmaceutical fraud in each of its most recent OIG Work Plans which include plans for the OIG to investigate reports from an unnamed state in connection with potential abuses in the Medicaid program related to the high costs associated with drugs used to treat HIV. The OIG’s 2008 Work Plan indicates that the OIG will review states’ compliance with the Ryan White Comprehensive AIDS Resources Emergency Act payor of last resort requirement in the administration of Title II ADAP funds. This review could result in a shifting of payment source from ADAP to other payors, the consequences of which are unknown. Also, the Department of Justice has identified prescription drug issues, including product substitution without authorization, controlled substances controls, free goods/diversion, medication errors, sale of samples, and contracting with pharmacy benefit management companies, as being among the “top 10” areas in the healthcare industry meriting the Department’s attention.
The relationships between drug manufacturers and providers of healthcare, including pharmacies, physicians, and hospitals, are under increased government scrutiny. In 2003, the OIG published the Compliance Program Guidance for Pharmaceutical Manufacturers. Any relationships we develop with pharmaceutical companies should be consistent with such guidelines.
In addition to investigations and enforcement actions initiated by government agencies, we could be the subject of an action brought under the federal False Claims Act by a private individual (such as a former employee, a customer or a competitor) on behalf of the government. Actions under the federal False Claims Act, commonly known as “whistleblower” or “qui tam” lawsuits, are generally filed under seal to allow the government adequate time to investigate and determine whether it will intervene in the action, and defendant healthcare providers are often without knowledge of such actions until the government has completed its investigation and the seal is lifted. If the suit eventually concludes with payments back to the government, the person who started the case can recover 25% to 30% of the proceeds if the government did not participate in the suit, or 15% to 25% if the government did participate in the suit.
Privacy and Confidentiality; Electronic Transactions and Security. Much of our business involves the receipt or use of confidential health information, including the transfer of the confidential information to a third-party payor program, such as Medicaid. DHHS has promulgated regulations implementing what are commonly referred to as the Administrative Simplification provisions of HIPAA, concerning the maintenance, transmission, privacy and security of electronic health information, particularly individually identifiable information. Pursuant to the privacy provisions of HIPAA, DHHS promulgated regulations that impose extensive requirements on the way in which healthcare providers, health plans and their business associates use and disclose protected health information. These regulations give individuals significant rights to understand and control how their protected health information is used and disclosed. Direct providers, such as pharmacies, must obtain an acknowledgement from their patients that the patient has received the pharmacy’s Notice of Privacy Practices. For most uses and disclosures of protected health information that do not involve treatment, payment or healthcare operations, the rule requires that all providers and health plans obtain a valid individual authorization. In most cases, use or disclosure of protected health information must be limited to the minimum amount necessary to achieve the purpose of the use or disclosure. Standards are provided for removing all individually identifiable health information in order to produce de-identified data that may be transferred without obtaining the patient’s authorization. Sanctions for failing to comply with the privacy standards issued pursuant to HIPAA include criminal penalties and civil sanctions. We have implemented certain privacy protections with respect to HIPAA privacy regulations. However, we cannot provide assurance that we have complied with all of the HIPAA privacy requirements. Any failure to comply could subject us to enforcement actions, including civil and criminal penalties, and could cause us to incur expense in changing our medical records system or information management systems.
In addition to the federal health information privacy regulations described above, most states have enacted confidentiality laws that limit the disclosure of confidential medical information. The final privacy rule under HIPAA does not preempt state laws regarding health information privacy that are more restrictive than HIPAA. The failure to comply with these state provisions could result in the imposition of administrative or criminal sanctions.
All healthcare providers who transmit certain protected health claims transactions electronically are required to comply with the HIPAA final regulations establishing transaction standards and code sets.
In addition, regulations pursuant to HIPAA govern the security of protected health information maintained or transmitted electronically. The regulations impose additional administrative burdens on healthcare providers, such as pharmacies, relating to the storage and utilization of, and access to, health information. We believe that we have complied with the regulations and have implemented reasonable measures to secure the protected health information that we maintain or transmit; however, we cannot provide assurance that we are in compliance with all of the HIPAA security rules. Any failure to comply could subject us to enforcement actions, including corrective action and civil penalties. In addition, if we choose to sell medications through new channels such as the Internet, we will have to comply with additional government regulations that exist now and that may be promulgated in the future with respect to electronic transmission.
On September 23, 2005, DHHS published in the Federal Register a proposed rule that adds to the HIPAA transaction standards regulations and describes the requirements that health plans, covered healthcare providers, and healthcare clearinghouses would have to meet to comply with the statutory requirement to use standard codes and formats for electronic claims attachment transactions, and to facilitate the transmission of certain types of detailed clinical information to support an electronic healthcare claim. There is no assurance that the rule will be adopted in its proposed form; however, if and when the rule is finalized, we will be required to comply and will endeavor to comply with the rule. On January 23, 2004, CMS published a rule announcing the adoption of the National Provider Identifier, or the NPI, as the standard unique health identifier for healthcare providers to use in filing and processing healthcare claims and other transactions. This rule was effective May 23, 2005, with a compliance date of May 23, 2007. We believe we have the required NPIs for our business.
In addition to those rules and regulations discussed here, from time to time, new standards and regulations may be adopted governing the use, disclosure and transmission of health information. We will endeavor to comply with all such requirements. We cannot, however, estimate the cost of compliance with such standards or determine if implementation of such standards will result in an adverse effect on our operations or profitability. Any failure to comply could subject us to enforcement actions, including civil penalties.
Developments in Health Information Technology. Healthcare providers are increasingly utilizing technology to make healthcare safer and more efficient. Health information technology initiatives include e-prescribing, which allows healthcare providers to transmit prescriptions electronically to a pharmacy rather than writing them on paper. E-prescribing products, services and arrangements must be compliant with numerous laws and regulations, including the final HIPAA security regulations, the federal anti-kickback law and the Stark Law. On August 8, 2006, the OIG published a final rule establishing a safe harbor for providers who receive non-monetary remuneration necessary to set up and operate e-prescribing systems. Specifically, the safe harbor would protect certain arrangements involving hospitals, group practices, PDP sponsors and Medicare Advantage, or MA, organizations that provide to specified recipients, such as prescribing health care professionals, pharmacies and pharmacists, certain non-monetary remuneration in the form of hardware, software or information technology and training services necessary and used solely to receive and transmit electronic prescription drug information. Also, on August 8, 2006, CMS published a final rule to create an exception to the physician self-referral prohibition for certain arrangements in which a physician receives necessary non-monetary remuneration that is used solely to receive and transmit electronic prescription drug information. We do not believe either of these safe harbors/exceptions is available to us, because the safe harbor is available only to hospitals, group practices, PDP plan sponsors and MA organizations and the self-referral exception only applies to relationships between physicians and those entities.
Under the MMA, PDPs participating in Part D must comply with national standards to be developed by the DHHS for electronic prescriptions. The final rule adopting standards for an electronic prescription drug program under the MMA was published in the Federal Register on November 7, 2005 and additional proposed standards were published in the Federal Register on November 16, 2007. Compliance with the standards is voluntary for prescribers and pharmacies, except if such prescribers or pharmacies send or receive prescription-related information electronically for medications covered under Medicare Part D. We will endeavor to comply with all applicable standards for the transmission of electronic prescriptions as such standards are developed. We cannot, however, estimate the cost of compliance with such standards or if implementation of such standards will result in an adverse effect on our operations or profitability.
Regulation of the Practice of Pharmacy. State laws regulate the practice of pharmacy. Pharmacies and pharmacists must obtain state licenses to operate and dispense medications. We are licensed to do business as a pharmacy in each state in which we operate a dispensing pharmacy. Our pharmacists are also licensed in those states where their activity requires it. Pharmacists must also comply with professional practice rules, and we monitor our pharmacists’ practices for compliance with such state laws and rules. We do not believe that the activities undertaken by our pharmacists violate rules governing the practice of pharmacy or medicine. In an effort to combat fraud, New York State enacted Section 21 of the Public Health Law, effective April 19, 2006, and promulgated emergency regulations requiring the use of an official New York State prescription for all prescribing done in-state. The emergency regulations are expected to become permanent.
Various states have enacted laws and adopted regulations requiring, among other things, compliance with all laws of the states into which the out-of-state pharmacy dispenses medications, whether or not those laws conflict with the laws of the state in which the pharmacy is located. To the extent that such laws or regulations are found to be applicable to our operations, and that the laws of states where our pharmacies dispense medications are more stringent than those of the states in which our pharmacies are located, we would be required to comply with them. In addition, to the extent that any of these laws or regulations prohibit or restrict the operation of mail service pharmacies and are found to be applicable to us, they could have a harmful effect on our prescription mail service operations, if any. Some federal and state pharmacy associations and some boards of pharmacy have attempted to develop laws or regulations restricting the activity of out-of-state pharmacies.
Laws enforced by the federal Drug Enforcement Administration, as well as some similar state agencies, require our pharmacy locations to individually register in order to handle controlled substances, including prescription drugs. A separate registration is required at each principal place of business where the applicant manufactures, distributes or dispenses controlled substances. Federal and state laws require that we follow specific labeling and record-keeping requirements for controlled substances. We maintain federal and state controlled substance registrations for each of our facilities that require it, and we follow procedures intended to comply with all such record-keeping requirements.
Liability Insurance. Providing healthcare services and products entails an inherent risk of liability. In recent years, participants in the healthcare industry have become subject to an increasing number of lawsuits, many of which involve large claims and significant defense costs. We may from time to time be subject to such suits as a result of the nature of our business. We maintain general liability insurance, including professional and product liability, in an amount our management believes to be adequate. There can be no assurance, however, that claims in excess of, or beyond the scope of, our insurance coverage will not arise. In addition, our insurance policies must be renewed annually. Although we have not experienced difficulty in obtaining insurance coverage in the past, there can be no assurance that we will be able to do so in the future on acceptable terms or at all.
The Company
We were incorporated in Delaware in 1983 under the name The Care Group, Inc. In 1999, upon our exit from bankruptcy, we changed our name to Allion Healthcare, Inc. and focused our business principally on serving HIV/AIDS patients. In 2005, we became a publicly-traded company. Our stock is listed on the NASDAQ Global Market, or NASDAQ, under the symbol “ALLI.” Our principal executive offices are located at 1660 Walt Whitman Road, Suite 105, Melville, New York 11747, and our telephone number at that address is (631) 547-6520. We also maintain three websites, which can be located at www.allionhealthcare.com, www.momspharmacy.com, and www.orismed.com.
We make available free of charge, on or through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished to the SEC pursuant to Section 13(a) or Section 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We are providing the addresses of our Internet websites solely for the information of investors. We do not intend the Internet addresses to be active links, and the contents of the websites are not part of this Report. Additionally, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC and can be accessed at www.sec.gov.
Employees
As of February 19, 2008, we had 190 full-time employees and 36 part-time and temporary employees, all of whom were engaged in management, sales, marketing, pharmacy operations, customer service, administration or finance. None of our employees are covered by a collective bargaining agreement. We have never experienced an employment-related work stoppage and consider our employee relations to be good.
Item 1A.
Item 1A. Risk Factors.
The occurrence of any of the following risks could materially harm our business, financial condition and results of operations.
Risks Related to Our Company
Changes in reimbursement by third-party payors could harm our business.
The price we receive for our products depends primarily on the reimbursement rates paid by government and private payors. In 2007, we generated approximately 64% of our net sales from patients who rely on Medicaid, ADAP and Medicare (excluding Part D, which is administered through private payor sources) for reimbursement. In recent years, these programs have reduced reimbursement to providers. Changes to the programs themselves, the amounts the programs pay, or coverage limitations established by the programs for the medications we sell may reduce our earnings. For example, these programs could revise their pricing methodology for the medications we sell, decide not to cover certain medications or cover only a certain number of units prescribed within a specified time period. We are likely to experience some form of revised drug pricing, as ADAP and Medicaid expenditures for HIV/AIDS medications have garnered significant attention from government agencies during the past few years. Any reduction in amounts reimbursable by government programs for our products and services or changes in regulations governing such reimbursements could harm our business, financial condition and results of operations. In addition, if we are disqualified from participating in the state Medicaid programs of New York, New Jersey, California, Florida or Washington, our net sales and our ability to maintain profitability would be significantly reduced.
We are also dependent on reimbursement from private payors. Many payors seek to limit the number of providers that supply drugs to their enrollees. From time to time, private payors with which we have relationships require that we and our competitors bid to keep their business, and there can be no assurance that we will be retained or that our margins will not be adversely affected if and when re-bidding occurs. If we are not retained, our net sales could be adversely affected.
If demand for our products and services is reduced, our business and ability to grow would be harmed.
A reduction in demand for HIV/AIDS medications would significantly harm our business, as we would not be able to quickly shift our business to provide medications for other diseases. Reduced demand for our products and services could be caused by a number of circumstances, such as:
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A cure or vaccine for HIV/AIDS;
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The emergence of a new strain of HIV that is resistant to available HIV/AIDS medications;
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Shifts to treatment regimens other than those we offer;
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New methods of delivery of existing HIV/AIDS medications that do not require our specialty pharmacy and disease management services;
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Recalls of HIV/AIDS medications we sell;
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Adverse reactions caused by the HIV/AIDS medications we sell;
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The expiration of or challenge to the drug patents on the HIV/AIDS medications we sell; or
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Competing treatment from a new HIV/AIDS medication or a new use of an existing HIV/AIDS medication.
Our revenues could be adversely affected if new HIV/AIDS drugs or combination therapies are developed and prescribed to our patients for which the reimbursement rate is less than that of the current drug therapies our patients receive.
There is a risk that the reimbursement rate for new HIV/AIDS drugs or combination therapies may be less than the reimbursement rate for the existing drugs or combination therapies. The number of total prescriptions received by our patients who begin to use a combination therapy may decline, resulting in reduced average revenues and a decrease in dispensing fees per patient. In the second half of 2006, we began dispensing ATRIPLA™. ATRIPLA is a once-daily single tablet regimen for HIV intended as a stand-alone therapy or in combination with other anti-retrovirals. ATRIPLA™ combines SUSTIVA®, manufactured by Bristol-Myers Squibb, and Truvada®, manufactured by Gilead Sciences. During the quarter ended December 31, 2007, approximately 9.6% of our patients received ATRIPLA™ compared 7.2% in the same period in 2006. Conversion to ATRIPLA™ has resulted in the loss of one or two dispensing fees per patient, depending on the previous drug combination used by these patients. Our results of operations may be negatively impacted if the number of our patients using ATRIPLA™ or other similar new therapies increases in the future or if the reimbursement for ATRIPLA™ or other similar new therapies is reduced.
We have an ongoing informal inquiry by the SEC’s Enforcement Division, and depending on the length, scope and results of the informal inquiry, our business, financial condition and results of operations could experience a material adverse impact.
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 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 our borrowing costs.
Furthermore, we may continue incurring expenses in connection with responding to 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 SEC’s informal inquiry. 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.
Our revenues may continue to be adversely affected in connection with payment rates for our patients who are “dual-eligible” under the Medicare Modernization Act.
Beginning January 1, 2006, under Medicare Part D, PDPs, and not Medicaid, began to reimburse us for the prescription drugs we provide to our dual eligible patients. Reimbursement rates for these patients are generally less favorable than the rates we received from Medicaid and result in lower gross margins for our dual eligible patients. In December 2007, we serviced 3,165 patients under Medicare Part D, which totaled approximately 20.3% of our patients. Our earnings have been negatively impacted from the movement of our patients from Medicaid to a Medicare Part D plan. If a higher number of our patients become eligible under the MMA, there is a risk that our gross margins will decline further and negatively impact earnings. Additional risks under the MMA that could affect financial performance include:
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The reimbursement rates we currently receive from the PDPs for our services could be reduced;
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Regulations that strictly limit our ability to market to our current and new patients may limit our ability to maintain and grow our current patient base;
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Part D may not continue to cover all the medications needed for persons with HIV/AIDS, including our patients; and
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Our contracts with PDPs could terminate if we fail to comply with the terms and conditions of such contracts.
Changes in Medicaid reimbursement could adversely affect the payment we receive for drugs we dispense and negatively impact our financial condition and results of operations as a result.
In January of 2006, the Reduction Act established AMP as the benchmark for prescription drug reimbursement in the Medicaid program, eliminating the previously used AWP standard. The Reduction Act also made changes to the federal upper payment limit for multiple source drugs, such as generics. Payments to pharmacies for Medicaid-covered outpatient prescription drugs are set by the states. Federal reimbursement to states for the federal share of those payments is subject to the FUL ceiling. Effective January 1, 2007, for multiple source drugs, the FUL became 250% of the AMP. On July 6, 2007, CMS issued final regulations that (1) defined what will be considered a multiple source drug, and (2) defined AMP by identifying the categories of drug sales that would be used to calculate AMP. The final regulations also mandated that CMS publish AMPs reported to it by manufacturers on CMS’ website. The final regulations became effective October 1, 2007.
The first publication of AMP data and the resulting FULs was scheduled to occur in December of 2007. However, on December 19, 2007, the NACD and the NCPA sought and were granted a preliminary injunction in U.S. District Court that halted CMS’ implementation of its AMP regulations and the posting of any AMP data. In their complaint, the two pharmacy groups allege that the AMP regulations go beyond what Congress intended when it passed the Social Security Act. Specifically, the lawsuit alleges that (1) in defining AMP, CMS included categories of drug sales that exceeded the plain language of the Social Security Act, and (2) CMS’ definition of multiple source drugs is impermissibly broad and, in some respects, contrary to the Social Security Act. On March 14, 2008, CMS issued an interim final rule revising its definition of multiple source drug to address an issue raised in the NACDS/NCPA lawsuit. The preliminary injunction is still in effect.
We cannot predict the outcome of the NACDS/NCPA case. If the preliminary injunction is lifted and CMS is allowed to implement the AMP regulations, it could adversely impact our revenues. While there is no requirement that states use AMP to set payment amounts, we believe that the adoption of AMP will result in lower Medicaid reimbursement rates for
medications we dispense. We continue to review the potential impact that the Reduction Act and the AMP regulations may have on our business and are not yet in a position to fully assess their impact on our business or profitability. However, the use of AMP in the FUL may have the effect of reducing the reimbursement rates for certain medications that we currently dispense or may dispense in the future. Further, states may elect to base all Medicaid pharmacy reimbursement on AMP instead of AWP. If the individual states make this decision, it may have the effect of reducing the reimbursement rates for certain medications that we currently dispense or may dispense in the future.
We have a history of losses and may not be able to sustain profitability.
We achieved profitability for the first time in the first quarter of 2005; however, we may not be able to maintain profitability on a regular basis. If we fail to maintain profitability, your investment in our stock could result in a significant or total loss. Our predecessor company, The Care Group, Inc., filed for protection under Chapter 11 of the Bankruptcy Code in September 1998. We emerged from bankruptcy in February 1999 and experienced operating losses from that time until the first quarter of 2005.
If we do not continue to qualify for preferred reimbursement programs in California and New York, our net sales could decline.
In 2004, California approved the California Pilot Program, which provides additional reimbursement for HIV/AIDS medications for up to ten qualified pharmacies. We own two of the ten pharmacies that qualified for this program. The California Pilot Program was recently extended as part of California’s 2007 budget process and is currently set to expire on June 30, 2008.
We have also qualified as a specialty HIV pharmacy in New York that makes us eligible to receive preferred reimbursement rates for HIV/AIDs medications. However, our continuing qualification for specialized HIV pharmacy reimbursement in New York is dependent upon our recertification every two years by the Department of Health in New York as an approved HIV pharmacy. We are certified through September 2008, but there can be no assurance that we will obtain our recertification in New York in the future. If we do not receive recertification in New York, our net sales and profit would be adversely affected.
There also 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 would be adversely impacted.
If we are not able to market our services effectively to HIV/AIDS clinics, their affiliated healthcare providers and PDPs, we may not be able to grow our patient base as rapidly as we have anticipated.
Our success depends, in part, on our ability to develop and maintain relationships with HIV/AIDS clinics and their affiliated healthcare providers because each is an important patient referral source for our business. In addition, we also have to maintain and continue to establish relationships with PDPs so we can continue to fill prescriptions for our dual eligible customers who receive prescription drug coverage under Medicare Part D. If we are unable to market our services effectively to these clinics, healthcare providers and PDPs, or if our existing relationships with clinics and providers are terminated, our ability to grow our patient base will be harmed, which could dramatically reduce our net sales and our ability to maintain profitability.
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.
If our credit terms with AmerisourceBergen become unfavorable or our relationship with AmerisourceBergen is terminated, our business could be adversely affected.
In September 2003, we entered into a five-year prime vendor agreement with AmerisourceBergen. Pursuant to the agreement, we are obligated to purchase at least 95% of the medications we sell from AmerisourceBergen. When we entered into the agreement, we depended on existing credit terms from AmerisourceBergen to meet our working capital needs between the times we purchased medications from AmerisourceBergen and when we received reimbursement or payment from third party payors. Although we no longer rely on credit terms from our suppliers, in the past, our ability to grow has been limited in part by our inability to negotiate favorable credit terms from our suppliers. If our position changes and we again have to rely on credit to meet working capital needs, we may become limited in our ability to continue to increase the volume of medications we need to fill prescriptions if we are unable to maintain adequate credit terms from AmerisourceBergen or, alternatively, if we are unable to obtain sufficient financing from third-party lenders.
There are only a few alternative wholesale distributors from which we can purchase the medications we offer to HIV/AIDS patients. In the event that our prime vendor agreement with AmerisourceBergen terminates or is not renewed, we might not be able to enter into a new agreement with another wholesale distributor on a timely basis or on terms favorable to us. Our inability to enter into a new supply agreement may cause a shortage of the supply of medications we keep in stock, or we may be required to accept pricing and credit terms from a vendor that are less favorable to us than those we have with AmerisourceBergen.
Our success in identifying and integrating acquisitions may impact our business and our ability to have effective disclosure controls.
As part of our strategy, we continually evaluate acquisition opportunities. There can be no assurance that we will complete any future acquisitions or that such transactions, if completed, will be integrated successfully or will contribute favorably to our operations and financial condition. The integration of acquisitions includes ensuring that our disclosure controls and procedures and our internal control over financial reporting effectively apply to and address the operations of newly acquired businesses. We may be required to change our disclosure controls and procedures or our internal control over financial reporting to accommodate newly acquired operations, and we may also be required to remediate historic weaknesses or deficiencies at acquired businesses. For example, the auditors of Specialty Pharmacies, Inc., or SPI, a company we acquired in 2005, identified certain material weaknesses in SPI’s internal controls in connection with its audit of the SPI’s 2004 financial statement. The auditors stated that SPI needed to implement an improved accounting system and implement better controls to segregate duties regarding the cash disbursements and cash receipts functions of SPI. Based on this letter and our own evaluation of SPI’s internal controls, we took a number of remedial steps, including increasing the number of persons (and making changes in the persons) who are primarily responsible for performing the accounting and financial duties at SPI. Our review and evaluation of disclosure controls and procedures and internal controls over financial reporting of the companies we acquire may take time and require additional expense, and if they are not effective on a timely basis, could adversely affect our business and the market’s perception of our company.
In addition, acquisitions may expose us to unknown or contingent liabilities of the acquired businesses, including liabilities for failure to comply with healthcare or reimbursement laws. While we try to negotiate indemnification provisions that we consider to be appropriate for the acquisitions, there can be no assurance that liabilities relating to the prior operations of acquired companies will not have a material adverse effect on our business, financial condition and results of operations. Furthermore, future acquisitions may result in dilutive issuances of equity securities, incurrence of additional debt, and amortization of expenses related to intangible assets, any of which could have a material adverse effect on our business, financial condition and results of operations.
We rely on third-party delivery services to deliver our products to the patients we serve. Price increases or service interruptions in our delivery services could adversely affect our results of operations and our ability to make deliveries on a timely basis.
Delivery is essential to our operations and represents a significant expense in the operation of our business that we cannot pass on to our customers. As a result, any significant increase in delivery rates, for example as a result of an increase in the price of gasoline, could have an adverse effect on our results of operations. Similarly, strikes or other service interruptions in these delivery services would adversely affect our ability to deliver our products on a timely basis. In addition, some of the medications we ship require special handling, including refrigeration to maintain temperatures within
certain ranges. The spoilage of one or more shipments of our products could adversely affect our business or potentially result in damage claims being made against us.
We rely on a few key employees whose absence or loss could adversely affect our business.
Many key responsibilities within our business have been assigned to a small number of employees. The loss of their services could adversely affect our business. In particular, the loss of the services of our named executive officers-Michael P. Moran, our Chairman, Chief Executive Officer and President; Stephen A. Maggio, our Interim Chief Financial Officer, Secretary and Treasurer; Anthony Luna, our Vice President, HIV Sales and Vice President, Oris Health, Inc.; or Robert Fleckenstein, our Vice President, Pharmacy Operations-could disrupt our operations. We have employment agreements in place with each of our named executive officers. However, any existing employment agreements or any employee agreement that we may enter into will not assure the retention of an employee. In addition, we do not maintain “key person” life insurance policies on any of our employees. As a result, we are not insured against any losses resulting from the death of our key employees. Further, as we grow we must be able to attract and retain other qualified technical operating and professional staff, such as pharmacists. If we cannot attract and retain on acceptable terms the qualified employees necessary for the continued development of our business, we may not be able to sustain or grow our business.
A prolonged malfunction of our MOMSPak automated packaging system could hurt our relationships with the patients we serve and our ability to grow.
We rely on our MOMSPak packaging system to create the MOMSPak for dispensing patient medication. We expect that prescriptions packaged in a MOMSPak will increase substantially in the future as more of the patients who we serve switch to the MOMSPak from traditional packaging system pill boxes and as the number of patients and prescriptions that we fill increases. We currently lease our MOMSPak machines. If these machines fail to function properly for a prolonged period, we may have to fill prescriptions by hand using pill boxes or by otherwise sorting the various drug combinations into individual doses. Delays or failure to package medications by our MOMSPak packaging system could result in the loss of a substantial portion of our patients who receive their prescriptions in MOMSPaks. Approximately 15% of our patients currently receive the MOMSPak.
Our financial results may suffer if we have to write off intangible assets or goodwill.
As a result of our acquisitions, a significant portion of our total assets consist of intangible assets (including goodwill). Intangible assets, net of amortization, and goodwill together accounted for approximately 55% and 60% of the total assets on our balance sheet as of December 31, 2007 and December 31, 2006, respectively. Under current accounting standards, we are able to amortize intangible assets over a period of five to fifteen years and do not amortize goodwill. We may not realize the full fair value of our intangible assets and goodwill. We expect to engage in additional acquisitions, which may result in our recognition of additional intangible assets and goodwill. We evaluate on a regular basis whether all or a portion of our goodwill and intangible assets may be impaired. Under current accounting rules, any determination that impairment has occurred would require us to write off the impaired portion of goodwill and such intangible assets, resulting in a charge to our earnings. Such a write-off could have a material adverse effect on our financial condition and results of operations.
We do not have patent or trademark protection for our MOMSPak, our automated prescription packaging system or for our trade name, MOMS Pharmacy.
We believe that several components of our ability to compete effectively include our MOMSPak package, created by our MOMSPak automated prescription packaging system, and our trade name, MOMS Pharmacy. We developed our MOMSPak packaging system with software and other technology that we license from third-parties. We have not attempted to obtain patent protection for our MOMSPak packaging system, and we do not intend to do so in the future. As a consequence, our competitors may develop technology that is substantially equivalent to our MOMSPak system, and we could not prevent them from doing so. If our competitors or other third parties were able to recreate the MOMSPak, one of our competitive advantages in serving HIV/AIDS patients could be lost. In addition, we do not have trademark protections for our automated packaging system, our MOMSPak package or our MOMS Pharmacy name, and there is no guarantee that if we were to decide to seek protection, we would be able to obtain it.
Unauthorized parties may attempt to use our name, or copy or otherwise obtain and use, our customized packaging solution or technology. We do not have any confidentiality agreements with any of our collaborative partners, employees or consultants that would prevent them from disclosing our trade secrets. There can be no assurance that we will have adequate remedies for any misuse or misappropriation of our trade secrets. If we are not adequately protected, other companies with sufficient resources and expertise could quickly develop competing products, which could materially harm our business, financial condition or results of operations.
A disruption in our telephone system or our computer system could harm our business.
We receive and take prescription orders over the telephone, by facsimile or through our electronic prescription writer. We also rely extensively upon our computer system to confirm payor information, patient eligibility and authorizations; to check on medication interactions and patient medication history; to facilitate filling and labeling prescriptions for delivery and billing; and to help with the collection of payments. Our success depends, in part, upon our ability to promptly fill and deliver complex prescription orders as well as on our ability to provide reimbursement management services for our patients and their healthcare providers. Any continuing disruption in our telephone, facsimile or computer systems could adversely affect our ability to receive and process prescription orders, make deliveries on a timely basis and receive reimbursement from our payors. This could adversely affect our relations with the patients and healthcare providers we serve and potentially result in a partial reduction in orders from, or a complete loss of, these patients.
Our investment portfolio may be adversely affected by volatile and illiquid market conditions.
We have an investment portfolio that we manage in accordance with our internal policies and procedures. Our investment portfolio may be adversely affected by market fluctuations including, without limitation, changes in interest rates and overall market liquidity. Certain markets have been experiencing disruptions in market liquidity and the lack of a secondary market may adversely affect the valuation of certain investments. There have been recent auction market liquidity failures and at present there is no official estimate of when liquidity will be restored to the market. As of December 31, 2007, we held approximately $9.3 million of auction rate securities; as of March 15, 2008 we held $2.2 million.
Risks Related to the Specialty Pharmacy Industry
There is substantial competition in our industry, and we may not be able to compete successfully.
The specialty pharmacy industry is highly competitive and is continuing to become more competitive. All of the medications, supplies and services that we provide are also available from our competitors. Our current and potential competitors may include:
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Other specialty pharmacy distributors;
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Specialty pharmacy divisions of wholesale drug distributors;
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Pharmacy benefit-management companies;
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Hospital-based pharmacies;
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Other retail pharmacies;
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Manufacturers that sell their products both to distributors and directly to clinics and physicians’ offices; and
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Hospital-based care centers and other alternate-site healthcare providers.
Many of our competitors have substantially greater resources and marketing staffs and more established operations and infrastructure than we have. A significant factor in effective competition will be our ability to maintain and expand our relationships with patients, healthcare providers and government and private payors.
If we are found to be in violation of Medicaid and Medicare reimbursement regulations, we could become subject to retroactive adjustments and recoupments.
As a Medicaid and Medicare provider, we are subject to retroactive adjustments due to prior-year audits, reviews and investigations, government fraud and abuse initiatives, and other similar actions. Federal regulations also provide for withholding payments to recoup amounts payable under the programs. While we believe we are in material compliance with applicable Medicaid and Medicare reimbursement regulations, there can be no assurance that we, pursuant to such audits, reviews, investigations, or other proceedings, will be found to be in compliance in all respects with such reimbursement regulations. A determination that we are in violation of any such reimbursement regulations could result in retroactive adjustments and recoupments of payments and have a material adverse effect on us. As a Medicaid and Medicare provider, we are also subject to routine, unscheduled audits that could have a material adverse impact on our results of operations, should an audit result in a negative finding, and we can offer no assurance that future Medicaid and Medicare audits will not result in a negative finding.
Our industry is subject to extensive government regulation, and noncompliance by us or our suppliers could harm our business.
The repackaging, marketing, sale and purchase of medications are extensively regulated by federal and state governments. As a provider of pharmacy services, our operations are subject to complex and evolving federal and state laws and regulations enforced by federal and state governmental agencies. These laws and regulations are described in Part I, Item 1. Business-Government Regulation and include, but are not limited to, the federal Controlled Substances Act, Pharmacy Drug Use Review Law, anti-kickback laws, HIPAA, the Stark Law and the federal Civil Monetary Penalty Law. Many of the HIV/AIDS medications that we sell receive greater attention from law enforcement officials than those medications that are most often dispensed by traditional pharmacies due to the high cost of HIV/AIDS medications and the potential for illegal use. If we fail to, or are accused of failing to, comply with laws and regulations, our business, financial condition and results of operations could be harmed. While we believe we are operating our business in substantial compliance with existing legal requirements material to the operation of our business, many of these laws remain open to interpretation. Changes in interpretation or enforcement policies could subject our current practices to allegation of impropriety or illegality. If we fail to comply with existing or future applicable laws and regulations, we could be subject to penalties which may include, but not be limited to, exclusion from the Medicare or Medicaid programs, fines, requirements to change our practices, and civil or criminal penalties.
In addition, we recognize that the federal government has an interest in examining relationships between providers or between providers and other third parties relating to health technology services, including those that facilitate the electronic submission of prescriptions. For example, it is possible that our prior relationship with Ground Zero, through the licensing of LabTracker and the LabTracker/Oris software interface, might invite inquiry from the federal government. Part of the earn-out payment under our purchase agreement to acquire OMS is based upon the number of patients who submit their prescriptions to our pharmacies through a clinic utilizing the Oris and/or LabTracker software. These payments are made directly to the shareholders of OMS and to Ground Zero. The purchase agreement expressly prohibits the shareholders of OMS and Ground Zero from marketing the Oris software. In addition, we will charge each provider who licenses the Oris software a fair market value license fee. While we believe our relationships with the shareholders of OMS and Ground Zero and with the users of the Oris software comply with the anti-kickback laws, if we are found to violate any of these laws, we could suffer penalties, fines, or possible exclusion from participation in federal and state healthcare programs, which would reduce our sales and profits.
Our business could also be harmed if the entities with which we contract or have business relationships, such as pharmaceutical manufacturers, distributors, physicians or HIV/AIDS clinics, are accused of violating laws or regulations. The applicable regulatory framework is complex and evolving, and the laws are very broad in scope. There are significant uncertainties involving the application of many of these legal requirements to our business. Many of the laws remain open to interpretation and have not been addressed by substantive court decisions to clarify their meaning. We are unable to predict what additional federal or state legislation or regulatory initiatives may be enacted in the future relating to our business or the healthcare industry in general, or what effect any such legislation or regulation might have on us. Further, we cannot provide any assurance that federal or state governments will not impose additional restrictions or adopt interpretations of existing laws that could increase our cost of compliance with such laws or reduce our ability to become profitable. If we are found to have violated any of these laws, we could be required to pay fines and penalties, which could materially adversely affect our profitability, and our ability to conduct our business as currently structured.
Federal and state investigations and enforcement actions continue to focus on the healthcare industry, scrutinizing a wide range of items such as referral and billing practices, product discount arrangements, dissemination of confidential patient information, clinical drug research trials, pharmaceutical marketing programs, and gifts for patients. It is difficult to predict how any of the laws implicated in these investigations and enforcement actions may be interpreted to apply to our business. Any future investigation may cause publicity, regardless of the eventual result of the investigation, or its underlying merits, that would cause potential patients to avoid us, reducing our net sales and profits and causing our stock price to decline.
Changes in industry pricing benchmarks, including changes in reimbursement by Medicaid and other governmental payors, 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 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 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.
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. Although the proposed settlement had received preliminary court approval, it was denied final court approval. We cannot predict the outcome of this case or, if any 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.
Most state Medicaid programs now pay substantially less than AWP for the prescription drugs we dispense. In January of 2006, the Reduction Act established AMP as the benchmark for prescription drug reimbursement in the Medicaid program, eliminating the previously used AWP standard.
The Reduction Act also made changes to the federal upper payment limit for multiple source drugs, such as generics. Payments to pharmacies for Medicaid-covered outpatient prescription drugs are set by the states. Federal reimbursement to states for the federal share of those payments is subject to the FUL ceiling. Effective January 1, 2007, for multiple source drugs, the FUL became 250% of the AMP. On July 6, 2007, CMS issued final regulations, effective October 1, 2007, that (1) defined what will be considered a multiple source drug, and (2) defined AMP by identifying the categories of drug sales that would be used to calculate AMP. The final regulations also mandated that CMS publish AMPs reported to it by manufacturers on CMS’ website.
The first publication of AMP data and the resulting FULs was scheduled to occur in December of 2007. However, on December 19, 2007, the NACDS and the NCPA sought and were granted a preliminary injunction in the U.S. District Court that halted CMS’ implementation of its AMP regulations and the posting of any AMP data. In their complaint, the two pharmacy groups allege that the AMP regulations go beyond what Congress intended when it passed the Social Security Act. Specifically, the lawsuit alleges that (1) in defining AMP, CMS included categories of drug sales that exceeded the plain language of the Social Security Act, and (2) CMS’ definition of multiple source drugs is impermissibly broad and, in some respects, contrary to the Social Security Act. On March 14, 2008, CMS issued an interim final rule revising its definition of multiple source drug to address an issue raised in the NACDS/NCPA lawsuit. The preliminary injunction is still in effect.
We are unable to predict or determine the future course of federal, state and local regulation, legislation or enforcement or what additional federal or state legislation or regulatory initiatives may be enacted in the future relating to our business or the healthcare industry in general, or what effect any such legislation or regulation might have on us. We cannot provide any assurance that federal or state governments will not impose additional restrictions or adopt interpretations of existing laws that could have a material adverse effect on our business or financial position. Consequently, any future change, interpretation, violation or alleged violation of law or regulations could have a material adverse effect on our business, financial condition and results of operations.
Our sales and profitability are affected by the efforts of healthcare payors to contain or reduce the cost of healthcare by lowering reimbursement rates, limiting the scope of covered services, and negotiating reduced or capitated pricing arrangements. Any changes that lower reimbursement levels under Medicaid, Medicare or private payors could also reduce our future revenue. Furthermore, other changes in these reimbursement programs or in related regulations could reduce our future revenue. These changes may include modifications in the timing or processing of payments and other changes intended to limit or decrease the growth of Medicaid, Medicare or third party expenditures. In addition, the failure, even if inadvertent, by us or our patients to comply with applicable reimbursement regulations could adversely affect our reimbursement under these programs and our ability to continue to participate in these programs. In addition, our failure to comply with these regulations could subject us to other penalties.
Our business could be affected by reforms in the healthcare industry.
Healthcare reform measures have been considered by Congress and other federal and state bodies during recent years. The intent of the proposals generally has been to reduce healthcare costs and the growth of total healthcare expenditures, and to eliminate fraud, waste and financial abuse. Comprehensive healthcare reform may be considered and efforts to enact reform bills are likely to continue. These changes are occurring on a fast-paced basis, and it is impossible to predict the extent or substance of the changes. For example, in 2005, Florida approved a sweeping change to its Medicaid program that shifts from the traditional Medicaid “defined benefit” plan to a “defined contribution” plan, under which the state sets a limit
on spending for each recipient. Under the program, Medicaid enrollees enrolled in, or were automatically enrolled in, private health plans, which have the authority to manage the enrollees Medicaid health care benefit. Other states are considering implementing such a change to the administration of their Medicaid programs. We are unable to predict the likelihood that any healthcare reform legislation or similar legislation will be enacted into law or the effects that any such legislation would have on our business.
We may not be able to obtain insurance that is sufficient to protect our business from liability.
Our business exposes us to risks inherent in the provision of drugs and related services. Claims, lawsuits or complaints relating to our products and services may be asserted against us in the future. Although we currently maintain professional and general liability insurance, there can be no assurance that the scope of coverage or limits of such insurance will be adequate to protect us against future claims. In addition, there can be no assurance that we will be able to maintain adequate liability insurance in the future on acceptable terms or with adequate coverage against potential liabilities.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our principal executive offices are located in Melville, New York, which we have leased through August 31, 2009. Both our executive offices and Melville, New York pharmacy operations are located at this site. We lease space in the following locations:
We believe we have adequate space for our current operations. We plan to renew these leases prior to expiration or move to other comparable space.
Item 3.
Item 3. 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, Inc., or OMS, filed a complaint against Allion, Oris Health, Inc., or Oris Health, and MOMS Pharmacy, Inc., or MOMS, on August 14, 2006, alleging 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 the May 19, 2005 Asset Purchase Agreement between Oris Health and MOMS on the one hand, and OMS on the other hand. We filed a motion to challenge the negligent misrepresentation cause of action, which the court granted and dismissed from the complaint. Allion, Oris Health and MOMS will continue to vigorously defend against the remaining claims.
In addition, Allion, Oris Health and MOMS have filed a cross-complaint against OMS, its majority shareholder Pat Iantorno, and the Iantorno Management Group, in which one or a number of the cross-complaints have alleged claims variously against either one or a number of the cross-defendants for deceit, negligent misrepresentation, breach of implied warranty, money had and received, rescission, breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, unfair competition, libel, false light, reformation and declaratory relief. Allion, Oris Health and MOMS intend to vigorously prosecute their cross-complaint.
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 or financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
On December 4, 2007, we held our annual meeting of stockholders. The purpose of the meeting was to elect six members to the board of directors to serve until the next annual meeting of stockholders and until their successors have been elected and qualified, to ratify the selection of BDO Seidman, LLP, or BDO, as our Independent Registered Public Accountants for work performed in 2007 and 2008, and to transact such other business as properly came before the annual meeting.
There were a total of 12,303,352 shares voted. All six nominees for director were elected to the board of directors with the voting as follows:
Our stockholders ratified the selection of BDO by a vote of 12,282,785 shares FOR, 14,313 AGAINST, and 6,254 shares abstained. No other matters were submitted to a vote of security holders during the fourth quarter for the year ended December 31, 2007.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information and Holders
Our common stock trades on the NASDAQ Global Market under the symbol “ALLI.” The following table sets forth the quarterly high and low closing sale prices for our common stock for the periods indicated, as reported by NASDAQ.
The last reported sale price of our common stock on March 12, 2008 was $5.50 per share. As of March 12, 2008, we had approximately 100 stockholders of record.
Dividends
We have not declared or paid cash dividends on our common stock in the last two fiscal years, and we do not plan to pay cash dividends to our stockholders in the near future.
Recent Sales of Unregistered Securities
During the fiscal year ended December 31, 2007, we did not issue or sell any securities that were not registered under the Securities Act.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2007 regarding compensation plans under which equity securities of the Company are authorized for issuance.
Equity Compensation Plan Information
(1)
Includes options granted pursuant to our 1998 Stock Option Plan and 2002 Stock Option Plan.
(2)
Includes warrants granted to individuals and corporations as consideration for services provided within the meaning of FAS 123R and for purchase consideration for acquisitions. The warrants were granted by us upon authorization of our Board of Directors and were not issued pursuant to a single equity compensation plan that exists to grant warrants in exchange for goods and services. The terms of the warrants vary from grant to grant and are disclosed in Note 16 to the Consolidated Financial Statements.
Each of the above plans provides that the number of shares with respect to which options may be granted, and the number of shares of common stock subject to an outstanding option, shall be proportionately adjusted in the event of a subdivision or consolidation of shares, and the purchase price per share of outstanding options shall be proportionately revised.
Performance Graph
The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
The following graph compares the cumulative total returns on our common stock with (1) the NASDAQ Stock Market (U.S. Companies) Index and (2) the NASDAQ Healthcare Services Index for the period from June 22, 2005, the date our common stock began to trade on NASDAQ, through December 31, 2007. We believe the NASDAQ Healthcare Services Index includes companies that are comparable to us in terms of their businesses.
For purposes of preparing the graph, we assumed that an investment of $100 was made on June 22, 2005 with reinvestment of any dividends at the time they were paid. We did not pay any dividends during the period indicated.
The comparison in the graph below is based on historical data and is not necessarily indicative of future performance of our common stock.
Item 6.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with, and is qualified in its entirety by reference to, our historical financial statements and the notes to those statements and Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
(Dollar amounts in thousands)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and Notes thereto, which appear in Item 8 of this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review Item 1A. Risk Factors of this Annual Report for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
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 ASOs, 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 ADAP, to pay for their HIV/AIDS medications.
We believe that the combination of services we offer to patients, healthcare providers and payors makes us an attractive source of specialty pharmacy and disease management services, contributes to better clinical outcomes and reduces overall healthcare costs. Our services include the following:
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Specialized MOMSPak prescription packaging that helps reduce patient error associated with complex multi-drug regimens, which require multiple drugs to be taken at varying doses and schedules;
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Reimbursement experience which assists patients and healthcare providers with the complex reimbursement processes and optimizes collection of payment;
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Arrangement for the timely delivery of medications in a discreet and convenient manner as directed by our patients or their physicians;
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Specialized pharmacists who consult with patients, physicians, nurses and ASOs to provide education, counseling, treatment coordination, clinical information and compliance monitoring; and
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Information systems and prescription automation solutions that make the provision of clinical data and the transmission of prescriptions more efficient and accurate.
We have grown our business primarily by acquiring other specialty pharmacies and expanding our existing business. In December 2007, we opened our first satellite pharmacy in Oakland, California. 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 in our existing locations. We will continue to evaluate acquisitions and expand our existing business as opportunities arise or circumstances warrant.
On March 13, 2008, we signed a definitive merger agreement to acquire 100% of the stock of Biomed for aggregate consideration of approximately $117.8 million. Biomed is a leading provider of specialized biopharmaceutical medications
and services to chronically ill patients. Under the definitive merger agreement, we will pay Biomed’s stockholders an aggregate of $48.0 million in cash and issue a total of 9.35 million shares of our common and preferred stock valued at approximately $51.4 million. We will also assume up to $18.4 million of Biomed’s debt. In addition, we may make an earn-out payment in 2009 if Biomed achieves certain financial performance benchmarks during the first 12 months after closing. We expect to pay the purchase price with funds from a new senior credit facility, available cash and newly issued common stock and preferred stock. The closing will be subject to government approval and is expected to close within 60 days.
Geographic Footprint. We operate our business as a single reporting segment configured to serve key geographic areas. As of December 31, 2007, we operated eleven distribution centers, strategically located in California (seven separate locations), New York (two separate locations), Florida and Washington to serve major metropolitan areas where 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 regional distribution centers because we believe this provides a meaningful indication of the historical performance of our business.
We ceased operating our Austin, Texas distribution center as of June 30, 2005. A significant portion of the operations of that distribution center was dedicated to serving organ transplant and oncology patients. 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 closing that facility. In 2005, our Austin, Texas distribution center contributed approximately $1,500 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 in the United States, or GAAP, we have restated prior periods to reflect the presentation of the Texas facility as “discontinued operations,” so that period-to-period results are comparable.
Net Sales. As of December 31, 2007, approximately 64% of our net sales came from payments directly from government sources such as Medicaid, ADAP, and Medicare (excluding Part D, described below, which is administered through private payor sources). These are all highly regulated government programs subject to frequent changes and cost containment measures. We continually monitor changes in reimbursement for HIV/AIDS medications.
On December 8, 2003, the MMA was signed into law. This legislation made significant structural changes to the federal Medicare program, including the establishment of a new Medicare Part D outpatient prescription drug program. Effective January 1, 2006, Medicaid coverage of prescription drugs for Medicaid beneficiaries who were also eligible for Medicare transitioned to the Medicare program. These beneficiaries, referred to as “dual eligibles,” are now enrolled in the Medicare PDPs. We have agreements in the geographic regions we serve with most of these PDPs to provide prescription drugs to our dual-eligible patients. Typically, the PDPs provide a lower reimbursement rate than the rates we received from the Medicaid programs. In December 2007 and 2006, approximately 20.3% and 19.4% of our patients, respectively, received coverage under a PDP.
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 prevents us from recovering the full amount of any price increases.
Operating Expenses. Our operating expenses are made up of both variable and fixed costs. Our principal variable costs, which increase as net sales increase, are labor and delivery. Our principal fixed costs, which do not vary directly with changes in net sales, are facilities, equipment and insurance.
While we believe that we now have a sufficient revenue base to continue to operate profitably given our current level of operating and other expenses, our business remains subject to uncertainties and potential changes that could result in losses. In particular, changes to reimbursement rates, 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. For a further discussion regarding these uncertainties and potential changes, see Item 1A. Risk Factors in this Annual Report on Form 10-K.
Critical Accounting Policies
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. 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 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.
We discuss these and other significant accounting policies related to our continuing operations in Note 2 of the notes to our Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Revenue Recognition. We are reimbursed for a substantial portion of our net sales by government and private payors. Net sales are recognized upon delivery, which occurs when our customers receive medications or products, and are recorded net of contractual allowances to patients, government and private payors and others in the period when delivery to our patients is completed. Contractual allowances represent estimated differences between billed sales and amounts expected to be realized from third-party payors under contractual agreements.
Any patient can initiate the filling of prescriptions by having a doctor call in prescriptions to our pharmacists, faxing our pharmacists a prescription, mailing prescriptions, or electronically submitting prescriptions to one of our facilities. Once we have verified that the prescriptions are valid and have received authorization from a patient’s insurance company or state insurance program, the pharmacist then fills the prescriptions and ships the medications to the patient through our outside delivery service, an express courier service or postal mail, or the patient picks up the prescription at the pharmacy. During December 2007, we serviced 15,610 patients.
We receive premium reimbursement under the California Pilot Program and have been certified as a specialized HIV pharmacy eligible for premium reimbursement under the New York State Medicaid program. The California Pilot Program was recently extended as part of California’s 2007 budget process and is currently set to expire on June 30, 2008. We are currently certified in New York through September 2008. We qualified for both the California and New York programs in 2005, including retroactive payment of prescriptions dating back to September 2004. 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. These revenues are estimated at the time service is provided and accrued to the extent that payment has not been received. Under the California Pilot Program, we receive regular payments for premium reimbursement, which are paid in conjunction with the regular reimbursement amounts due through the normal payment cycle. In New York, we receive the premium payment annually, and we received the annual payment for fiscal 2006 under the New York program in October 2007. For additional information regarding each of these reimbursement programs, please refer to Part I, Item 1. Business-Third Party Reimbursement, Cost Containment and Legislation.
The California Department of Health Services, or DHS, audited the premium reimbursement paid to us under the California Pilot Program for the period September 1, 2004 to August 2, 2007. Upon completion of the audit, we were assessed and paid $758 of which $640 relates to periods prior to 2007, which was recorded in 2007.
Allowance for Doubtful Accounts. Management regularly reviews the collectibility of accounts receivable by tracking collection and write-off activity. Estimated write-off percentages are then applied to each aging category by payor classification to determine the allowance for estimated uncollectible accounts. The allowance for estimated uncollectible accounts is adjusted as needed to reflect current collection, write-off and other trends, including changes in assessment of realizable value. 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. Our ability to successfully collect our accounts receivable depends, in part, on our ability to adequately supervise and train personnel in billing and collections and minimize losses related to system changes.
Long-Lived Asset Impairment. In assessing the recoverability of our intangible assets, we 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 material decreases in the fair value of some or all of the assets. Changes in strategy or market conditions could significantly impact these assumptions, and as a result, we may be required to record impairment charges for these assets. We have adopted Statement of Financial Accounting Standards, or SFAS, No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS No. 144. For the year ended
December 31, 2007, we recorded a non-cash charge of $599 to our results of operations to reflect the impairment of our intangible asset as a result of the termination of our license for the Labtracker-HIVTM software from Ground Zero.
Goodwill and Other Intangible Assets. In accordance with SFAS No. 141, “Business Combinations,” and SFAS 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 the carrying value of reporting units. Measuring the 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 that 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
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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 2007 impairment review process, we have not recorded any impairment to goodwill and other intangible assets that have indefinite lives during the fiscal year ended December 31, 2007.
Recently Issued Accounting Pronouncements
We describe recent accounting pronouncements applicable to us under Note 3 to our Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Results of Operations
Fiscal Years Ended December 31, 2007 and 2006
The following table sets forth the net sales and operating data for each of our distribution centers for the 12 months ended December 31, 2007 and 2006:
(In thousands, except patient and prescription data)
(1)
California operations for the 12 months ended December 31, 2006 include $858 of retroactive premium reimbursement for prior periods in 2005 and 2004. California operations for the 12 months ended December 31, 2006 also include partial period contributions from the acquisitions of H&H Drug Stores, Inc., or H&H, and Whittier Goodrich Pharmacy, Inc., or Whittier. We acquired H&H on April 6, 2006 and Whittier on May 1, 2006. California operations for the 12 months ended December 31, 2007 include a reduction of $640 of premium reimbursement for prior periods in 2006, 2005 and 2004 related to the DHS audit. In the second quarter of 2007, we identified an error in the reporting of Gardena prescriptions and corrected the previously reported number of prescriptions of 595,208 in California for the 12- month period ended December 31, 2006.
(2)
New York operations for the 12 months ended December 31, 2006 include $59 of retroactive premium reimbursement for prior periods in 2005. New York operations for the 12 months ended December 31, 2006 include partial period contributions from the acquisitions of H.S. Maiman Rx, Inc., or Maiman, and St. Jude Pharmacy & Surgical Supply Corp., or St. Jude. We acquired Maiman on March 13, 2006 and St. Jude on July 14, 2006.
The prescription and patient month data has been presented to provide additional data about our 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 for a yearly period, a count of 12 would be included in patient months irrespective of the number of medications filled each month.
Net Sales. Net sales in 2007 increased to $246,661 from $209,503 in 2006, an increase of 17.7%. Included in net sales for the year ended December 31, 2006 is $917 of retroactive premium reimbursement relating to prior periods in 2005 and 2004, as a result of retroactive payment of prescriptions dating back to September 2004 upon our qualification in 2005 for the California Pilot Program and premium reimbursement in New York. Included in net sales for the year ended December 31, 2007 is a reduction of $640 of premium reimbursement, previously reported in 2005 and 2006 revenue, related to prior periods in 2006, 2005 and 2004, as a result of the DHS audit. Net sales in California and New York increased by 15.9% and 22.4%, respectively for the year ended December 31, 2007 as compared to the same period in 2006, primarily attributable to acquisitions completed during fiscal 2006 and an increase in volume from the addition of new patients. For the years ended December 31, 2007 and 2006, we recorded net sales of $2,330 and $2,685, respectively, for the New York and California premium reimbursement programs collectively.
As of December 31, 2007 and 2006, the receivable balance relating to premium reimbursement was $792 and $606. Accounts receivable at December 31, 2007 consisted of $792 relating to the New York reimbursement program for which we receive annual payments. Based on our experience in 2007, we expect to receive payment with respect to the New York program in the fourth quarter of 2008; however, there can be no assurance as to when we will actually receive payment. At December 31, 2007, we had a liability of $180 related to the California reimbursement program for overpayments made in 2007.
Gross Profit. Gross profit was $35,274 and $30,641 for the years ended December 31, 2007 and 2006, respectively, and represents 14.3% and 14.6% of net sales, respectively. Gross profit for the years ended December 31, 2007 and 2006 includes ($640) and $917, respectively, related to the retroactive premium reimbursement (in net sales) from prior periods.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2007 increased to $30,302 from $27,698 for the year ended December 31, 2006, but declined as a percentage of net sales to 12.3% in 2007 from 13.2% in 2006. The increase in selling, general and administrative expenses was primarily due to increased expenses related to acquisitions. The decrease in selling, general and administrative expenses as a percentage of net sales is primarily due to integrating the acquisitions into our existing facilities, which improved operating efficiencies related to labor and other resources as prescription volumes increased.
The increase in selling, general and administrative expenses for the year ended December 31, 2007 as compared to the same period in 2006 primarily consisted of the following components:
Included in selling, general & administrative expenses for the fiscal year ended December 31, 2007 was approximately $1,485 of legal expenses relating to the litigation with Oris Medical Systems, Inc., or OMS, discussed in Part I, Item 3. Legal Proceedings of this Annual Report on Form 10-K.
Increase in labor and shipping expenses are related the increased costs associated with a full year of our 2006 acquisitions of Maiman, H&H, Whittier and St. Jude.
Impairment of Long-Lived Assets. As a result of the termination of the LabTracker license agreement with Ground Zero, we recorded a charge of $599 ($1,228, less accumulated amortization of $629) for the year ended December 31, 2007 to reflect the impairment of a long-lived asset related to the LabTracker license.
Operating Income. Operating income for the year ended December 31, 2007 was $4,373 as compared to an operating income of $2,943 for the year ended December 31, 2006, which represented 1.8% and 1.4% of net sales, respectively. The increase in operating income in 2007 is attributable to an increase in gross profit of $4,633, offset by an increase in selling, general and administrative expenses of $2,604 and an impairment of long-lived assets charge of $599. The overall increase in operating income resulted primarily from a full year of our 2006 acquisitions integrated into our existing facilities and, to a lesser extent, prescription growth at our existing pharmacies.
Interest Income. Interest income was $804 and $1,254 for the years ended December 31, 2007 and 2006, 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, and to the change in our investment portfolio to non-taxable securities. We receive interest income primarily from our investment in short-term securities and other cash equivalents.
Provision for Taxes. We recorded a provision for taxes in the amount of $1,917 and $1,007 for the years ended December 31, 2007 and 2006, respectively. The provision for the years ending December 31, 2007 and 2006 relate to federal, state and local income tax as adjusted for certain permanent differences. Our income taxes payable were significantly less than the tax provisions due to significant tax deductions related to non-cash compensation in 2006 and net operating loss deductions attributable to such non-cash compensation in 2007. The tax benefit of these deductions was credited to additional paid in capital.
The increase in the effective tax rate to 37.0% for the year ended December 31, 2007 from 24.0% for the year ended December 31, 2006 is due to the fact that, for the year ended December 31, 2006, a benefit was recognized upon the reversal of a valuation allowance against our deferred tax assets, thereby reducing the effective tax rate. Because the valuation allowance was released at December 31, 2006, there is no such benefit recognized in the year ended December 31, 2007.
Net Income. For the year ended December 31, 2007, we recorded net income of $3,260 as compared to a net income of $3,190 for the comparable period in 2006. Net income for the year ended December 31, 2007 includes a ($640) pre-tax adjustment to premium reimbursement for prior periods ($403 net of tax) as a result of the DHS audit and a $599 pre-tax charge for the impairment of long-lived assets ($377 net of tax). Net income for the year ended December 31, 2006 includes $917 of pre-tax retroactive premium reimbursement ($697 net of tax) from prior periods in 2005 and 2004, as a result of retroactive payment of prescriptions dating back to September 2004 upon our qualification in 2005 for the California Pilot Program and premium reimbursement in New York.
Fiscal Years Ended December 31, 2006 and 2005
The following table sets forth the net sales and operating data for each of our distribution centers for the 12 months ended December 31, 2006 and 2005:
(In thousands, except patient & prescription data)
(1)
California operations for the 12 months ended December 31, 2006 includes $858 of retroactive premium reimbursement for prior periods in 2005 and 2004. For the 12 months ended December 31, 2005, California operations include retroactive premium reimbursement of $185 for prior periods in 2004. California operations for the 12 months ended December 31, 2006 also includes 12 months of contribution from the acquisitions of Specialty Pharmacies, Inc, or SPI, Frontier Pharmacy & Nutrition, or PMW and Priority Pharmacy, or Priority. Additionally, it includes 8.5 months of contribution from H&H and eight months of contribution from Whittier. In the second quarter of 2007, we identified an error in the reporting of Gardena prescriptions and corrected the previously reported number of prescriptions of 595,208 in California for the 12- month period ended December 31, 2006.
(2)
California operations for the 12 months ended December 31, 2005 includes ten months of contribution from SPI, five months of contribution from PMW and one month of contribution from Priority.
(3)
New York operations for the 12 months ended December 31, 2006 includes $59 of retroactive premium reimbursement for prior periods in 2005. For the 12 months ended December 31, 2005, New York operations include retroactive premium reimbursement of $99 for prior periods in 2004. New York operations for the 12 months ended December 31, 2006 also includes 9.5 months of contribution from Maiman and 5.5 months of contribution from St. Jude.
(4)
Seattle operations for the 12 months ended December 31, 2005 includes ten months of contribution from SPI.
The prescription and patient month data has been presented to provide additional data about our 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 for a yearly period, a count of 12 would be included in patient months irrespective of the number of medications filled each month.
Net Sales. Net sales in 2006 increased to $209,503 from $123,108 in 2005, an increase of 70.2%. Included in net sales for the years ended December 31, 2006 and 2005 is $917 and $284 of retroactive premium reimbursement, respectively, relating to prior periods as a result of retroactive payment of prescriptions dating back to September 2004 upon our qualification in 2005 for the California Pilot Program and premium reimbursement in New York. Net sales in California and New York increased by 83.4% and 52.1%, respectively for the year ended December 31, 2006 as compared to the same period in 2005, primarily because of acquisitions completed during fiscal 2006, and, to a lesser extent, increases in the number of prescriptions filled at our existing facilities. Sales increased in Seattle primarily due to a full year’s contribution from SPI in 2006 as compared to ten months contribution in 2005. Our Florida revenue increased 3.4% year over year primarily due to an increase in the average revenue per prescription.
In 2005, we qualified for the California Pilot Program 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 fiscal 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 years ended December 31, 2006 and 2005, we recorded net sales of $2,685 and $2,555, respectively, for the New York and California premium reimbursement programs, collectively. As of December 31, 2006 and 2005, we had accounts receivable of $606 and $2,412, respectively, relating to premium reimbursement in New York and California including retroactive payments for prior periods. The accounts receivable at December 31, 2006 consisted of $487 relating to the New York reimbursement program, which was collected in October 2007. The balance relating to the California Pilot Program has been collected.
Gross Profit. Gross profit was $30,641 and $19,862 for the years ended December 31, 2006 and 2005, respectively, and represents 14.6% and 16.1% of net sales, respectively. Gross profit for the years ended December 31, 2006 and 2005 includes $917 and $284, respectively, related to the retroactive premium reimbursement (in net sales) from prior periods. Gross margin for the fiscal year ended December 31, 2006 decreased 1.5% as compared with the gross margin for the fiscal year ended December 31, 2005, primarily due to lower reimbursement on patients that moved from state Medicaid programs to Medicare Part D PDPs and our increased focus on our lower-margin HIV business as our higher-margin North American Home Health Supply, Inc., or NAHH, business becomes a smaller portion of our overall business.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2006 increased to $27,698 from $18,350 for the year ended December 31, 2005, but declined as a percentage of net sales to 13.2% in 2006 from 14.9% in 2005. The increase in selling, general and administrative expenses was primarily due to increased expenses related to acquisitions. The decrease in selling, general and administrative expenses as a percentage of net sales is primarily due to integrating the acquisitions into our existing facilities, which improved operating efficiencies related to labor and other resources as prescription volumes increased.
The increase in selling, general and administrative expenses for the year ended December 31, 2006 as compared to the same period in 2005 primarily consisted of the following components:
Included in selling, general & administrative expenses for the fiscal year ended December 31, 2006 was approximately $607 of legal, accounting and printing expenses relating to the SEC’s informal inquiry, discussed in Part I, Item 3. Legal Proceedings of this Annual Report on Form 10-K, our comment letter review process with the SEC in 2006 and the restatement of our financial statements for prior periods in 2006 and 2005.
Included in selling, general & administrative expenses for the fiscal year ended December 31, 2006 was $1,077 of bad debt expense. This balance includes a bad debt adjustment of $453 for retroactive premium reimbursement related to our San
Francisco facility. The State of California issued payment to us for retroactive premium reimbursement for prior periods in 2004 and early 2005, which was less than the amount California previously indicated we would receive. We are now receiving regular weekly payments for current transactions under the California Pilot Program through the normal reimbursement process. In 2005, we recorded $128 in bad debt expense. This amount includes a recovery of $88 for accounts previously deemed uncollectible and recorded as bad debt in prior periods. This resulted in a net increase in bad debt of $408 year over year; however, bad debt remained relatively flat as a percentage of net sales.
Operating Income. Operating income for the year ended December 31, 2006 was $2,943 as compared to an operating income of $1,512 for the year ended December 31, 2005, which represented 1.4% and 1.2% of net sales, respectively. The increase in operating income is attributable to an increase in gross profit of $10,779, partially offset by an increase in selling, general and administrative expenses of $9,348. The overall increase in operating income resulted primarily from our acquisitions in 2006 and, to a lesser extent, increased prescription volume at our existing pharmacies.
Interest Income (Expense). Interest income was $1,254 for the year ended December 31, 2006 as compared to interest expense of $1,059 for the year ended December 31, 2005. 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 our initial public offering, or IPO, in 2005, as well as to $966 of non-cash expense recorded in June 2005 related to the fair value of warrants that we issued in connection with the private placement of subordinated notes and that we issued to a director in exchange for the guarantee of a credit facility. Interest income for the year ended December 31, 2006 was primarily due to our investment in short-term securities and cash balances.
Other Income (Expense). Other expense was $1,133 for the year ended December 31, 2005 related to the fair value adjustment of redeemable warrants that became non-redeemable upon the completion of our IPO. For the year ended December 31, 2006, there were no other expenses recorded.
Provision for Taxes. We recorded a provision for taxes in the amount of $1,007 and $329 for the years ended December 31, 2006 and 2005, respectively. These provisions relate primarily to state income tax and federal alternative minimum tax, which would have been payable before income tax deductions relating to stock-based compensation created a taxable loss, and deferred taxes relating to tax-deductible goodwill. Because the tax provisions are not payable by us, the amounts were credited to additional paid in capital. The effective tax rates for the years ended December 31, 2006 and 2005 were 24.0% and (48.4%), respectively, in each case, as a result of the utilization of prior year net operating loss carry forwards.
Net Income. For the year ended December 31, 2006, we recorded net income of $3,190 as compared to a net loss of ($2,383) for the comparable period in 2005. Net income for the year ended December 31, 2006 includes $917 of pre-tax retroactive premium reimbursement ($697 net of tax) from prior periods in 2005 and 2004, as a result of retroactive payment of prescriptions dating back to September 2004 upon our qualification in 2005 for the California Pilot Program and premium reimbursement in New York.
Liquidity and Capital Resources
As of December 31, 2007, we had $19,557 of cash and cash equivalents and $9,283 of short-term investments, as compared to cash and cash equivalents of $17,062 and short-term investments of $6,450 as of December 31, 2006. The increase in cash and cash equivalents was primarily due to an increase in cash provided by operating activities.
Our short-term investments as of December 31, 2007 are investments in auction rate securities. Contractual maturities for these auction rate securities range from 18 years to 34 years with an interest reset date of approximately 35 days. Historically, the carrying value of auction rate securities approximated fair value due to the frequent resetting of the interest rates. With the liquidity issues experienced in the global credit and capital markets, some of our auction rate securities have experienced multiple failed auctions. We have been able to successfully liquidate $7,100 of these instruments held at December 31, 2007 in auctions held in early 2008. However, we have not been able to liquidate the remaining balance and have not purchased any additional auction rate securities in 2008. It is our intent to hold the $2,200 balance until liquidity is restored which we expect to be later in 2008 and we do not expect to incur any losses. We do not anticipate having to sell these securities in order to operate our business. We believe that with our current cash and cash equivalents of $19,557 at December 31, 2007, the current lack of liquidity in the credit and capital markets will not have a material impact on our liquidity, cash flow or our ability to fund our operations.
Accounts receivable, net of allowance, increased $724 in the fiscal year ended December 31, 2007 from December 31, 2006, primarily due to increased revenues. Inventory increased $3,142 in the fiscal year ended December 31, 2007 from December 31, 2006 due to an increase in purchasing to take advantage of product discounts and additional inventory needed to support the current volume of business. The increase in accounts payable and accrued expenses from $17,601 as of
December 31, 2006 to $18,151 as of December 31, 2007 was due principally to Medi-Cal liability that resulted from the DHS audit related to our premium reimbursement in California.
On April 21, 2006, we allowed our credit facility agreement with GE HFS Holdings, Inc. f/k/a Heller Healthcare Finance, or GE, to expire. The GE credit facility had provided us with the ability to borrow up to a maximum of $6,000, based on our accounts receivable. As of February 5, 2007, this agreement had been fully terminated and the UCC financing statement removed.
During the fourth quarter of 2007, we serviced 1,177 total patients that were monitored under the LabTracker software and/or Oris System, an electronic prescription writing system, both of which are subject to an earn-out formula that gives OMS and Ground Zero the right to receive quarterly payments based on the net number of new HIV patients of physician customers who utilize the LabTracker software or the Oris System. The number of patients monitored under the LabTracker software and/or under Oris System and covered under the Oris earn-out formula decreased by 31 patients from the third quarter of 2007. Since acquiring the assets of OMS, a total of 638 patients have been subject to the Oris earn-out formula set forth in the asset purchase agreement with OMS, with $638 earned by OMS and Ground Zero under the agreement.
On April 2, 2007, Ground Zero formally notified us of the termination of our license to use the LabTracker software. Notwithstanding the termination, additional earn-out payments will continue to be recorded as earned over the succeeding 16 months following the license termination. OMS’ and Ground Zero’s rights to the additional payments terminate in October 2008.
Operating Requirements. Our primary liquidity need is cash to purchase medications to fill prescriptions. Our primary vendor, AmerisourceBergen, requires payment within 31 days of delivery of the medications to us. We are reimbursed by third-party payors, on average, within 30 days after a prescription is filled and a claim is submitted in the appropriate format.
The five-year purchase agreement that we signed with AmerisourceBergen in September 2003 improved our supplier payment terms from an original payment period of 13 days to 31 days. These payment terms improved our liquidity and enabled us to reduce our working capital. Since entering into the agreement with Amerisource Bergen, we have purchased the majority of our medications from AmerisourceBergen. If we do not meet the aggregate minimum purchase commitments under our agreement with AmerisourceBergen by the end of the five-year term, we will be charged 0.2% of the un-purchased volume commitment. We have purchased approximately $437,212 under the agreement with Amerisource Bergen, and we believe we have met our minimum purchase obligations under this agreement. Pursuant to the terms of a related security agreement, AmerisourceBergen has a subordinated security interest in all of our assets.
Our operations provided $6,168 and $5,131 of cash over the fiscal year ended December 31, 2007 and 2006, respectively.
Cash flows used in investing activities were $3,660 and $22,349 for the years ended December 31, 2007 and 2006, respectively. This included payments of $519 and $38,316 for acquisitions, net investments in short term securities of $2,820 and ($16,501), and the purchase of property and equipment of $321 and $534 for the years ended December 31, 2007 and 2006, respectively.
Cash flows used in financing activities for the year ended December 31, 2007 was $13 and provided by financing activities for the year ended December 31, 2006 was $30,435. Net proceeds provided by financing activities for the year ended December 31, 2006 included net proceeds of $28,852 from our secondary offering of common stock in January 2006. Also included for the year ended December 31, 2006 was net proceeds of $2,153 from the exercise of employee stock options and warrants and the tax benefit realized from the exercise of employee stock options of $733 and $212 for the years ended December 31, 2007 and 2006, respectively. Cash flows were net of the repayment of various obligations (principally debt) of $746 and $782 for the years ended December 31, 2007 and 2006, respectively.
As of March 10, 2008, we had approximately $31,037 in cash and short term investments. We believe that our cash balances will be 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.
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.
Although we currently believe that we have sufficient capital resources to meet our anticipated working capital and capital expenditure requirements beyond the next 12 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. However, we can offer no assurance that we will be able to obtain adequate financing on reasonable terms or on a timely basis, if at all.
Contractual Obligations. At December 31, 2007, our contractual cash obligations and commitments over the next five years were as follows:
(In thousands)
(1)
Interest payments on these amounts will be approximately $3 over the next three years.
On March 13, 2008, we signed a definitive merger agreement to acquire 100% of the stock of Biomed for aggregate consideration of approximately $117.8 million. Biomed is a leading provider of specialized biopharmaceutical medications and services to chronically ill patients. Under the definitive merger agreement, we will pay Biomed’s stockholders an aggregate of $48.0 million in cash and issue a total of 9.35 million shares of our common and preferred stock valued at approximately $51.4 million. We will also assume up to $18.4 million of Biomed’s debt. In addition, we may make an earn-out payment in 2009 if Biomed achieves certain financial performance benchmarks during the first 12 months after closing. We expect to pay the purchase price with funds from a new senior credit facility, available cash and newly issued common stock and preferred stock. The closing will be subject to government approval and is expected to close within 60 days.
Off-Balance Sheet Arrangements. We do not have any off-balance sheet arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Sensitivity
We have limited exposure to financial market risks, including changes in interest rates. At March 10, 2008, we had cash and cash equivalents of approximately $28.8 million and short-term investments of approximately $2.2 million. Cash and cash equivalents consisted of demand deposits, money market accounts and government obligations. Short-term investments consisted of highly liquid investments in auction rate securities. These investments are classified as available-for-sale and are considered short-term because they mature within 12 months. Due to their short maturities, we do not believe these investments are subject to a material interest rate risk. 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. We have not hedged against our interest rate risk exposure for our cash or investments.
Other Market Risk
With the liquidity issues experienced in the global credit and capital markets, $2.2 million of our auction rate securities have experienced multiple failed auctions in early 2008. It is our intent to hold the $2.2 million until liquidity is restored, and we do not expect to incur any losses.
We are not subject to other market risks such as currency risk, commodity price risk or equity price risk.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The following financial statements are included in this Report.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2007 and 2006
Consolidated Statements of Operations for the years ended December 31, 2007, 2006, and
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2007, 2006, and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006, and
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Allion Healthcare, Inc.
Melville, New York
We have audited the accompanying consolidated balance sheets of Allion Healthcare, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2007. In connection with our audit of the consolidated financial statements, we have also audited the financial statement schedule as listed in Part IV, Item 15(2) of this Annual Report, for each of the three years in the period ended December 31, 2007. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statement and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allion Healthcare, Inc. and Subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2006 the Company changed its method of accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123R, “Share-Based Payment.”
We also have audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), Allion Healthcare, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 14, 2008 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Melville, New York
March 14,
ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2007 AND 2006
See accompanying notes to consolidated financial statements.
ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
See accompanying notes to consolidated financial statements.
ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
See accompanying notes to consolidated financial statements.
ALLION HEALTHCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
ALLION HEALTHCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except per share and patient data)
Note 1. The Company
Allion Healthcare, Inc. (the “Company” or “Allion”) is the parent corporation of several subsidiaries that operate under the MOMS Pharmacy name as one reportable segment. These subsidiaries are located in California, New York, Florida and Washington. In March 2005, the Company decided to cease operations in Texas and these operations have been reflected as a discontinued operation in the statements of operations. The Company is a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. The Company sells HIV/AIDS medications, ancillary drugs and nutritional supplies under its trade name MOMS Pharmacy. Most of the Company’s patients rely on Medicare, Medicaid and other state-administered programs, such as the AIDS Drug Assistance Program (“ADAP”), to pay for their HIV/AIDS medications.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
Inventories. Inventories consist entirely of pharmaceuticals available for sale. Inventories are recorded at lower of cost or market, cost being determined on a first-in, first-out basis.
Use of Estimates by Management. The preparation of the Company’s financial statements, in conformity with United States generally accepted accounting principles (“GAAP”), requires the Company’s management to make certain estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Such estimates primarily relate to accounts receivable, deferred tax valuation and intangibles. Actual results could differ from those estimates.
Property and Equipment. Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful life. Machinery and equipment under capital leases is amortized over the life of the respective lease or useful life of the asset, whichever is shorter.
Revenue Recognition. Net sales are recognized upon delivery, which occurs when medications or products are received by customers. A substantial portion of the Company’s net sales are billed to third-party payors, including insurance companies, managed care plans and governmental payors. Sales are recorded net of contractual adjustments and related discounts. Contractual adjustments represent estimated differences between billed sales and amounts expected to be realized from third-party payors under contractual agreements. Any customer can initiate the filling of prescriptions by having a doctor call in prescriptions to one of the Company’s pharmacists, faxing over a prescription to the Company’s pharmacists, or mailing prescriptions to one of the Company’s facilities. Once the Company has verified that the prescriptions are valid and has received authorization from a customer’s insurance company or state insurance program, the pharmacist fills the prescriptions and ships the medications to the customers through the Company’s outside delivery service, an express courier service or postal mail, or the patient picks up the prescription at the pharmacy.
The Company receives premium reimbursement under the California HIV/AIDS Pharmacy Pilot Program (the “California Pilot Program”) and is certified as a specialized HIV pharmacy eligible for premium reimbursement under the New York State Medicaid program. 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. Payments for premium reimbursement are paid to the Company in conjunction with the regular reimbursement amounts due through the normal payment cycle for the California Pilot Program, and the Company receives annual payment under the New York program.
Income Taxes. The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the Company’s financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount currently estimated to be realized.
Cash Equivalents. For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents include money market accounts and government obligations.
Short Term Investments. The Company’s short term investments consist of certificates of deposit and available for sale securities (principally auction rate securities), which are carried at fair value. Unrealized gains and losses are reported as accumulated comprehensive income in stockholders’ equity until realized. For additional discussion of short term investments, refer to Note 7 in the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.
Credit Risk. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. The Company has substantially all of its cash, cash equivalents and short-term investments with two financial institutions. Such cash balances, at times, may exceed FDIC limits. To date, the Company has not experienced any losses in such accounts. The Company’s trade receivables represent a broad customer base, and the Company routinely assesses the financial strengths of its customers. As a consequence, concentrations of credit risk are limited.
In early 2008, the global credit and capital markets have experienced liquidity issues. There have been recent auction market failures and at present there is no official estimate when liquidity will be restored to the market. Approximately $7,100 auction rate securities were sold in the first quarter of 2008. It is the Company’s intention to hold the balance of $2,200 until liquidity is restored (expected to be later in 2008) and the Company does not expect to incur any losses. As of December 31, 2007, the Company did not incur any impairment charge.
Net Earnings (Loss) Per Share Information. Basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share are adjusted for the impact of common stock equivalents using the treasury stock method when the effect is dilutive. The following table sets forth the computation of basic and diluted net income per share:
For the years ended December 31, 2007, 2006 and 2005, the diluted earnings (loss) per share does not include the impact of common stock options and warrants then outstanding of 915, 150, and 2,603, respectively, as the effect of their inclusion would be anti-dilutive.
Stock-Based Compensation Plans. Under the terms of the Company’s stock option plans, the Board of Directors may grant incentive and nonqualified stock options to employees, officers, directors, agents, consultants and independent contractors of the Company.
On January 1, 2006, the Company adopted Financial Accounting Standards Board (“FASB”) Statement on Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share Based Payment” (“SFAS 123R”), which requires the grant-date fair value of all share-based payment awards that are expected to vest, including employee share options, to be recognized as compensation expense over the requisite service period. The Company adopted SFAS 123R by applying the modified prospective transition method and, therefore, (i) did not restate any prior periods and (ii) is recognizing compensation expense for all share-based option awards granted after January 1, 2006 and that were outstanding, but not yet vested, as of January 1, 2006, based upon the same estimated grant-date fair values and service periods used to prepare the Company’s SFAS 123 pro-forma disclosures.
Prior to adopting SFAS 123R, 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 share-based compensation. Under APB No. 25, compensation expense was recorded if, on the date of grant, the market price of the underlying share 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 awards issued been determined under the fair value method of SFAS No. 123, the Company’s net loss and EPS for the year ended December 31, 2005 would have been:
During the year ended December 31, 2007 and 2006, the Company recorded $354 and $310, respectively, in non-cash compensation expense related to its share-based compensation awards. The Company recognizes compensation expense for share-based option awards on a straight-line basis over the requisite service period of the entire award. Compensation expense related to share-based option awards is recorded in selling, general and administrative expenses. The grant-date fair value of share-based payment awards is determined using a Black-Scholes model. The weighted average grant-date fair value of options granted during 2006 and 2005 were $4.29 and $4.43, respectively. The Company did not grant any options in 2007.
The following table summarizes the assumptions used for option grants during the years ended December 31, 2006 and 2005.
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. The Company has not declared or paid any dividends and does not currently expect to do so in the future. The expected term of options represents the period during which the share-based awards are expected to be outstanding and were determined based on contractual terms of the share-based awards and vesting schedules. Expected volatility is based on market prices of traded shares for comparable entities within the Company’s industry. Prior to the Company’s June 22, 2005 initial public offering (“IPO”), Allion used the minimum value method to calculate volatility.
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.
Allowance for Doubtful Accounts. Management regularly reviews the collectibility of accounts receivable by tracking collection and write-off activity. Estimated write-off percentages are then applied to each aging category by payor classification to determine the allowance for estimated uncollectible accounts. The allowance for estimated uncollectible accounts is adjusted as needed to reflect current collection, write-off and other trends, including changes in assessment of realizable value. While management believes the resulting net carrying amounts for accounts receivable are fairly stated at each quarter end and that the Company has made adequate provisions for uncollectible accounts based on all information available, 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. The Company’s ability to successfully collect its accounts receivable depends, in part, on its ability to adequately supervise and train personnel in billing and collections and minimize losses related to system changes.
Shipping and Handling Costs. Incurred shipping and handling costs are included in selling, general and administrative expenses. Shipping and handling costs were approximately $2,770, $2,313 and $1,715, in 2007, 2006, and 2005, respectively. Shipping and handling costs are not billed to customers.
Long-Lived Assets. In accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), amortization of intangible assets is provided using the straight-line method over the estimated useful lives of the assets. The carrying values of intangible and other long-lived assets are periodically reviewed to determine if any impairment indicators are present. If it is determined that such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization and depreciation period, 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 market value of some or all of the assets. Assets are grouped at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows generated by other asset groups. For the year ended December 31, 2007, the Company recorded a non-cash charge of $599 to reflect the impairment of an intangible asset as a result of the termination of a license for the Labtracker-HIVTM software from Ground Zero Software, Inc. (“Ground Zero”).
Goodwill and Other Indefinite-Lived Intangible Assets. In accordance with SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets associated with the Company’s 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. The Company assesses 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 considered 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 the Company’s use of the acquired assets or the strategy for its overall business; and
•
Significant negative industry or economic trends.
If the Company determines through the impairment review process that goodwill has been impaired, an impairment charge would be recorded in the consolidated statement of operations. Based on the 2007 review process, there was no goodwill impairment.
Advertising Costs. Advertising costs are expensed as incurred. Advertising costs in 2007, 2006 and 2005 were approximately $108, $74, and $30, respectively, and were included in selling, general and administrative expenses.
Reclassifications. Certain prior years’ balances have been reclassified to conform with the current year’s presentation.
Note 3. Recent Accounting Pronouncements
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 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. In February 2008, the FASB provided a one-year deferral for the implementation of SFAS No. 157 for nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company is currently evaluating the impact of implementation of SFAS No. 157 on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of implementation of SFAS No. 159 on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS No. 141 (R)”). This statement requires an acquirer to measure the identifiable assets acquired and the liabilities assumed at their fair values on the acquisition date , with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 141 (R), applies
prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this pronouncement will have a material impact on acquisitions consummated after the effective date of this pronouncement.
Note 4. Discontinued Operations
In March 2005, the Company decided to cease its operations in Texas and closed its Texas facility in June 2005. In accordance with the provisions of SFAS No. 144, the results of operations for the Company’s Texas operations have been classified as discontinued operations for all periods presented in the accompanying consolidated statements of operations. The Texas results for those periods are below.
Note 5. Acquisitions
On March 13, 2006, MOMS Pharmacy of Brooklyn, Inc. (“MOMS of Brooklyn”), purchased certain assets of H.S. Maiman Rx, Inc. (“Maiman”) for $5,381 pursuant to an asset purchase agreement; on April 6, 2006, Medicine Made Easy (“MME”) purchased certain assets of the HIV business of H&H Drug Stores, Inc. (“H&H”) for $4,673 pursuant to an asset purchase agreement; on May 1, 2006, MME purchased substantially all of the assets of Whittier Goodrich Pharmacy, Inc. (“Whittier”) for $15,198 pursuant to an asset purchase agreement; and on July 14, 2006, MOMS of Brooklyn purchased certain assets of the HIV business of St. Jude Pharmacy & Surgical Supply Corp. (“St. Jude”) for $10,072 pursuant to an asset purchase agreement. The results of operations from these acquisitions are included in Allion’s consolidated operating results as of the dates of acquisition.
On January 4, 2005, the Company acquired 100% of the outstanding stock of North American Home Health Supply, Inc. (“NAHH”) for $6,938 pursuant to a stock purchase agreement; on February 28, 2005, the Company acquired 100% of the outstanding stock of Specialty Pharmacies, Inc. (“SPI”) for $9,730 pursuant to a stock purchase agreement; on August 5, 2005, the Company acquired the business of Frontier Pharmacy & Nutrition, Inc., d/b/a PMW Pharmacy (“PMW”) for $9,845 pursuant to an asset purchase agreement; and on December 9, 2005, the Company acquired certain assets of Priority Pharmacy, Inc. (“Priority”) for $7,929 pursuant to an asset purchase agreement. The results of operations from these acquisitions are included in Allion’s consolidated operating results as of the dates of acquisition.
The following pro forma results were developed assuming the acquisitions of Maiman, H&H, Whittier, and St. Jude all occurred on January 1, 2006. The pro forma results do not purport to represent what the Company’s results of operations actually would have been if the transactions set forth above had occurred on the date indicated or what the Company’s 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.
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. (“OMS”), a development-stage company incorporated in Washington. The acquisition included an assignment of OMS’ license to use Ground Zero’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, OMS 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 new HIV patients of physician customers utilizing the LabTracker-HIV™ software or the Oris System to fill their prescriptions at a MOMS Pharmacy or an affiliate of a MOMS Pharmacy.
OMS’ 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 OMS in reference to patients served from existing clinics are allocated to the clinic list and amortized over a fixed 15-year period beginning from when OMS was acquired, and earn-out payments made to OMS in reference to patients served from new clinics are expensed. Earn-out payments made to Ground Zero in reference to patients served from both new and existing clinics are allocated to the exclusive LabTracker license agreement and are amortized over its remaining life. Because OMS does not qualify as a business, the transaction was accounted for as the acquisition of certain assets and liabilities of OMS.
On April 2, 2007, Ground Zero notified the Company of the termination of the license for the LabTracker - HIV™ software pursuant to the terms of the Distribution and License Agreement, dated March 1, 2005 (the “License Agreement”), between Oris Medical Systems, Inc. (“Oris”) and Ground Zero. Oris assigned the License Agreement to the Company when the Company acquired substantially all of Oris’ assets in June 2005. As a result of the termination of the LabTracker license agreement with Ground Zero, the Company recorded a charge of $599 ($1,228 less accumulated amortization of $629) for the year ended December 31, 2007 to reflect the impairment of a long-lived asset related to the LabTracker license.
The changes in the carrying amount of goodwill including any purchase price adjustments for the years ended December 31, 2007 and 2006 are as follows:
Note 6. 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. Cash and cash equivalents consisted of the following:
Note 7. Short-Term Investments and Securities Held for Sale
Short-term investments include available-for-sale securities, which are carried at market value. Short-term investments and securities held for sale consisted of approximately $9,300 in auction rate securities at December 31, 2007. At December 31, 2006, short-term investments consisted of approximately $5,900 of auction rate securities and $501 in government obligations. There have been recent auction market failures in 2008 and at present there is no official estimate when liquidity will be restored to the market. Approximately $7,100 of auction rate securities were sold in the first quarter of 2008. It is the Company’s intention to hold the balance of $2,200, until liquidity is restored (expected to be later in 2008), and the Company does not expect to incur any losses. As of December 31, 2007, the Company did not incur any impairment charge.
The short-term securities are generally government obligations and are carried at amortized cost, which approximates fair market value. The unrealized loss at December 31, 2007 and 2006 was $6 ($3, net of tax) and $18 ($11, net of tax), respectively, and is recorded as a component of accumulated other comprehensive income.
Note 8. Initial and Secondary Public Offerings
On June 22, 2005, the Company completed an IPO of its common stock. The Company sold 4,000 shares of its common stock at a price of $13.00 per share, less an underwriting discount and commission of $0.91 per share. In addition, the Company granted the underwriters an over-allotment option, exercisable until July 21, 2005, to purchase up to an additional 600 shares at the IPO price, less the underwriting discount and commission. On July 8, 2005, the underwriters exercised their over-allotment option in full. The Company used the proceeds from its IPO to repay approximately $12,000 of debt on June 27, 2005. The Company received proceeds, net of underwriting discount and commissions, of $48,400 from the IPO and $7,300 from the exercise of the over-allotment option, less costs incurred of $2,100.
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 shares of its common stock and participating stockholders sold 2,636 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 shares at the secondary public offering price, less the underwriting discount and commission. On January 27, 2006, the underwriters exercised their over-allotment option in full. The Company received net proceeds of approximately $21,700 and $8,100 from the secondary public offering and from the exercise of the over-allotment option, respectively, less expenses incurred of $929. The Company did not receive any proceeds from the sale of shares by the participating stockholders.
Note 9. Intangible Assets
Intangible assets as of December 31, 2007 and 2006 are as follows:
Amortization of intangible assets for the years ended December 31, 2007, 2006 and 2005 was approximately $3,153, $3,124, and $1,613, respectively. The estimated annual amortization expense, based on current intangible balances, for the next five fiscal years beginning January 1, 2008 is as follows:
Note 10. Property and Equipment
Depreciation and amortization expense relating to property and equipment for the years ended December 31, 2007, 2006 and 2005 was approximately $421, $417 and $322, respectively.
Note 11. Notes Payable
As part of the acquisition of NAHH, the Company issued two notes. The Company paid one note for $675 on January 2, 2006 and the second note for $700 on January 2, 2007. The notes accrued interest at an imputed rate of 5.25% per year. The discount as of December 31, 2006 was fully amortized. The discount amortization reported as interest in 2006 and 2005 was $17 and $34, respectively.
Note 12. Income Taxes
The income tax expense computed at the statutory federal income tax rate reconciled to the reported amount is as follows:
At December 31, 2007, the Company had net operating loss carryforwards for tax purposes of approximately $6,000 expiring at various dates from 2018 through 2025, all of which were generated by stock-based compensation deductions, which are not included in the Company’s deferred taxes.
Deferred tax assets (liabilities) comprise of the following:
The Company’s federal, state and local income taxes payable for 2007 were reduced by $733 through the utilization of net operating loss deductions that were generated in prior years attributable to tax deductions for equity-based compensation. This benefit was credited to additional paid in capital.
Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, future ownership changes and other limitations may apply to the utilization of the Company’s net operating loss carry forwards.
The provisions for income taxes for the years ended December 31, 2007, 2006 and 2005 consist of the following:
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting uncertainty in income taxes recognized in an enterprise’s financial statements. 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. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The Company adopted FIN 48 effective January 1, 2007. Under FIN 48, tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement.
Unrecognized tax benefits are tax benefits claimed in tax returns that do not meet these recognition and measurement standards. At December 31, 2007, the Company did not have any uncertain tax positions, and the Company does not expect the change to have a significant impact on its results of operations or financial position during the next 12 months.
As permitted by FIN 48, the Company also adopted an accounting policy to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in its income tax provision. Previously, the Company’s policy was to classify interest and penalties as an interest expense in arriving at pre-tax income. At December 31, 2007, the Company did
not have accrued interest and penalties related to any unrecognized tax benefits. The years subject to potential audit varies depending on the tax jurisdiction. Generally, the Company’s statutes are open for tax years ended December 31, 2004 and forward. The Company’s major taxing jurisdictions include the United States, New York and California.
Note 13. Lease Commitments
The Company leases commercial property as follows:
At December 31, 2007, the Company’s lease commitments provide for the following minimum annual rentals.
During the years ended December 31, 2007, 2006 and 2005, rental expense approximated to $777, $761, and $573, respectively.
The Company has an immaterial capital lease due in 2008 for which the present value of the minimum lease payments is $47.
Note 14. Contingencies-Legal Proceedings
On March 9, 2006, the Company alerted the staff of the SEC’s Division of Enforcement to the issuance of its press release of that date announcing the Company’s intent to restate its financial statements for the periods ended June 30, 2005 and September 30, 2005 relating to the valuation of warrants. On March 13, 2006, the Company received a letter from the Division of Enforcement notifying it that the Division of Enforcement had commenced an informal inquiry and requested that the Company 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. The Company is 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. OMS filed a complaint against Allion on August 14, 2006, alleging 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 the May 19, 2005 Asset Purchase Agreement between Allion and OMS. Allion filed a motion to challenge the negligent misrepresentation cause of action, which the court granted and dismissed from the complaint. Allion will continue to vigorously defend against the remaining claims.
In addition, Allion has filed a cross-complaint against OMS, OMS’ majority shareholder Pat Iantorno, and the Iantorno Management Group, in which one or a number of the cross complaints have alleged claims variously against either one or a number of the cross-defendants for deceit, negligent misrepresentation, breach of implied warranty, money had and received, rescission, breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, unfair competition, libel, false light, reformation and declaratory relief. Allion intends to vigorously prosecute its cross-complaint.
The Company is involved from time to time in legal actions arising in the ordinary course of its business. Other than as set forth above, the Company currently has no pending or threatened litigation that it believes will result in an outcome that would materially adversely affect its business. Nevertheless, there can be no assurance that current or future litigation to which the Company is or may become a party will not have a material adverse effect on its business.
Note 15. Concentrations of Credit Risk and Major Customers
The Company provides prescription medications to its customers in the United States. Credit losses relating to customers historically have been minimal and within management’s expectations.
Federal and state third-party reimbursement programs represented approximately 64%, 65% and 87% of the Company’s total sales for the years ended December 31, 2007, 2006 and 2005, respectively. At December 31, 2007 and 2006, the Company had an aggregate outstanding receivable from federal and state agencies of $12,785 and $12,033, respectively.
Note 16. Stockholder’s Equity
A. Stock Options
Under the terms of the Company’s stock option plans, the Board of Directors of the Company may grant incentive and nonqualified stock options to employees, officers, directors, agents, consultants and independent contractors of the Company. In connection with the 2002 Stock Option Plan and the 1998 Stock Option Plan, 2,750 shares of common stock have been reserved for issuance. The Company grants stock options with exercise prices equal to the fair market value of the common stock on the date of the grant. Options generally vest over a two-year to five-year period and expire ten years from the date of the grant.
A summary of the status of the Company’s stock option plans as of December 31, 2007, 2006, 2005 and changes during the years then ended is presented below:
(1)
The total intrinsic value of options exercised during the years ended December 31, 2006 and 2005 was $4,129 and $2,109, respectively.
The aggregate intrinsic value of options outstanding and exercisable as of December 31, 2007 was $2,460.
As of December 31, 2007, the Company had approximately $853 of unrecognized compensation expense related to its unvested share options and expects to recognize this compensation expense over a weighted average period of 2.3 years.
B. Warrants
In January 2005, as part of the NAHH acquisition, the Company issued warrants, which have an exercise price of $6.26 per share, to purchase 150 shares of common stock to the former owners of NAHH. These warrants expire five years from the date of issuance. The fair value of each warrant was $242 and was estimated on the date of the issuance using the Black-Scholes option-pricing model. Valuation assumptions used in the Black-Scholes calculation consisted of a volatility of 20%, a stock price of $6.25 and an expected term equivalent to the contractual life of each warrant. These warrants were recorded as part of acquisition cost. In addition, the Company entered into a registration rights agreement on January 4, 2005, as amended on May 19, 2005, with the former owners of NAHH covering the common shares issued or issuable upon exercise of the warrants. Under the terms of the registration rights agreement, the warrant holders are entitled to one demand registration on a form selected by the Company’s legal counsel, but are not entitled to any piggyback registration rights. Upon receiving a demand registration notice from the holders, and subject to certain limited deferral rights, the Company shall as soon as practicable, but in no event more than 90 days after the date on which it receives such notice, file the registration statement and use its reasonable best efforts to cause the registration statement to become effective within 180 days of such filing. If the registration statement is declared effective, the Company must maintain the effectiveness of the registration statement for a period of 60 days or until each holder has completed the distribution covered by the registration statement, whichever occurs first. The registration rights agreement does not require the Company to pay penalties or liquidated damages for a failure to achieve or maintain effectiveness of a registration statement. The Company will pay all registration expenses except for underwriting discounts. The registration rights terminate when the warrant shares are eligible to be sold or transferred in compliance with Rule 144 or any other exemption from registration.
In February 2005, pursuant to the terms of the stock purchase agreement with the owners of SPI, the Company issued warrants to purchase 351 shares of common stock with an exercise price of $6.26 per share. These warrants expire five years from the date of issuance. The warrants required the Company to redeem and acquire 50% of these warrants following its IPO. During June 2005, the Company redeemed 176 of the shares covered by these warrants.
The February 2005 warrants were initially recorded as a $1,898 liability, which represented the fair market value of the mandatorily redeemable warrants as of the acquisition date. The 351 warrants had a fair market value of $1,898 and were recorded as a liability because the warrants were redeemable in full at the option of the holders if the Company failed to complete an IPO by a specified date, or 50% mandatorily redeemable upon a qualifying IPO. The valuation of the warrants was based on the value of the various financial outcomes to the holders of the warrants, which were in turn, based on the Company’s ability to complete an IPO by June 1, 2006. A value was determined under each scenario and then the probability of the outcome was applied to the value of each outcome to get a weighted average value. Upon completion of an IPO, the Company would be required to redeem 50% of the warrants; therefore, 50% of the warrants were valued at $9.00 per share, which is the fixed price at which the Company would redeem such warrants. The fair value of the remaining 50% of the warrants was valued using the Black-Scholes option-pricing model. Valuation assumptions used in the Black-Scholes calculation consisted of a volatility of 20% (based on the company being a private company considering a public offering), a stock price of $6.25, and an expected term equivalent to the contractual life of each warrant. If the Company was unable to complete an IPO by June 1, 2006, the holders of these warrants had the right to have the Company acquire 100% of their warrants at a price of $6.26 per share. In this scenario, 100% of the warrants were valued using the Black-Scholes option-pricing model using the same assumptions set forth above.
Upon completion of its IPO in June 2005, Allion redeemed and acquired 50% of the warrants issued to the former owners of SPI at a price of $9.00 per share in accordance with the terms of the warrants. Allion paid $1,581 of proceeds from the IPO to repurchase warrants to purchase 176 shares, or 50% of the warrants issued to the SPI sellers. The warrants for the remaining 50%, or warrants to purchase 176 shares, were revalued at fair value and re-classified to equity. Valuation was based on a Black-Scholes calculation that assumed a volatility of 40%, a stock price of $13.00 and an expected term of 56 months (the remaining life of the warrants). The fair value of the remaining 50% was $1,450 and resulted in a fair value adjustment of $1,133 that was recorded as other expense.
In April 2005, the Company issued a warrant to purchase 100 shares of common stock to John Pappajohn, a member of the Company’s Board of Directors, for the extension of his guaranty of a $1,500 line of credit. This warrant has an exercise price of $13.00 per share (equal to the stock price at the IPO) and expires ten years from the date of issuance. The fair value of the warrant was determined using the Black-Scholes pricing model. The fair value at the date of issuance was $753 and was recognized as interest expense. Valuation was based on a Black-Scholes calculation that assumed a volatility of 40%, a stock price of $13.00 and an expected term equivalent to the contractual life of the warrant.
In May 2005, the Company granted a warrant to purchase 40 shares of the Company’s common stock in connection with a private placement to an institutional accredited investor. This warrant has an exercise price of $13.00 per share (equal to the stock price at the IPO) and expires five years from the date of issuance. The fair value of the warrant was determined using Black-Scholes pricing model. The fair value at the date of issuance was $214 and was recognized as interest expense. Valuation was based on a Black-Scholes calculation that assumed a volatility of 40%, a stock price of $13.00 and an expected term equivalent to the contractual life of the warrant. In addition, the Company entered into a registration rights agreement on May 13, 2005 with the accredited investor, covering the common shares issued or issuable upon exercise of the warrant. Under the terms of the registration rights agreement, the warrant holder is entitled to one demand registration on a form selected by the Company’s legal counsel, but is not entitled to any piggyback registration rights. Upon receiving a demand registration notice from the holder, and subject to certain limited deferral rights, the Company shall as soon as practicable, but in no event more than 60 days after the date on which it receives such notice, file the registration statement and use its reasonable best efforts to cause the registration statement to become effective within 90 days of such filing. If the registration statement is declared effective, the Company must maintain the effectiveness of the registration statement until the holder has completed the distribution covered by the registration statement, the warrant expires unexercised or two years elapse from the warrant issue date, whichever occurs first. The registration rights agreement does not require the Company to pay penalties or liquidated damages for a failure to achieve or maintain effectiveness of a registration statement. The Company will pay all registration expenses except for underwriting discounts. The registration rights terminate when the warrant shares are eligible to be sold or transferred in compliance with any exemption from registration that does not contain a volume limitation.
A summary of the status of the Company’s warrants outstanding as of December 31, 2007, 2006, 2005 and changes during the years then ended is presented below:
(1)
During the fiscal year ended December 31, 2006, we issued an aggregate of 362 shares of common stock, upon the net issue exercise of 447 warrants, with a weighted average exercise price of $4.99.
C. Convertible Preferred Stock
The Company has authorized 20,000 shares of preferred stock, $0.001 par value, which the Board of Directors has authority to issue from time to time in series. The Board of Directors also has the authority to fix, before the issuance of each series, the number of shares in each series and the designation, preferences, rights and limitations of each series. Upon the IPO in June 2005, all of the preferred stock outstanding was converted to common stock.
In 2005, the Company recognized a deemed dividend of $1,338 for additional shares of common stock, par value $0.001 per share, issued in connection with the conversion of preferred stock immediately prior to the Company’s IPO. These additional shares were issued in accordance with the terms of the Company’s Amended and Restated Certificate of Incorporation and the Certificate of Designation of Rights and Preferences for the Series D and Series E Preferred Stock as follows:
Series C
shares of common stock at $5.00 per share;
Series D
113 shares of common stock at $6.00 per share; and
Series E
shares of common stock at $6.25 per share.
Note 17. Related Party Transaction
In April 2005, the Company issued warrants to purchase 100 shares of common stock to John Pappajohn at a price of $13.00 per share in consideration for the renewal of his guarantee of the Company’s West Bank loan through September 2005. See Note 16 for a complete description of the warrants issued.
Note 18. Major Suppliers
During the years ended December 31, 2007, 2006 and 2005, the Company purchased approximately $138,502, $130,541 and $99,437, respectively, from one major drug wholesaler. Amounts due to this supplier at December 31, 2007 and 2006 were approximately $11,154 and $12,952, respectively.
In September 2003, the Company signed a five-year agreement with this drug wholesaler that requires certain minimum purchases. If the Company did not meet the minimum purchase commitments as set forth in the agreement, the Company would be charged a prorated amount of 0.20% of the projected volume remaining on the term of the Agreement. The agreement also provides that the Company’s minimum purchases during the term of the agreement will be no less than $400,000. The Company believes it has met its minimum purchase obligations under this agreement. Pursuant to the terms of a related security agreement with this drug wholesaler, this drug wholesaler has a subordinated security interest in the Company’s assets.
Note 19. Supplemental Disclosure of Non-cash Financing Activities
During 2006 and 2005, the Company made eight acquisitions with part of the consideration to be paid with notes payable or having a portion of the purchase price paid in months following the acquisition. The detail for these transactions can be found in Note 5.
Note 20. Fair value of financial instruments
The carrying amount of cash, receivables and payables and certain other short-term financial instruments approximate their fair value.
Note 21. Quarterly financial information (unaudited)
Quarterly financial information for the years ended December 31, 2007 and 2006 is summarized below:
(1)
Included in net sales for the fourth quarter of 2007 is a reduction of $758 of premium reimbursement, related to prior periods in 2007, 2006, 2005 and 2004, as a result of the DHS audit.
(1)
Included in net sales for the first quarter of 2006 is $858 of retroactive premium reimbursement in California for prior periods in 2005 and 2004.
(2)
Included in net sales for the third quarter of 2006 is $59 of retroactive premium reimbursement in New York for prior periods in 2005.
Note 22. Subsequent Event
On March 13, 2008, the Company signed a definitive merger agreement to acquire 100% of the stock of Biomed for aggregate consideration of approximately $117.8 million. Biomed is a leading provider of specialized biopharmaceutical medications and services to chronically ill patients. Under the definitive merger agreement, the Company will pay Biomed’s stockholders an aggregate of $48 million in cash and issue a total of 9.35 million shares of the Company’s common and preferred stock valued at approximately $51.4 million. The Company will also assume up to $18.4 million in Biomed’s debt. In addition, the Company may make an earn-out payment in 2009 if Biomed achieves certain financial performance benchmarks during the first 12 months after closing. The Company expects to pay the purchase price with funds from a new senior credit facility, available cash and newly issued common stock and preferred stock. The closing will be subject to government approval and is expected to close within 60 days.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure 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 Interim 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) of the Exchange Act. 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 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 Interim 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 Interim Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2007.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting of the Company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our process related to internal control and financial reporting was effective as of December 31, 2007.
The effectiveness of our internal control over financial reporting as of December 31, 2007 has been audited by BDO Seidman, LLP, our independent registered public accounting firm, and their attestation report appears below.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Allion Healthcare, Inc.
Melville, New York
We have audited Allion Healthcare’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Allion Healthcare Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Allion Healthcare, Inc. maintained effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Allion Healthcare, Inc. as of December 31, 2007 and 2006 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007 and our report dated March 14, 2008, expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
New York, New York
March 14,
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item with respect to directors and executive officers is incorporated herein by reference from the information contained in our definitive proxy statement for our 2008 Annual Meeting of Stockholders, which we refer to as the Proxy Statement.
The information required by this Item regarding compliance with Section 16(a) of the Exchange Act appears under the heading “Other Matters-Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement. That portion of the Proxy Statement is incorporated by reference into this Annual Report on Form 10-K.
The information required by this Item with respect to corporate governance and our Code of Conduct is incorporated herein by reference from the information contained in the Proxy Statement under the heading “The Board of Directors and Corporate Governance”.
Item 11.
Item 11. Executive Compensation.
The information required by this Item regarding executive compensation is incorporated herein by reference from the information contained in the Proxy Statement under the headings “Compensation of Executive Officers” and “Director Compensation”.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item regarding security ownership of certain beneficial owners and management is incorporated herein by reference from the information contained in the Proxy Statement under the heading “Stock Ownership of Certain Beneficial Owners and Management”.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item about certain relationships and related transactions appears under the heading “Certain Relationships and Related Transactions” in the Proxy Statement and is incorporated herein by reference. The information required by this Item regarding director independence is incorporated herein by reference from the information contained in the Proxy Statement under the heading “The Board of Directors and Corporate Governance”.
Item 14.
Item 14. Principal Accountant Fees and Services.
Information about principal accountant fees and services as well as related pre-approval policies appears under the heading “Audit and Related Fees” in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
The following documents are filed as part of this report.
(1)
Financial Statements.
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2007
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2005, 2006 and 2007
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2005, 2006 and 2007
Consolidated Statement of Cash Flows for the years ended December 31, 2005, 2006 and
Notes to Consolidated Financial Statements
(2)
Schedules. An index of Exhibits and Schedules follows below in this Annual Report. Schedules other than those listed below have been omitted from this Annual Report because they are not required, are not applicable or the required information is included in the financial statements or the notes thereon.
Index to Financial Statements, Supplementary Data and Financial Statement Schedules
(3)
Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Annual Report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Name
Title
Date
/s/ Michael P. Moran
Michael P. Moran
Chief Executive Officer and Director
(principal executive officer)
March 17, 2008
/s/ Stephen A. Maggio
Stephen A. Maggio
Interim Chief Financial Officer
(principal financial and accounting officer)
March 17, 2008
/s/ Gary P. Carpenter
Gary P. Carpenter
Director
March 17, 2008
/s/ Russell J. Fichera
Russell J. Fichera
Director
March 17, 2008
/s/ John Pappajohn
John Pappajohn
Director
March 17, 2008
Derace Schaffer, M.D.
Director
/s/ Harvey Z. Werblowsky, Esq.
Harvey Z. Werblowsky, Esq.
Director
March 17, 2008
Supplemental Information to be Furnished With Reports Filed
Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered
Securities Pursuant to Section 12 of the Act
Allion Healthcare, Inc. furnished a 2006 annual report and proxy statement to its stockholders in 2007 covering the 2006 fiscal year and intends to furnish a 2007 annual report and proxy statement to its stockholders in 2008.
EXHIBIT INDEX
2.1
Stock Purchase Agreement, dated as of May 1, 2003, among MOMS Pharmacy, Inc. as buyer, Allion Healthcare, Inc. as parent, and Darin A. Peterson and Allan H. Peterson collectively as sellers. (Incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on May 16, 2003.)
2.2
Stock Purchase Agreement by and among MOMS Pharmacy, Inc. as buyer and Michael Stone and Jonathan Spanier collectively as sellers dated as of January 4, 2005. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on January 10, 2005.)
2.3
Stock Purchase Agreement by and among MOMS Pharmacy, Inc. as buyer and Pat Iantorno, Eric Iantorno, Jordan Iantorno, Jordan Iantorno A/C/F Max Iantorno, Michael Winters and George Moncada collectively as sellers dated as of February 28, 2005. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on March 4, 2005.)
2.4
Asset Purchase Agreement by and between MOMS Pharmacy, Inc. and Oris Medical Systems, Inc. dated as of May 19, 2005. (Incorporated by reference to Exhibit 2.6 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
2.5
Asset Purchase Agreement by and among Medicine Made Easy and Priority Pharmacy, Inc., the David C. Zeiger Trust UTD 4/30/93, David C. Zeiger and Peter Ellman dated as of December 9, 2005. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 12, 2005.)
3.1
Amended and Restated Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit C to the Registrant’s proxy statement filed on June 4, 2003.)
3.2
Certificate of Designation of Rights and Preferences of Series D Preferred Stock of Allion Healthcare, Inc. (Incorporated by reference to Exhibit 3.6 to the Registrant’s Annual Report on Form 10-K filed on March 31, 2005.)
3.3
Certificate of Designation of Rights and Preferences of Series E Preferred Stock of Allion Healthcare, Inc. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on December 20, 2004.)
3.4
Certificate of Correction of Allion Healthcare, Inc., relating to the Certificate of Designation of Rights and Preferences of Series D Preferred Stock. (Incorporated by reference to Exhibit 3.9 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
3.5
Certificate of Correction of Allion Healthcare, Inc., relating to the Certificate of Designation of Rights and Preferences of Series E Preferred Stock. (Incorporated by reference to Exhibit 3.10 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
3.6
Certificate of Correction of Allion Healthcare, Inc., relating to the Amended and Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3.12 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
3.7
Fourth Amended and Restated Bylaws of the Registrant.*
4.1
Form of Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to the former owners of North American Home Health Supply, Inc., as of January 4, 2005. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report of Form 8-K filed on January 10, 2005.)
4.2
Form of Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to the former owners of Specialty Pharmacies Inc., as of February 28, 2005. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report of Form 8-K filed on March 4, 2005.)
4.3
Form of Subordinated Secured Promissory Notes of MOMS Pharmacy, Inc., dated as of January 4, 2005, in the aggregate amount of $1,375,000, issued to the former owners of North American Home Health Supply, Inc. (Incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on January 10, 2005.)
4.4
Guaranty given by Allion Healthcare, Inc. to and for the benefit of Michael Stone and Jonathan Spanier dated as of January 4, 2005. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on January 10, 2005.)
4.5
Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to John Pappajohn on January 11, 2000. (Incorporated by reference to Exhibit 4.12 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
4.6
Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to John Pappajohn on April 15, 2005. (Incorporated by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K filed on April 21, 2005.)
4.7
Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to Crestview Capital Master, LLC on May 13, 2005. (Incorporated by reference to Exhibit 4.1 to the Registrant’s Quarterly Report on Form 10-Q filed on May 18, 2005.)
4.8
Form of Stock Certificate. (Incorporated by reference to Exhibit 4.16 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005).
10.1
Registration Rights Agreement, dated as of October 30, 2001, by and between Allion Healthcare, Inc. and Gainesborough, L.L.C. (Incorporated by reference to Exhibit 3.(I)D) to the Registrant’s Annual Report on 10-KSB/A filed April 29, 2004.)
10.2
Registration Rights Agreement issued to the holders of Series E convertible preferred stock, dated as of December 17, 2004. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on December 20, 2004.)
10.3
Stock Option Plan. (Incorporated by reference to Exhibit 10.3 to the Registrant’s Annual Report on Form 10-K filed on March 31, 2005.)
10.4
Amendment No. 1 to the 1998 Stock Option Plan. (Incorporated by reference to Exhibit 10.1 to the Registrant’s quarterly report on Form 10-Q filed on November 14, 2005).
10.5
Amended and Restated 2002 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.2 to the Registrant’s quarterly report on Form 10-Q filed on November 14, 2005).
10.6
Agreement of Lease Between Reckson Operating Partnership, L.P and Allion Healthcare, Inc. (Incorporated by reference to Exhibit 10.11 to the Registrant’s Annual Report on Form 10-KSB filed on April 14, 2004.)
10.7
AmerisourceBergen Prime Vendor Agreement dated September 15, 2003. (Incorporated by reference to Exhibit 10.14 to the Registrant’s Annual Report on Form 10-K filed on March 31, 2005.)**
10.8
Registration Rights Agreement, dated as of January 4, 2005, by and between Allion Healthcare, Inc. and Michael Stone and Jonathan Spanier. (Incorporated by reference to Exhibit 10.16 to the Registrant’s Annual Report on Form 10-K filed on March 31, 2005.)
10.9
Amendment to Registration Rights Agreement dated as of May 19, 2005, between Allion Healthcare, Inc. and Michael Stone and Jonathan Spanier. (Incorporated by reference to Exhibit 10.15A to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
10.10
Registration Rights Agreement, dated as of April 4, 2003 issued to the holders of Series C convertible preferred stock. (Incorporated by reference to Exhibit 10.17 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
10.11
Form of Registration Rights Agreement, dated as of April 16, 2004 issued to the holders of Series D convertible preferred stock. (Incorporated by reference to Exhibit 10.18 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
10.12
Form of Registration Rights Agreement, dated as of March 30, 2001 issued to the holders of Series A convertible preferred stock. (Incorporated by reference to Exhibit 10.19 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
10.13
Registration Rights Agreement dated as of May 13, 2005 by and between Allion Healthcare, Inc. and Crestview Capital Master, LLC. (Incorporated by reference to Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q filed on May 18, 2005.)
10.14
Non-competition and non-solicitation agreement by and between Allion Healthcare, Inc. and MikeLynn Salthouse dated as of August 27, 2002. (Incorporated by reference to Exhibit 10.24 to the Registrant’s Registration Statement on Form S-1/A filed on May 24, 2005.)
10.15
Asset Purchase Agreement by and among Medicine Made Easy and Frontier Pharmacy & Nutrition, Inc. dated as of August 4, 2005. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q filed on August 15, 2005.)
10.16
Agreement with the California Department of Health Services dated as of August 2005. (Incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q filed on November 14, 2005.)
10.17
Agreement of Sublease for 191 Golden Gate Avenue, San Francisco, CA 94102, dated as of February 25, 2005, by and between Tenderloin AIDS Resource Center and Specialty Pharmacies, Inc. (Incorporated by reference to Exhibit 10.6 to the Registrant’s Quarterly Report on Form 10-Q filed on November 14, 2005.)
10.18
Agreement of Lease for 19300 S. Hamilton Ave, Gardena, CA 90248, dated as of August 23, 2005, by and between Kroeze Koncepts, Inc, and Medicine Made Easy. (Incorporated by reference to Exhibit 10.29 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2006.)
10.19
Agreement of Lease for 3940-58 Fourth Avenue, San Diego, CA 92103, dated as of January 9, 2006, by and between Acadia Corporation and Medicine Made Easy DBA Priority Pharmacy. (Incorporated by reference to Exhibit 10.30 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2006.)
10.20
Asset Purchase Agreement among Medicine Made Easy and Priority Pharmacy, Inc., the David C. Zeiger Trust UTD 4/30/93, David C. Zeiger and Peter Ellman dated as of December 9, 2005. (Incorporated by reference to Exhibit 10.31 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2006.)
10.21
Asset Purchase Agreement Among MOMS Pharmacy of Brooklyn, Inc., H.S. Maiman Rx, Inc. and Scott Maiman and Nancy Maiman, dated as of March 10, 2006. (Incorporated by reference to Exhibit 10.32 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2006.)
10.22
Warrant to Purchase Common Stock of Allion Healthcare, Inc. issued to John Pappajohn Revocable Trust on April 1, 2003. (Incorporated by reference to Exhibit 10.33 to the Registrant’s Annual Report on Form 10-K/A filed on November 17, 2006.)
10.23
Asset Purchase Agreement by and among Medicine Made Easy and H&H Drug Stores, Inc., The Youredjian Family Trust, H&H Drug Stores, Inc. Employee Stock Ownership Trust and Hagop Youredjian, dated as of April 6, 2006. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 11, 2006.)
10.24
Asset Purchase Agreement by and among Medicine Made Easy and Whittier Goodrich Pharmacy, Inc., Eddie Gozini and Chen Jing, dated as of April 28, 2006. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 3, 2006.)
10.25
Form of Nonqualified Stock Option Agreement to the Amended and Restated 2002 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on June 30, 2006.)
10.26
Asset Purchase Agreement by and among MOMS Pharmacy of Brooklyn, Inc., Allion Healthcare, Inc., St. Jude Pharmacy & Surgical Supply Corp., Millie Chervin and Mitchell Chervin, dated as of July 14, 2006. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on July 14, 2006.)
10.27
Employment Agreement by and between Allion Healthcare, Inc. and Michael P. Moran. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on October 5, 2006.)
10.28
Employment Agreement by and between Allion Healthcare, Inc. and James G. Spencer. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on October 5, 2006.)
10.29
Employment Agreement by and between Allion Healthcare, Inc. and Stephen A. Maggio. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 10-Q filed on November 9, 2007.)
10.30
Employment Agreement by and between Allion Healthcare, Inc. and Robert E. Fleckenstein. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 10-Q filed on November 9, 2007.)
10.31
Employment Agreement by and between Allion Healthcare, Inc. and Anthony D. Luna. (Incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 10-Q filed on November 9, 2007.)
21.1
Subsidiaries of the Registrant. *
23.1
Consent of BDO Seidman, LLP. *
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 Interim Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended. *
32.1
Certification by the Chief Executive Officer and Interim Chief Financial Officer pursuant to Rule 13a-14b/13d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. § 1350 Section 906 of the Sarbanes-Oxley Act of 2002. *
*
- Filed herewith
**
- Certain portions of this document have been omitted pursuant to a request for confidential treatment. We have filed non-redacted copies of this agreement with the Securities and Exchange Commission.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(1)
Consists primarily of direct write offs net of any recoveries of accounts previously deemed uncollectible.