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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 28, 2002
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 0-19952
CHRONIMED INC.
(Exact name of registrant as specified in its charter)
A MINNESOTA CORPORATION IRS EMPLOYER IDENTIFICATION
NO. 41-1515691
10900 RED CIRCLE DRIVE
MINNETONKA, MINNESOTA 55343
TELEPHONE NUMBER (952) 979-3600
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $.01 par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of the voting and non-voting common equity
of Chronimed Inc. held by non-affiliates as of close of business on September 3,
2002, was approximately $60 million based on the closing price of $4.93 per
share reported on the NASDAQ National Market System. The number of shares of
Common Stock outstanding as of September 3, 2002 was 12,352,501.
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held November 20, 2002, to be filed with the
Commission are incorporated by reference in Part III of the Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
Chronimed Inc. is a distributor of prescription drugs for people with
certain chronic health conditions. We consider our business to be unique, and
refer to it as specialty pharmacy. We serve patients with highly specialized
pharmaceutical needs and help employers and third-party payors manage patient
care costs. Chronimed distributes pharmaceuticals and provides specialized
patient management services nationwide for people with chronic conditions
including HIV/AIDS, organ transplants, and diseases treated with biotech
injectable medications. We work directly with patients, physicians, healthcare
providers, insurance companies, health maintenance organizations, preferred
provider organizations, government agencies, and other third-party payors to
improve clinical and financial outcomes for patients with chronic, complex and
expensive pharmaceutical needs.
We operate in two business segments: Mail Order and Retail. We
distribute pharmaceuticals and related educational materials via Chronimed mail
service and through our nationwide StatScript retail pharmacy chain. See Note
12, Notes to Consolidated Financial Statements, Item 14 of this Annual report on
Form 10-K, for information regarding our segments.
Our specialty medications are quite expensive (ranging from $3,000 to
$150,000 per patient per year), often need refrigerated packaging, may require
overnight delivery, and are usually part of a complex regimen -- all reasons
these medications are not routinely stocked in standard retail pharmacies. By
applying our unique distribution and management techniques and coordinating with
our healthcare partners, we are able to improve the quality of care for people
afflicted by very expensive diseases and to help the healthcare reimbursement
system contain costs. We also work with our healthcare partners to develop
patient and therapy management guidelines through ongoing monitoring and
evaluation of patient outcomes.
Our services are most effective for patients who:
- - have illnesses that are generally not being served by traditional
pharmacies because their illnesses occur in less than one percent of
the nation's population;
- - require high-cost, complex medications that are not always available
through traditional retail pharmacies and the majority of which must be
taken for the rest of the patient's life;
- - require treatment by pharmacists with advanced knowledge about the
patient's disorder; and
- - require a significant amount of self-management and ongoing education
where patient compliance is critical for improving clinical and
financial outcomes.
Our key relationships are with:
- - Patients: For the patient, we provide a confidential, convenient,
competitively priced source of prescription drugs, counseling, and a
variety of educational materials to help the patient achieve maximum
control over his or her condition. Educating patients, improving
patient compliance, and increasing provider support and intervention
favorably affect clinical outcomes and decrease the long-term costs of
care. Our patient-specific, value-added services include counseling by
highly trained registered pharmacists and internally certified patient
specialists, confidentiality, the provision of educational materials,
compliance monitoring, insurance billing, refill reminders, 24-hour
pharmacist availability, automated reorder capabilities, and timely
shipments to patients' homes, workplaces, physicians' offices, and
treatment facilities.
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- - Healthcare Providers: We believe our expertise makes us a valuable
partner for healthcare providers working with patients experiencing
chronic health conditions. We have developed relationships with several
treatment centers, foundations, and medical associations that
specialize in the treatment or support of patients with chronic
conditions. Through these relationships, we are able to introduce our
services to a large number of individuals with chronic conditions and
the healthcare specialists treating them.
- - Pharmaceutical Developers and Manufacturers: We believe our system is
well suited for developers and manufacturers of pharmaceutical products
who are targeting small or hard-to-identify patient populations. We
have established relationships with developers and manufacturers of
prescription drugs necessary to manage various chronic conditions and
provide these companies with assistance in rapid product introduction,
a cost-effective means for distributing products to specific patient
populations, and a method for monitoring product use.
- - Payors: Managed care plays a significant role in the provision of
healthcare in the United States, and the majority of our patient
referrals come from contracted third-party payors and the government.
These payors benefit from our services because our experience in
managing specific patient groups allows us to improve patient care
while minimizing overall expenditures.
We work directly with all of these constituents in a concerted effort
to improve clinical and financial outcomes while enhancing the quality of life
for the chronically ill, in a manner consistent with our obligations to patient
confidentiality.
Chronimed was founded in 1985 as a Minnesota corporation and has been
publicly traded on the NASDAQ National Market since 1992.
In this Form 10-K, fiscal 2002, fiscal 2001, and fiscal 2000 refer to
our fiscal years ended June 28, 2002, June 29, 2001, and June 30, 2000.
BUSINESS STRATEGY
We believe that we have a competitive advantage because we possess both
mail and retail capabilities to serve our patients, physicians, and payors. Our
retail capability, branded as StatScript, is the largest specialty franchise
that serves patients with HIV/AIDS. We intend to leverage this position as the
leading provider of medications for patients with HIV/AIDS to grow both our
retail and mail businesses, and to deliver value add services to manufacturers.
We expect to do the same with our second largest disease franchise which serves
individuals who have received an organ transplant.
We will continue our growth in the biotech injectable business,
served mainly through our mail service. Currently, we distribute virtually all
products for all of the specialty disease categories. We intend to build on
this broad base through greater focus on those medications and disease
categories where we can leverage an already strong franchise or where our
service capabilities allow us to provide a competitive advantage to our
customers.
We are committed to being a low cost provider, and intend to increase
our technology capabilities as a key driver in lowering our operational
expenses. In addition, all of our facilities have the capability to handle more
business without adding considerable resources.
Due to the chronic nature of our patients' diseases and the high level
of drug spend per patient, our patients have a high annuity value to our
Company. We will continue to invest in building our customer service
capabilities in order to attract and retain these patients over their lifetime.
Also, we will be investigating opportunities to establish market presence in
select new disease specialty areas. We are also examining how we may serve key
programs and other standard pharmacies as their specialty pharmacy provider.
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We believe that acquisitions will play an important role in building
our business, particularly where the acquisition target can add depth in new or
underserved chronic disease categories and geographic markets. As our financial
position continues to improve, we will be seeking acquisition opportunities to
strengthen our position.
Our growth strategy is to expand our distribution of prescription drugs
by increasing the number of patients served. In addition, we plan to enhance our
programs with manufacturers and to expand our services to persons with other
types of chronic conditions. We anticipate that we will add to the range and
depth of services we provide in order to meet the demand for improved patient
outcomes, cost of care, and patient-reported satisfaction.
SPECIALTY PHARMACY MARKET
We serve three patient populations within the specialty pharmacy
industry: people with HIV/AIDS, people who have had an organ transplant, and
people with complex conditions treated with biotech injectable medications.
Descriptions of our current services to these populations follow.
BIOTECH INJECTABLE MEDICATIONS
We began distributing biotech injectable medications through our mail
order pharmacy in 1994. The biotech injectables we provide treat many chronic
conditions, including: cancer, endometriosis, growth hormone deficiency,
hemophilia, hepatitis B and C, immune deficiency disorders, infertility,
multiple sclerosis, neutropenia, rheumatoid arthritis, and respiratory syncytial
virus ("RSV"). Much of our injectable business revenue is derived from the
following six diseases:
Rheumatoid Arthritis
Rheumatoid arthritis ("RA") is caused by inflammation in the lining of
the joints or other internal organs. It typically affects many different joints.
It can be chronic and can be a disease of flares (active) and remissions (little
to no activity). RA is a systemic disease that affects the entire body and is
one of the most common forms of arthritis. Cells in the inflamed joint lining
(called the "synovium") release enzymes that invade and digest bone and
cartilage. The involved joint can lose its shape and alignment, resulting in
pain, stiffness, warmth, redness, swelling, and loss of movement.
According to the Arthritis Foundation, RA affects 2.1 million
Americans, mostly women. Onset usually occurs in middle-age, but is often
detected in people in their 20s and 30s. About 50,000 new cases of RA are
detected each year. Drug therapy for RA consists of drugs used to reduce
symptoms and inhibit the progression of structural damage. We supply patients
with all currently available products, including Enbrel(R), Remicade(R), and
Kineret(R).
Multiple Sclerosis
Multiple sclerosis ("MS") is a disease of the central nervous system in
which the protective layer surrounding nerve fibers is damaged or destroyed.
Once damaged, electrical nerve impulses are not properly conducted to and from
the brain, resulting in the various symptoms of MS. The Multiple Sclerosis
Association of America estimates that more than 350,000 people in the United
States have MS and that 10,000 new cases are diagnosed every year.
Therapy for MS includes use of drugs to lessen the severity or
frequency of attacks, to slow the increase of disability resulting from the
disease, and to treat the various resulting symptoms (muscle stiffness, fatigue,
and bladder problems). We supply patients with all currently available products,
including Avonex(R), Betaseron(R), Copaxone(R) and Rebif(R).
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Hepatitis C
The Hepatitis C virus ("HCV") attacks the liver and can cause long-term
renal illnesses such as infection, cirrhosis, and cancer. According to the
Centers for Disease Control ("CDC"), as many as 4,000,000 Americans may be
infected with HCV, and 36,000 new infections occur each year. HCV is the leading
cause of liver transplantations in the United States and accounts for 8,000 to
10,000 deaths per year. The CDC also estimates that the annual cost associated
with treating HCV (excluding transplant costs) exceeds $600 million.
We sell injectable drugs used to treat HCV, including pegylated
interferon alfa (Peg-Intron(R)) or interferon alfa (Intron-A(R) with or without
ribavirin (Rebetron(R)) and (Rebetol(R)). Although the CDC reports that these
drugs are ineffective in about 60% of HCV infections, for the 40% of patients
who do respond, treatment usually requires many months of sustained therapy for
optimal effectiveness. Our programs for these patients reduce costs through
lower acquisition costs, efficient delivery of medication in temperature
controlled packaging, counseling, and management of side effects.
Growth Hormone Deficiency
The Human Growth Foundation estimates that 10,000 to 15,000 children in
the United States have growth failure due to growth hormone deficiency. Growth
hormone is a protein that is produced by the pituitary gland and is vital for
normal growth. Growth hormone deficiency may occur by itself or in combination
with one or more other pituitary hormone deficiencies.
Growth hormone deficiency is treated with injections of synthesized
growth hormone. Some children receive three or four injections a week, while
others receive daily injections. A prompt increase in growth rate usually occurs
after treatment starts and may be noticeable to the child and parent within
three to four months. This faster-than-normal growth rate slowly declines over
time, but continues to be greater than the rate that would occur without
treatment. We supply patients with all currently available products, including
Genotropin(TM), Humatrope(R), Norditropin(R), Nutropin Depot(R), Protropin(R),
and Saizen(R).
Cancer
Chemotherapeutic agents are used to treat a variety of cancers by
destroying rapidly growing cancer cells within the body. We offer most of the
medications used to treat the different forms of cancer. We distribute these
products to the patient's home for self-administration or to the physician's
office for administration in a clinical setting.
Drugs used to fight cancer also destroy the body's ability to produce
erythropoietin, resulting in a reduction in red blood cells. Low levels of red
blood cells cause a reduction in the amount of oxygen available in the body,
resulting in fatigue. We supply medications such as Epogen(R), Procrit(R) and
Aronesp(R) that increase the number of available red blood cells by
supplementing the body's natural production of erythropoietin.
White blood cells are responsible for helping the body fight
infections. The chemotherapeutic drugs used to fight cancer substantially reduce
the number of white blood cells in the patient's body leaving the patient
susceptible to common and serious opportunistic infections. We supply
medications such as sargramostim (Leukine(R)) and filgrastim (Neupogen(R)) to
stimulate production of white blood cells following chemotherapy treatments.
5
Respiratory Syncytial Virus
Respiratory syncytial virus ("RSV") is a serious lower respiratory
tract disease that primarily attacks infants. RSV is the most common cause of
pneumonia and bronchiolitis in infants and children. Approximately two-thirds of
infants are infected with RSV during the first year of life, and almost all have
been infected by age two. It has been estimated that, nationwide, approximately
300,000 children are at risk of RSV each year, and approximately 90,000
hospitalizations are due to RSV infections. We supply physicians, clinics, and
patients with currently available products, including Synagis(R), the primary
treatment for RSV infections.
ORGAN TRANSPLANT
We have served people with solid organ or bone marrow transplants since
1990. According to the United Network for Organ Sharing (UNOS), as of August
2002, approximately 150,000 people were living with transplanted organs. Our
experience has shown that transplant recipients typically require about $12,000
of prescription drugs during the first year following transplantation and about
$9,000 per year thereafter. We serve organ transplant patients through our
centralized mail-order pharmacy and through our community-based StatScript
retail pharmacies.
HIV/AIDS
We began to serve people with HIV/AIDS through our StatScript retail
pharmacies in 1996. Human immunodeficiency virus ("HIV") results in
immunosuppression by attacking and destroying T cells that coordinate much of
the network of normal immune responses. Without normal immune responses, people
with HIV are unable to fight and overcome routine infections leading to a
diagnosis of acquired immune deficiency syndrome ("AIDS"). People with HIV/AIDS
have a suppressed immune mechanism that requires treatment with complex
medication regimens. These patients face many long-term physical, financial,
social, and psychological challenges due to the often debilitating nature of the
disease. Our programs are intended to assist them in gaining maximum control
over their disease, to lower the incidence of complications, and to improve
their quality of life.
The CDC estimates that as many as 900,000 HIV positive individuals are
living in the United States, approximately 350,000 of whom are being treated.
Approximately 40,000 new infections occur annually in the U.S. Currently, the
average HIV/AIDS patient we serve requires approximately $12,000 of prescription
drugs per year
PRODUCT DISTRIBUTION
We distribute our products through mail order facilities located in
Minnesota, California, Texas, and Florida In addition, we distribute our
products through our nationwide proprietary retail chain, StatScript Pharmacy.
MAIL ORDER
We inventory approximately 3,500 brand name and generic prescription
drugs, which we distribute directly to the patients and physicians we serve
through our centralized pharmacy mail order system. We believe that we can
distribute these specialty products with considerably higher levels of service
at a competitive price in comparison to local and national retail pharmacies.
Cost savings are accomplished through our distribution of a high volume of
relatively less common products and efficient processing of specialty products
unfamiliar to many retail pharmacists. Patients benefit from the convenience of
having products delivered directly to their homes and, in many cases, at lower
initial out-of-pocket costs than they might obtain from other sources. We
maintain toll-free telephone numbers and automated and online capabilities for
patients to place orders, and we generally ship orders by FedEx or UPS to ensure
prompt delivery.
Our mail order revenue is derived from the sale of biotech injectable
medications and immunosuppressive drugs for organ transplant recipients.
Patients using the service may pay cash, have standard indemnity coverage,
Medicare or Medicaid, or a pharmacy benefit defined by their managed care health
plan.
6
In fiscal 2001, we expanded our mail order business through the
acquisition of The Transplant Pharmacy(R), which provides mail order
distribution of immunosuppressive drugs and transplant patient management
services, from SangStat Medical Corporation. We paid $1.8 million in cash for
the acquisition of the business and assets, which excluded inventory and
accounts receivable.
COMMUNITY-BASED RETAIL PHARMACIES
Our StatScript retail pharmacies give us a significant presence in the
retail marketplace, particularly in the HIV/AIDS disease market. The StatScript
pharmacy chain is the market leader in providing retail specialty pharmacy
services and prescription drugs to people with HIV/AIDS. Our revenue growth in
this business comes from the continued rollout of the combination drug therapies
of protease inhibitors and nucleoside, necleotide, and non-nucleoside reverse
transcriptase inhibitors. Revenue growth is also generated from strategic new
pharmacy acquisitions and openings, and increased patient intake at existing
sites.
StatScript pharmacies are located within patient communities and are
committed to the HIV/AIDS patient through community resources, clinical team
communication, patient education, and complete patient tracking. We believe
StatScript to be the largest network of HIV/AIDS community-based specialty
pharmacies in the country.
More recently, we have begun distributing organ transplant drugs
through our localized retail StatScript pharmacies in order to better meet the
needs of transplant patients and transplant centers. Transplant medications
sometimes require same-day delivery, and our local StatScript pharmacies offer
an efficient, practical solution to meet this need. We also have been using the
local presence of our StatScript pharmacies to distribute biotech injectable
medications, particularly for Hepatitis C and infertility.
As of June 28, 2002, StatScript has 27 pharmacies located in the
following cities: Atlanta, Boston, Chicago, Dallas, Ft. Lauderdale, Houston (two
locations), Indianapolis, Kansas City, Las Vegas, Los Angeles, Miami Beach,
Milwaukee, Minneapolis, Memphis, New York City, Orlando, Philadelphia, San
Diego, San Francisco, Seattle, St. Louis, St. Petersburg, Tampa, Washington,
D.C., West Hollywood, and West Palm Beach.
MANUFACTURER SERVICES
We provide several services for manufacturers:
Distribution
We combine our mail service and retail channels to offer specialized
distributor services to drug manufacturers. This service is best suited to
companies requiring secured tracking that have limited production capabilities
(resulting in limited product supplies) or for products that are intended for
use in small patient populations. We can also distribute drugs that are still in
clinical trials and coordinate data collection on adherence and side effect
incidence.
Data and Analysis
Our large, specialized patient base provides valuable data on
treatments, adherence, usage, and prescribing trends. This information is
provided to manufacturers as a fee-for-service product. All data is
de-identified to remove any element that could identify an individual patient.
Promotion
Due to our local presence and highly qualified pharmacists, we help
drug companies drive product usage and adoption. We only support products that
are clearly appropriate for our patients and follow clinical guidelines to
identify opportunities. Even with these rules, we can be very effective in
increasing market share for target products.
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Consultation
We work with drug manufacturers before and after their product is
launched. We focus on areas such as reimbursement, packaging, distribution,
marketing, promotion, and pricing. We represent the views of patients, payors,
and pharmacies to help manufacturers optimize their sales and marketing efforts.
PAYOR RELATIONSHIPS
Healthcare costs have increased significantly in the United States in
recent years and are expected to continue increasing in the near future.
According to the Health Care Financing Administration ("HCFA"), national health
expenditures are expected to reach $1.5 trillion in 2002, up from $990 billion
in 1995, or 14.7% of U.S. Gross Domestic Product. According to Partnership for
Solutions (a project of Johns Hopkins University and The Robert Wood Johnson
Foundation), health care costs for people with chronic conditions averaged in
excess of $6,000 per person in 2000, more than five times higher than for people
without such conditions. Employers bear a significant share of this cost through
payments for employee benefit plans. As a result, public and private employers
have been emphasizing managed care techniques in employee benefit plans in an
attempt to control rising health care costs.
Most managed care programs have plan design features that limit the
number of providers eligible to serve plan members. For example, most managed
care plans will not pay for services, or will require substantially higher
co-pays or deductibles, if a patient chooses to use a provider that is
considered "outside" the patient's plan network. The high costs of the specialty
medications we provide create a significant disincentive for recipient patients
to use "out-of-network" providers.
Payors often have difficulty quantifying and controlling the cost of
the medications used to treat chronic conditions. We help payors identify and
lower their costs by reducing product acquisition expenses, offering efficient
delivery systems, providing excellent patient care, and streamlining claims and
billing services. We have payor contracts with HMOs, major health insurers,
government agencies, and other managed health plans covering significant patient
populations. As part of these contracts, we offer payors customized programs
designed to maximize care and to manage high-cost medications and low patient
utilization rates. Specifically, we offer payors the following services:
- Distribution of specialty prescription drugs at a cost
competitive with, or lower than, local and national retail and
hospital pharmacies.
- Review and monitoring of compliance with prescribed drug
regimens. By monitoring patient order patterns and drug use,
we assist payors and healthcare providers in early
identification of patients whose treatment outcomes may be
improved by more support or assistance in managing their
chronic conditions.
- Disease expertise. By focusing on the needs of specific
patient populations, our pharmacists are experts in the
requirements and treatment patterns for the identified patient
populations.
- Distribution of educational materials designed to help
patients achieve maximum control over their chronic
conditions.
In fiscal year 2002, Aetna, Inc. and its affiliates ("Aetna") accounted
for approximately 26% of our revenue. We entered into a Specialty Pharmacy Mail
Service Vendor Agreement with Aetna effective May 1, 2000. Our Agreement has an
initial term of three years ending April 30, 2003, and renews on an annual basis
thereafter. Either party may terminate the Agreement on 90 days notice. Except
for Aetna, no private payor accounts for 10% or more of our revenue.
8
SALES AND MARKETING ACTIVITIES
To be successful in our business, we believe that we must both enter
into payor relationships on a national and regional basis and gain referrals
from healthcare providers at the local level. We use a multi-faceted sales and
marketing approach to support this strategy.
At the national and regional level, we employ a sales force that is
responsible for negotiating and signing "network provider" contracts with
healthcare payors. In exchange for network provider status, we offer our
products and services at discounted pricing.
At the local level, we use a marketing team and our StatScript pharmacy
personnel to build relationships with physicians, clinics, hospitals, transplant
centers, and support groups to secure additional patients. By marketing through
these various constituencies, we can improve care, facilitate existing patient
compliance, and achieve new patient referrals.
SUPPLIERS
We purchase prescription drugs and related products directly from
manufacturers and wholesalers. We inventory approximately 3,500 brand name and
generic prescription drugs and related products. We take advantage of special
discounts offered by suppliers when available. When we receive a prescription
for a drug that we do not have in inventory, we generally can obtain the
required item from a wholesaler the same day. The availability and prices of the
products we distribute are subject to market conditions. We regularly seek to
enhance our distribution contract opportunities with existing or new
manufacturers.
We use McKesson Corporation, a national distributor, to supply
pharmaceuticals for both the Retail and the Mail Order segments. This supplier
made up 92%, 85%, and 79% of our continuing operations inventory purchases for
fiscal years 2002, 2001, and 2000, respectively. We are aggressively pursuing
programs with manufacturers, wholesalers, and group purchasing organizations to
lower our drug acquisition costs.
REIMBURSEMENT
We have developed a significant level of expertise in managing the
reimbursement process. Generally, before delivering products to a patient, we
contact the appropriate payor to determine the patient's health plan coverage
and the portion of costs that the payor will reimburse. Our reimbursement
specialists review issues such as lifetime limits, pre-existing condition
clauses, and the availability of special state programs. We accept assignment of
benefits from more than 4,000 payors, which substantially eliminates the claims
submission process for many patients. These reimbursement services are a
significant value-add offering to our patients and payors, and help
differentiate us from our competition.
INFORMATION SYSTEMS
Our mail order operations include an automated call center and a fully
integrated information system. The information system provides our customer
service representatives with the necessary on-line information to service
patients, including product purchase histories, payor billing and account
balances, inventory levels, and co-payment amount requirements. Mail order
distribution sites are on-line with inventory control, purchasing, shipping, and
receiving functions. The telephone system has an automatic call distribution
capability utilizing the latest advances in skills-based call routing to
distribute incoming calls to customer service representatives. We are linked to
key customers for eligibility verification and electronic claims submission.
In fiscal 2001 we began an e-commerce initiative to create a commercial
presence on the Internet, including the sale of prescription medications, the
dissemination of disease-specific information, and the sale of health-related
products. Our initial emphasis was to Web-enable the prescription ordering and
fulfillment functions for our existing customers. We expect that the proportion
of our transactions conducted by electronic commerce will increase in the
future.
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We are in the process of selecting a new retail information and
operating system, expected to be implemented in fiscal year 2003. This new
system will include integrated pharmacy operations, billing, and accounts
receivable capabilities, and it will represent a significant enhancement from
the current system.
COMPETITION
The distribution of specialized prescription drugs is a highly
competitive business. We compete on the basis of service, convenience, product
availability, price, and outcomes impact. Some of our competitors are larger
than we are and have significantly greater financial resources. Despite the
presence of significant competitors in each of our lines of business, we believe
that only a very few competitors offer a similar combination of mail-order and
retail specialty pharmacy distribution focused on the disease states that we
manage.
LIABILITY INSURANCE
Providing healthcare services entails inherent risk. 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, and we may from time to time be subject to such suits. We maintain
general liability insurance, including professional liability coverage, in an
amount deemed adequate by management. We are further insured for product
liability under various policies held by drug manufacturers.
GOVERNMENT REGULATION
Our business is subject to substantial governmental regulation,
including laws governing the dispensing of prescription drugs and laws
prohibiting the payment of remuneration for patient referrals. Because sanctions
may be imposed for violations of these laws, compliance is a significant
operational requirement for us. We believe that we are in substantial compliance
with all existing statutes and regulations materially affecting the conduct of
our business, however, we are routinely subject to periodic audits regarding
compliance with these governmental regulations.
Our primary mail pharmacy is regulated under the laws of the State of
Minnesota. We are also regulated by the laws of each state in which we maintain
a retail or mail pharmacy. We also deliver prescription products from our
licensed pharmacies to patients in states in which we do not operate a pharmacy.
Many of these states have laws or regulations requiring out-of-state pharmacies
to be licensed as a condition to the delivery of prescription products to their
residents. We believe that we are in material compliance with these laws and
regulations in substantially all relevant jurisdictions.
Federal laws also establish standards for the labeling, packaging,
advertising, adulteration of prescription drugs, and the dispensing of
"controlled" substances and prescription drugs. The Federal Trade Commission and
United States Postal Service require mail service pharmacies to engage in
truthful advertising, stock a reasonable supply of drugs, fill mail orders
within 30 days and, if that is impossible, inform the consumer of his or her
right to a refund. We believe that we are in substantial compliance with these
requirements. Substantially all of our products are shipped by commercial
delivery services, with the exception of walk-in customers at our StatScript
retail pharmacies.
We are subject to various federal laws that regulate healthcare
services receiving governmental reimbursement. These laws include the "fraud and
abuse" provisions of the Social Security Act, which prohibit remuneration in
return for referrals of patients who are eligible for reimbursement under the
Medicare or Medicaid programs. Violations of the law may result in civil and
criminal penalties. Civil penalties range from monetary fines that may be levied
on a per violation basis to temporary or permanent exclusion from these
programs. In addition, numerous states have existing or pending laws prohibiting
financial arrangements among healthcare providers. Violations of these laws
include civil and criminal penalties, as well as the suspension or termination
of a provider's ability to continue to provide services in the state.
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The federal prohibitions on inducements for referrals are broadly
drafted, and the fraud and abuse provisions of the Social Security Act
concerning illegal remuneration arrangements have been broadly construed by
federal courts, the Department of Health and Human Services ("HHS"), and
officials of the Office of Inspector General. "Safe harbor" regulations define a
narrow scope of practices that will be exempted from prosecution or other
enforcement action under the illegal remuneration provisions, but due to the
narrow scope of the safe harbor exemptions, the legality of numerous types of
business and financial relationships between healthcare providers and
practitioners remains uncertain. Similarly, state fraud and abuse laws, which
vary from state to state, are often vague and rarely have been interpreted by
courts or regulatory agencies.
In situations where we purchase or provide services and products or
otherwise contract with healthcare providers who may be in a position to refer
patients to us, we believe we have exercised care in an effort to structure such
arrangements to comply with existing federal and state laws.
Political, economic, and regulatory influences are subjecting the
healthcare industry and prescription drug providers in the United States to
fundamental change. A variety of new approaches have been proposed, including
mandated basic healthcare benefits, controls on healthcare spending through
limitations on the growth of private health insurance premiums and Medicare and
Medicaid spending, and the creation of large purchasing groups. In addition,
some of the states in which we operate have adopted or are considering various
healthcare reform proposals. We anticipate that Congress and state legislatures
will continue to review and assess alternative healthcare delivery systems and
payment methods and that public debate of these issues will likely continue in
the future. Any of these developments could affect our ability to carry out our
business.
SEASONALITY
Historically we have had minimal seasonality in our business, although
we have had higher revenues in our second fiscal quarter (ending December) than
in our first, third, or fourth fiscal quarters. We believe the seasonality of
our revenues and earnings is a consequence of the acceleration of purchases of
prescription drugs by individuals with non-contracted indemnity insurance prior
to the beginning of a new calendar year (which is generally when payors impose
new deductible calculations) and the seasonal requirements of a limited number
of medications for certain disease specialties.
EMPLOYEES
As of September 3, 2002, we employed 346 full-time and 26 part-time
employees. None of our employees are represented by a labor union, and we
believe that our employee relations are excellent.
RECENT ACQUISITIONS
In February 2001, we acquired the four retail pharmacies of American
Prescription Providers, Inc. These pharmacies, which were located in New York
City, Miami Beach, Atlanta, and Philadelphia, were renamed and integrated into
our retail chain of StatScript pharmacies. We paid $16.0 million in cash for
substantially all of the four pharmacies' assets, excluding accounts receivable.
In April 2001, we acquired the Transplant Pharmacy business of SangStat
Medical Corporation, which provides mail order distribution of drugs and
transplant patient management services. We acquired substantially all the assets
of the Transplant Pharmacy business excluding inventory and accounts receivable
for $1.8 million cash.
In April 2001, we acquired the stock of Los Feliz Drugs, Inc. d/b/a
Oaks Pharmacy, a California corporation, which operated a pharmacy in a suburb
of Los Angeles. This pharmacy was integrated into our StatScript chain. We paid
$5.2 million in cash for the stock of this pharmacy, and the seller retained its
accounts receivable as of the transaction date.
11
RECENT DISPOSITIONS
In September, 2000, we sold our Home Service Medical ("HSM") subsidiary
to Express-Med, Inc. of New Albany, Ohio. HSM was a direct-to-consumer, mail
order catalog business that contributed $15.0 million in revenue to our total
results for the fiscal year ended June 30, 2000. We received $2.7 million in
cash and a $3.8 million note that was collected in June 2002 resulting in a gain
in fiscal 2002.
In January 2001, we sold the assets of our wholly owned diagnostic
products subsidiary, MEDgenesis Inc., to Medisys PLC of Suffolk, England. The
sale price of $39.975 million consisted of $30.475 million in cash and $9.5
million in Medisys common stock. In connection with this sale, we have
classified MEDgenesis as "discontinued operations" for financial reporting
purposes. As a result, all financial results concerning MEDgenesis have been
classified as discontinued operations.
RECENT STORE CLOSINGS
During fiscal 2002, we closed fourteen StatScript retail locations,
leaving 27 retail locations. Five of the StatScript stores were closed in the
fiscal 2002 second quarter and nine stores where closed during fiscal 2002
fourth quarter. These pharmacies were located in Austin, Chicago (two
locations), Columbus, Dallas, Denver, New Orleans, New York City, Phoenix,
Portland, Safety Harbor, Salt Lake City, San Antonio and Springfield.
In addition, the StatScript headquarters in Overland Park, Kansas, was
closed during the fiscal 2002, second quarter to consolidate operations at our
corporate headquarters in Minneapolis, Minnesota.
ITEM 2. PROPERTIES
We believe that our properties provide a suitable work environment for
employees and the necessary productive capacity to distribute our products and
services. We currently lease all of our properties. These properties are
described below.
FUNCTIONS LOCATIONS SIZE LEASE TERMS
--------- --------- ---- -----------
(SQUARE FEET)
Corporate office and Minnetonka, MN 62,000 Through March 31, 2005
mail order pharmacy,
including
customer service and
distribution
Retail and Mail Order California, Florida Various Expire over periods
specialty pharmacies Georgia, Illinois, up to extending to June,
Indiana, Massachusetts, 4,200 2010
Minnesota, Missouri,
Nevada, New York,
Pennsylvania,
Tennessee, Texas,
Washington,
Washington D.C.,
Wisconsin
12
ITEM 3. LEGAL PROCEEDINGS
On June 15, 2001, a putative class action lawsuit captioned Judith
Barclay v. Chronimed Inc., et. al. (01-CV-1092 DWF) was commenced in the United
States District Court for the District of Minnesota against us and certain of
our current and former officers. The Complaint alleges that we and individual
defendants violated Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10(b)-5 promulgated thereunder, and that the individual defendants violated
Section 20(a) of the Exchange Act. Eight other lawsuits asserting claims
identical to the Barclay case were brought by other plaintiffs during the weeks
following the initial filing. The nine lawsuits have been consolidated into a
single case.
The Complaints allege in general terms that we made false and
misleading statements about our financial statements in violation of the
securities laws. The alleged violations arise out of the requirement to restate
previously issued financial statements. We issued public statements regarding
these matters on June 14, June 21, August 14, August 23, and September 25, 2001.
Each plaintiff seeks compensatory damages in an unstated amount, interest, fees,
expenses, and unspecified equitable relief. We are unable to reasonably quantify
the alleged damages on the basis of the general allegations of the Complaints.
We believe that the above claims are wholly without merit and will
vigorously defend against the lawsuits. We have retained the law firm of Dorsey
& Whitney LLP to represent us in the shareholder actions. An adverse ruling in
these actions in excess or outside of our insurance coverage could have a
material adverse impact on us. The lawsuit is in the discovery phase and is
scheduled for trial to commence in January, 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Our Common Stock, $.01 par value per share, is currently traded on the
NASDAQ National Market System. The following table sets forth the quarterly high
and low closing transaction prices as reported by NASDAQ for the years ended
June 29, 2001, and June 28, 2002:
HIGH LOW
---- ---
FISCAL YEAR 2001
First Quarter............................. $ 8.31 $ 6.62
Second Quarter............................ 12.12 6.00
Third Quarter............................. 15.00 10.25
Fourth Quarter............................ 13.94 4.09
FISCAL YEAR 2002
First Quarter............................. $ 5.35 $ 2.10
Second Quarter............................ 7.20 2.72
Third Quarter............................. 8.00 6.15
Fourth Quarter............................ 6.79 4.80
NUMBER OF SHAREHOLDERS OF RECORD
The number of shareholders of record of our Common Stock as of
September 3, 2002 was approximately 380. The number of beneficial owners of our
Common Stock was approximately 4,600 as of the same date.
DIVIDENDS
We have never declared or paid cash dividends on our Common Stock. We
do not anticipate paying cash dividends in the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
None.
14
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations and our Consolidated Financial Statements and notes thereto included
elsewhere in this Annual Report on Form 10-K. The selected financial data as of
June 28, 2002, and June 29, 2001, and for each of the fiscal years in the three
year period ended June 28, 2002, have been derived from our audited financial
statements included elsewhere in this Annual Report on Form 10-K. The selected
financial data as of June 30, 2000, July 2, 1999, and July 3, 1998, and for the
two-year periods ended July 2, 1999, are derived from our audited financial
statements previously filed with the SEC. The information set forth below is not
necessarily indicative of the results of future operations.
FINANCIAL RESULTS JUNE 28, JUNE 29, JUNE 30, JULY 2, JULY 3,
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 2002 2001 2000 1999 1998
-------- -------- -------- ------- -------
Revenue .......................................... $ 397,437 $ 297,925 $ 222,497 $ 168,624 $ 115,614
Gross profit ..................................... 47,732 35,693 36,891 31,179 39,223
Bad debt expense ................................. 3,504 7,140 7,154 945 993
Income (loss) from continuing operations ......... 1,858 (5,774) (9,115) 173 1,046
Interest income (expense), net ................... 104 568 (191) 419 1,453
Other (loss) income .............................. 3,906 (1,837) -- 503 --
Income tax benefit (expense) ..................... (2,131) 2,585 3,398 (427) (1,019)
Net income (loss) from continuing operations ..... 3,737 (4,458) (5,908) 668 1,480
Income from discontinued operations, net of tax .. -- 15,235 1,840 3,459 5,671
--------- --------- --------- --------- ---------
Net income (loss) ................................ $ 3,737 $ 10,777 $ (4,068) $ 4,127 $ 7,151
========= ========= ========= ========= =========
Diluted earnings (loss) per share:
Income (loss) from continuing operations ......... $ 0.30 $ (0.37) $ (0.49) $ 0.06 $ 0.12
Income from discontinued operations .............. -- 1.25 0.15 0.28 0.47
--------- --------- --------- --------- ---------
Net income (loss) ................................ $ 0.30 $ 0.88 $ (0.34) $ 0.34 $ 0.59
========= ========= ========= ========= =========
Weighted average shares outstanding -- diluted ... 12,342 12,206 12,116 12,256 12,221
FINANCIAL POSITION
Working capital .................................. $ 43,850 $ 36,982 $ 36,393 $ 31,472 $ 26,147
Total assets ..................................... 99,495 98,993 78,430 78,542 71,280
Shareholder's equity ............................. 79,401 75,502 63,057 66,487 62,319
NOTES:
Fiscal 1999 results include a $0.5 million gain (pre-tax) on the
disposition of our publishing business, classified as other income.
Fiscal 2000 results include the following charges (pre-tax) to
operating expense:
- Write-down of $5.5 million investment in Clinical Partners, an
HIV case management business within the Retail segment.
- Expenses of $0.9 million related to the retention of an
investment banker in the review of corporate strategic
alternatives.
- Charges of $0.5 million relating to the contemplated spin-off
of MEDgenesis, Inc.
15
Fiscal 2001 results include the following gain and loss:
- A $13.8 million after-tax gain on the sale of MEDgenesis, Inc.
in January, 2001, included in discontinued operations.
- A loss on the sale of available-for-sale securities of $1.8
million (pre-tax).
Fiscal 2002 results include the following charge and benefit:
- Pre-tax charges of $3.6 million related to the StatScript
retail business for the costs of transferring the Kansas City
retail headquarters to Minneapolis, store closing costs, and
costs associated with the fiscal 2001 financial restatement.
- A $3.8 million pre-tax gain on the June 2002 collection of a
previously reserved note receivable from the buyer of Home
Service Medical (HSM), included in Other Income.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
BUSINESS
We are a distributor of prescription drugs for people with certain
chronic health conditions. We consider our business to be unique and refer to it
as specialty pharmacy. We serve patients with highly specialized pharmaceutical
needs and help employers and third-party payors manage patient care costs. We
distribute pharmaceuticals and provide specialized patient management services
nationwide for people with chronic conditions including HIV/AIDS, organ
transplants, and diseases treated with biotech injectable medications. We work
directly with patients, physicians, healthcare providers, insurance companies,
health maintenance organizations, preferred provider organizations, government
agencies, and other third-party payors to improve clinical and financial
outcomes for patients with chronic, complex, and expensive pharmaceutical needs.
We are comprised of two operating segments - Mail Order and Retail. The
Mail Order segment includes the biotech injectables program, organ transplant
medications, and Home Service Medical (the Home Service Medical business was
sold as of September 1, 2000 - See Note 4, Notes to Consolidated Financial
Statements in Item 14 of this Annual Report on Form 10-K). The Retail segment
focuses on HIV/AIDS, organ transplant medications, and certain biotech
injectables through the StatScript specialty pharmacy stores.
During fiscal year 2001, we disposed of or shut down certain lines of
business (together, the "Disposed Businesses"). Within the Mail Order segment,
we sold the Home Service Medical ("HSM") business and closed the diabetes
service centers in the first quarter of fiscal 2001. Within the Retail segment,
the remaining Clinical Partners business ceased operations in the second quarter
of fiscal 2001.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with
United States generally accepted accounting principles, which require us to make
estimates and assumptions (See Note 1, Notes to Consolidated Financial
Statements).
We believe the following critical accounting policies, among others,
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements.
16
Revenue Recognition
Revenue is recognized at the time prescriptions are dispensed by the
pharmacist and shipped to or picked up by the patient. We participate in various
third party provider networks and state Medicaid programs. Under a majority of
these networks, the amount to be paid for our products is determined (or
"adjudicated") through electronic connections with these networks at the time of
sale. However, for certain third-party providers and state Medicaid programs for
which there is no electronic adjudication process available at the time of sale,
we determine an appropriate estimate for expected payor discount. Revenue is
then reported at the estimated net realizable amount and adjusted in future
periods as final settlements are determined. Although management continually
monitors its assumptions used in estimating payor discounts, such subsequent
adjustments could be favorable or unfavorable to future periods.
Collectibility of Accounts Receivable
Accounts receivable consist primarily of amounts due from the Medicare
and Medicaid programs, other government programs, prescription benefits
managers, managed care health plans, commercial insurance companies and
individual patients. Estimated provisions for doubtful accounts are recorded to
the extent it is probable that a portion or all of a particular account will not
be collected.
In evaluating the collectibility of accounts receivable, we consider a
number of factors, including the age of the accounts, changes in collection
patterns, the composition of accounts by payor type, and general industry
conditions. Actual collections of accounts receivable in subsequent periods may
require changes in estimated provision for loss. Changes in these estimates are
charged or credited to the results of operations in the period of the change.
Goodwill
We have $30.2 million of goodwill on our balance sheet at June 28,
2002, related to acquisitions. The periodic assessment of the valuation of these
assets involves significant judgments and the use of estimates. We will also
review the carrying value of these assets whenever there are any events or
circumstances that indicate the potential for impairment. If an impairment is
determined, the carrying values of these assets will be reduced to fair value.
17
RESULTS OF OPERATIONS
INCOME AND EXPENSE ITEMS AS A PERCENTAGE OF REVENUE
FISCAL YEAR
-------------------------------
2002 2001 2000
---- ---- -----
Revenue
Mail Order ................................ 43.6% 51.5% 53.6%
Retail .................................... 56.4 48.5 46.4
----- ----- -----
100.0 100.0 100.0
Cost of revenue .................................. 88.0 88.0 83.4
----- ----- -----
Gross profit ..................................... 12.0 12.0 16.6
Operating expenses
Selling and marketing ..................... 0.8 1.1 2.0
General and administrative ................ 9.8 10.4 13.0
Bad debt expense .......................... 0.9 2.4 3.2
Other expenses - asset write down ......... -- -- 2.5
----- ----- -----
Total operating expenses ......................... 11.5 13.9 20.7
Income (loss) from operations .................... 0.5 (1.9) (4.1)
Interest income (expense), net ................... -- 0.2 --
Other income (loss) .............................. 1.0 (0.6) --
Income tax (expense) benefit ..................... (0.6) 0.8 1.5
----- ----- -----
Net income (loss) from continuing operations ..... 0.9 (1.5) (2.6)
Income from discontinued operations, net of tax .. -- 5.1 0.8
----- ----- -----
Net income (loss) ................................ 0.9% 3.6% (1.8)%
===== ===== =====
FISCAL 2002 COMPARED TO FISCAL 2001
CONTINUING OPERATIONS
Revenue
Total revenue for fiscal 2002 was up 33.4% to $397.4 million from
$297.9 million in fiscal 2001, reflecting strong existing business as well as
full year revenues from three acquisitions in the second half of fiscal 2001,
which, together will be referred to as the "Acquired Businesses". Our existing
business and the Acquired Businesses together will be referred to as the
"On-going Business". The Acquired Businesses include four retail pharmacies of
American Prescription Providers ("APP") (acquired in February, 2001) and a
single location pharmacy in Sherman Oaks, California ("Oaks") (acquired in
April, 2001) in the Retail segment, and the organ transplant pharmacy of
SangStat Medical ("SangStat") (acquired in April, 2001) in the Mail Order
segment. Overall, these three acquisitions contributed approximately $55.7
million or 54.6% of our $102.1 million year-over-year growth (excluding the
Disposed Businesses, as noted below). During fiscal year 2001, we disposed of or
shut down certain lines of business (together, the "Disposed Businesses").
Within the Mail Order segment, the HSM business was sold and the diabetes
service centers were closed in the first quarter of fiscal year 2001. Within the
Retail segment, the remaining Clinical Partners business ceased operation in the
second quarter of fiscal 2001. By revenue source, fiscal 2002 compares to fiscal
2001 as follows:
18
($ In Thousands) FISCAL YEAR
-----------------------
2002 2001 % CHANGE
---- ---- --------
Mail Order Segment
On-going Business ..... $173,202 $151,224 14.5 %
Disposed Businesses ... -- 2,237 (100.0)
-------- -------- ------
Total Mail Order .... 173,202 153,461 12.9 %
Retail Segment
On-going Business ..... 224,235 144,104 55.6 %
Disposed Businesses ... -- 360 (100.0)
-------- -------- ------
Total Retail ........ 224,235 144,464 55.2 %
-------- -------- ------
Total Company ................ $397,437 $297,925 33.4 %
======== ======== ======
The Mail Order segment revenue grew 12.9% year-over-year, despite the
September, 2000 sale of the segment's HSM business and the closure of its
diabetes service centers. Excluding these businesses in both years, the
year-over-year growth was 14.5%. This growth was due to several factors,
including the addition of new biotech injectable patients from several payors,
the April, 2001 SangStat acquisition, and price inflation. The SangStat
acquisition contributed approximately $8 million of the growth in
year-over-year revenue. Excluding the SangStat acquisition, the rate of revenue
growth slowed to approximately 9.4% in fiscal year 2002 compared to 45.9% in
fiscal year 2001, due to new patients from the contract with Aetna that became
effective July 15, 2000, unfavorable retention of organ transplant patients, and
product shortages for Enbrel and the Hepatitis-C drug Peg-Intron. Payor
reimbursements from Aetna represented 59.7% and 65.5% of our Mail Order revenues
for fiscal years 2002 and 2001, respectively. Except for Aetna, no other private
payor accounts for 10% or more of our revenues in fiscal years 2002 and 2001.
The Retail segment revenue grew 55.2% for the year due to continued
additions of new patients at existing stores and the full year benefit of the
acquisition of the APP and Oaks specialty pharmacies. The newly acquired stores
accounted for approximately $42.4 million of our growth in the On-going
Business, while same store revenue accounted for the remainder of the revenue
growth, with a 25.9% increase for the year. The same store growth was due to a
combination of increased anti-viral medication volume bolstered by increased
post-transplant drug sales. We plan to continue our expansion of retail product
offerings beyond our HIV/AIDS focus, to include post-transplant and Hepatitis C
medications. A single private payor represented approximately 6.1% and 7.0% of
our on-going Retail revenues for fiscal years 2002 and 2001, respectively.
Cost of Revenue and Gross Profit
Total gross profit dollars increased $12.0 million or 33.7%, from $35.7
million in fiscal 2001 to $47.7 million in fiscal 2002. Gross margins as a
percentage of revenue remained unchanged at 12.0% in fiscal 2001 and fiscal
2002.
Mail Order margins as a percentage of revenue increased slightly from
the year ago period due to a stabilization in pricing pressures in markets we
serve, improved purchasing programs, and a change in product mix toward higher
margin products. Aetna represented 37.4% and 35.1% of our Mail Order margins for
fiscal years 2002 and 2001, respectively.
Retail margins as a percentage of revenue decreased slightly from the
year ago period primarily due to the closing of selected geographic markets or
store locations and a large payor's decision to reduce reimbursement in the
middle of fiscal year 2001. A single private payor represented 10.0% and 13.6%
of our Retail margins for fiscal years 2002 and 2001, respectively.
19
We anticipate that payors will continue to exert downward pressure on
the prices we will be able to charge as payors continue to seek containment of
healthcare costs, which will negatively affect margins in the future. We are
working to offset this pricing pressure in a number of ways, including sales and
marketing efforts to direct more profitable medications into both the Retail and
Mail Order segments; enhanced programs with manufacturers, wholesalers, and
group purchasing organizations to reduce product costs; and a store-by-store
focus on payor and drug mix to improve gross margins.
Operating Expenses
Our operating expenses include selling and marketing, general and
administrative (G&A), and bad debt expenses. Our G&A expenses include both
corporate G&A expenses (corporate management, information systems, accounting,
human resources) and direct segment G&A expenses (division management, customer
service, billing, pharmacy fulfillment). Our business model for operating
expenses is to continue to improve efficiency on greater volume.
Selling and Marketing Expenses
The following chart shows the year-to-year comparisons of selling and
marketing expenses.
($ In Thousands) FISCAL YEAR
------------------------------
2002 2001 % CHANGE
---- ---- --------
On-going Business .......................................... $3,329 $2,776 19.9%
Disposed Businesses ........................................ -- 433 (100.0)
------ ------ ------
Total Company .............................................. $3,329 $3,209 3.7%
====== ====== ======
Our selling and marketing expenses increased $0.1 million, or 3.7% in
fiscal 2002. Our selling and marketing expenses for On-going Business increased
$0.6 million, or 19.9% in fiscal 2002, from $2.8 million to $3.3 million. These
marketing expenses for On-going Business represented 0.8% and 0.9% of revenues
for fiscal 2002 and fiscal 2001, respectively. This increase in expenses is
primarily due to head count additions and increased travel and promotion
activities.
We operate a consolidated selling and marketing organization serving
both the Mail Order and Retail segments. We believe this integrated approach
increases the effectiveness of our selling and marketing efforts.
General and Administrative Expenses
The following chart shows the year-to-year comparisons of general and
administrative expenses, excluding bad debt expense.
($ In Thousands) FISCAL YEAR
-----------------------------
2002 2001 % CHANGE
---- ---- --------
On-going Business ........................................ $39,041 $30,487 28.1%
Disposed Businesses ...................................... -- 631 (100.0)
------- ------- ------
Total Company ............................................ $39,041 $31,118 25.5%
======= ======= ======
Our general and administrative expenses increased $7.9 million, or
25.5% in fiscal 2002, due primarily to Retail store acquisitions in the latter
part of fiscal 2001 and higher lease and pharmacist operating costs in existing
specialty pharmacy stores. For our On-going Business, general and administrative
expenses increased $8.5 million, or 28.1% in fiscal 2002, from $30.5 million to
$39.0 million, and declined as a percentage of total revenue from 10.2% to 9.8%
reflecting our emphasis on operating leverage against increasing revenues. We
expect to see
20
continued operating leverage in this area in the future. Included in fiscal 2001
general and administrative expenses was $1.4 million of goodwill amortization
that was not expensed in fiscal 2002 as a result of our adoption of Statement
142 - See New Accounting Pronouncements included in this Item 7. In addition,
fiscal 2002 included charges of $3.6 million related to the StatScript retail
business for the costs of transferring the Kansas City retail headquarters to
Minneapolis, store closing costs, and costs associated with the fiscal 2001
financial restatement. Excluding these charges and the Disposed Businesses,
fiscal year 2002 and 2001 general and administrative expenses were $35.5 million
and $29.1 million, or 8.9% and 9.9% of revenues, respectively.
Bad Debt Expenses
Our bad debt expense decreased $3.6 million, or 50.9% in fiscal 2002.
Bad debt expenses represented 0.9% and 2.4% of revenues for fiscal 2002 and
fiscal 2001, respectively. This high rate of bad debt expense in 2001 was due
primarily to a higher write-off of receivables in the Retail Segment. The bad
debt experience in fiscal year 2002 reflects our consolidation of billing and
collection operations to our Minneapolis headquarters and related process
improvements. Fiscal 2002 results are representative of our expectation for
future bad debt expense of approximately 1% of revenue.
Interest Income
Interest income, net of interest expense, decreased $0.5 million, from
$0.6 million in fiscal 2001 to $0.1 million in fiscal 2002, reflecting our
invested asset levels and declining interest rate environment, net of short-term
borrowing costs on our line of credit. Included in interest income for fiscal
2002 and 2001 was $0.4 million and $0.3 million, respectively, of interest on a
note receivable with the buyer of our HSM business in September 2000. This note
has been paid in full and as a result will not be generating interest income in
fiscal 2003.
Other Income (Loss)
Other income of $3.9 million in fiscal 2002 reflects primarily a $3.8
million gain on the collection of a previously reserved note receivable due from
the buyer of our HSM business. The $1.8 million loss in fiscal 2001 reflects our
loss on sale of available-for-sale securities that had been received as
consideration in the sale of our MEDgenesis business.
Income Taxes
In fiscal 2002 and 2001 the income tax expense (benefit) was calculated
on rates of 36.3% and 36.7%, respectively. See Note 7, Notes to Consolidated
Financial Statements for the reconciliation to our statutory rate. Looking
forward, we expect our combined Federal and State tax rate to approximate 39.0%.
FISCAL 2001 COMPARED TO FISCAL 2000
CONTINUING OPERATIONS
Revenue
Total revenue for fiscal 2001 was up 33.9% to $297.9 million from
$222.5 million in fiscal 2000, reflecting strong existing business growth as
well as growth from three acquisitions in the second half of the year, which
together will be referred to as the "Acquired Businesses". The existing business
and the Acquired Businesses together will be referred to as the "On-going
Business". The Acquired Businesses include four retail pharmacies of American
Prescription Providers ("APP") (acquired in February, 2001) and a single
location pharmacy in Sherman Oaks, California ("Oaks") (acquired in April, 2001)
in the Retail segment, and the organ transplant pharmacy of SangStat Medical
("SangStat") (acquired in April, 2001) in the Mail Order segment. Overall, these
three acquisitions contributed
21
one-fourth ($22.9 million) of the Company's 45.1% ($91.9 million) year-on-year
growth (excluding the Disposed Businesses, as noted below). By revenue source,
fiscal 2001 compares to fiscal 2000 as follows:
($ In Thousands) FISCAL YEAR
----------------------------------
2001 2000 % CHANGE
---- ---- --------
Mail Order Segment
On-going Business .................................... $151,224 $102,286 47.8%
Disposed Businesses .................................. 2,237 16,884 (86.8)
-------- -------- ------
Total Mail Order ................................. 153,461 119,170 28.8%
Retail Segment
On-going Business .................................... 144,104 101,192 42.4%
Disposed Businesses .................................. 360 2,135 (83.1)
-------- -------- ------
Total Retail ..................................... 144,464 103,327 39.8%
-------- -------- ------
Total Company ............................................. $297,925 $222,497 33.9%
======== ======== ======
The Mail Order segment grew 28.8% year-on-year, despite the September
2000 sale of the HSM business and the closure of its diabetes service centers.
Excluding these businesses in both years, the year-on-year growth was 47.8%.
This growth was driven primarily by the addition of new patients from the
biotech injectables contract with Aetna that became effective July 15, 2000. The
SangStat acquisition in April 2001 strengthened our position in the transplant
market and contributed approximately $2 million in fourth quarter revenue.
The Retail segment grew 39.8% for the year due to continued additions
of new patients at existing stores and the acquisition of the APP and Oaks
specialty pharmacies. The newly acquired stores accounted for approximately one
half of the 42.4% fiscal year growth in the On-going Business, while same store
revenue accounted for the remainder of the revenue growth, with approximately a
22% increase for the year. The Retail segment faced significant reimbursement
pressure in fiscal 2001, which lowered the revenue growth rate and reduced gross
margins.
Cost of Revenue and Gross Profit
Total gross profit dollars decreased by $1.2 million from $36.9 million
in fiscal 2000 to $35.7 million in fiscal 2001. Gross margins as a percentage of
revenue declined 4.6 percentage points, from 16.6% in fiscal 2000 to 12.0% in
fiscal 2001. However, exclusive of the Disposed Businesses, higher revenue led
to a gross profit dollar increase of $4.6 million, from $30.2 million in fiscal
2000 to $34.8 million in 2001, while margins declined 3.1 percentage points,
from 14.9% to 11.8% in the respective years.
Mail Order margins as a percentage of sales declined slightly due to a
change in product mix toward lower margin products, a continuing supply shortage
of a high-margin product (beginning in January, 2001), and lower than average
reimbursement rates under our contract with Aetna.
Two primary factors contributed to a significant decline in Retail
margins. First, a large uncontracted payor significantly reduced its
reimbursement schedule, which caused an approximate two percentage point
decrease in the segment's margins. Second, continued pricing pressures from
other payors at existing stores lowered the overall segment margins by an
additional two percentage points.
Operating Expenses
Our operating expenses include selling and marketing, general and
administrative (G&A), and bad debt expenses. Our G&A expenses include both
corporate G&A expenses (corporate management, information systems, accounting,
human resources) and direct segment G&A expenses (division management, customer
service, billing, pharmacy fulfillment). Our business model for operating
expenses is to continue to improve efficiency on greater volume.
22
Selling and Marketing Expenses
The following chart shows the year-to-year comparisons of selling and
marketing expenses.
($ In Thousands) FISCAL YEAR
---------------------------------
2001 2000 % CHANGE
---- ---- --------
Mail Order Segment
On-going Business ..................................... $ 1,198 $ 991 20.9%
Disposed Businesses ................................... 433 1,804 (76.0)
------- ------- ------
Total Mail Order .................................. 1,631 2,795 (41.6)%
Retail Segment
On-going Business ..................................... 1,578 1,374 14.8 %
Disposed Businesses ................................... -- 286 (100.0)
------- ------- ------
Total Retail ...................................... 1,578 1,660 (4.9)%
------- ------- ------
Total Company .............................................. $ 3,209 $ 4,455 (27.9)%
======= ======= ======
Total Company selling and marketing expenses decreased almost $1.3
million, or 27.9% in fiscal 2001. Our selling and marketing expenses from
On-going Business actually increased $0.4 million in fiscal 2001, from $2.4
million to $2.8 million, as a result of increased labor, travel and marketing
promotion expenditures in both the Mail Order and Retail segments. The Disposed
Businesses accounted for a $1.7 million decrease in selling and marketing in
fiscal 2001.
Total Mail Order selling and marketing expenses decreased $1.2 million,
or 41.6% in fiscal 2001, due to the elimination of the Disposed Businesses.
Excluding the Disposed Businesses, selling and marketing expenses increased $0.2
million, or 20.9%, as costs remained essentially constant as a percentage of
revenue at 0.8%.
Total Retail selling and marketing expenses decreased $0.1 million, or
4.9% in 2001, again due to the elimination of the Disposed Businesses. Excluding
the Disposed Businesses, selling and marketing expenses increased $0.2 million
due to increased sales activity in support of new specialty pharmacies, and
declined as a percentage of revenue from 1.4% to 1.1%.
In the fourth quarter of fiscal 2001, we consolidated our selling and
marketing efforts into one organization serving both the Mail Order and Retail
segments. We believe this integrated approach increases the effectiveness of our
selling and marketing efforts.
General and Administrative Expenses
The following chart shows a breakdown of our corporate G&A and direct
segment G&A expenses, excluding bad debt expense.
($ In Thousands) FISCAL YEAR
---------------------------------
2001 2000 % CHANGE
---- ---- --------
Corporate .................................................. $ 9,633 $10,306 (6.5)%
Mail Order Segment
On-going Business ..................................... 5,251 3,804 38.0%
Disposed Businesses ................................... 244 1,423 (82.9)
------- ------- ------
Total Mail Order .................................. 5,495 5,227 5.1%
Retail Segment
On-going Business ..................................... 15,603 10,976 42.2%
Disposed Businesses ................................... 387 2,388 (83.8)
------- ------- ------
Total Retail ...................................... 15,990 13,364 19.6%
------- ------- ------
Total Company .............................................. $31,118 $28,897 7.7%
======= ======= ======
23
Total Company general and administrative expenses increased $2.2
million, or 7.7% in fiscal 2001, due primarily to Retail store acquisitions in
fiscal 2001 and higher operating costs in the specialty pharmacy stores. G&A
declined as a percentage of revenue from 13.0% to 10.4%. Excluding Disposed
Businesses, the increase was $5.4 million, or 21.5%, on comparable revenue
growth of 45.1%.
Corporate general and administrative expenses decreased by 6.5%, or
$0.7 million, and decreased as a percentage of revenue from 4.7% to 3.2%. The
decline is attributed primarily to the cost of our pursuit of strategic
alternatives in the first three quarters of fiscal 2000 ($0.9 million) and
certain costs incurred in the fourth quarter of fiscal 2000 related to the
contemplated spin-off of the MEDgenesis diagnostic products business ($0.5
million). We incurred no such related costs in fiscal 2001. Aside from these
items, corporate G&A expenses increased 9%, a favorable comparison against a
reported 33.9% increase in revenue.
Mail Order Segment general and administrative expense grew 5.1%, from
$5.2 million to $5.5 million. However, expenses associated with the Disposed
Businesses (primarily HSM) decreased by $1.2 million, offsetting a $1.4 million
increase in the On-going Business. The increase is attributable to increased
direct costs (customer service, billing, fulfillment) associated with the
revenue growth. As a percentage of on-going Mail Order revenue, on-going Mail
Order G&A expense decreased slightly from 3.7% to 3.5%.
Retail Segment general and administrative expenses increased 19.6%, or
$2.6 million. Expenses relating to the Disposed Businesses (primarily Clinical
Partners) decreased by $2.0 million, while expenses relating to the On-going
Businesses increased by $4.6 million, or 42.2%, from $11.0 million to $15.6
million. This expense growth was in line with revenue growth; as a percentage of
revenue, these expenses increased only slightly from 10.6% to 10.8%. The
absolute dollar growth of $4.6 million in the On-going Business is attributed to
the APP and Oaks acquisitions by the Retail segment during fiscal 2001 and
increasing labor and facility costs in the specialty pharmacy stores.
Bad Debt Expenses
($ In Thousands) FISCAL YEAR
---------------------------------
2001 2000 % CHANGE
---- ---- --------
Corporate .................................................. $ (119) $ 140 --
Mail Order Segment
On-going Business ..................................... 1,524 1,272 19.8%
Disposed Businesses ................................... 39 424 (90.8)
------- ------- -----
Total Mail Order .................................. 1,563 1,696 (7.8)%
Retail Segment
On-going Business ..................................... 5,693 5,124 11.1%
Disposed Businesses ................................... 3 194 (98.5)
------- ------- -----
Total Retail ...................................... 5,696 5,318 7.1%
------- ------- -----
Total Company .............................................. $ 7,140 $ 7,154 0.2%
======= ======= =====
Total Company bad debt expense remained nearly flat in fiscal 2001
compared to fiscal 2000, at $7.1 million. As a percent of revenue, bad debt
expense was 2.4% and 3.2% in the respective fiscal 2001 and 2000 periods.
Interest Income
The increase in interest income from an expense of $0.2 million in
fiscal 2000 to income of $0.6 million in fiscal 2001 is due primarily to $0.3
million of interest earned from the invested proceeds from the sale of
MEDgenesis in January, 2001, and $0.3 million of interest earned on a note
receivable from the buyer of our HSM business, sold in September 2000. The
MEDgenesis sale proceeds were later used to fund acquisitions in the third (APP)
and fourth quarters (Oaks and SangStat) of fiscal 2001.
24
Other Income (Loss)
The $1.8 million loss in fiscal 2001 reflects our loss on sale of
available-for-sale securities that had been received as consideration in the
sale of our MEDgenesis business. These securities were received in January, 2001
(third quarter of fiscal 2001), and then sold in both the third and fourth
quarters of fiscal 2001. All securities have been sold as of June 29, 2001.
Income Taxes
In fiscal 2000 and 2001 the income tax benefits on operating losses
were at approximately 37%. See Note 7, Notes to Consolidated Financial
Statements, for the reconciliation to our statutory rate.
LIQUIDITY AND CAPITAL RESOURCES
As of June 28, 2002, we had $43.9 million of working capital, compared
to $37.0 million as of June 29, 2001. During fiscal 2002, we generated $7.8
million of cash from operating activities. The average days sales outstanding
(DSO) of our accounts receivable improved from 52 days at June 29, 2001, to 44
days at June 28, 2002. Faster payment from our larger payors and active
collection efforts led to this improvement. Despite this improvement in DSO, we
used $4.1 million in cash to finance our receivable growth resulting from
increasing revenues. We expect our receivables to perform at or better than 44
days sales outstanding in fiscal 2003. The average days inventory on hand also
improved from 10 days at June 29, 2001, to 9 days at June 28, 2002. This
improvement resulted in a $0.5 million source of cash during fiscal 2002. We
expect our inventory to perform at or below 10 days on hand in fiscal 2003.
During fiscal 2002, we collected approximately $7.0 million in income tax
refunds resulting from prior years' tax losses.
Approximately $2.5 million of cash was provided by investing activities
during fiscal 2002, consisting of $3.8 million from the collection of a note
from the buyer of our HSM business, offset by $1.3 million cash used for the
purchases of property and equipment, primarily leasehold improvements for the
StatScript specialty pharmacies.
We had no long-term debt as of fiscal year end 2002 and 2001.
Shareholders' equity as of fiscal year end 2002 and 2001 was $79.4 million and
$75.5 million, respectively. Net tangible assets, an indicator of borrowing
capacity, as of years ended 2002 and 2001 were $49.2 million and $45.3 million,
respectively. As of June 28, 2002, we had a secured line of credit totaling $30
million. We are in compliance with the debt covenants of the line of credit as
of June 28, 2002. Under the terms of the agreement, the debt is secured by
receivables and inventory and bears interest at Prime Rate. The line of credit
expires in January, 2003. We are currently in the process of securing a new,
long-term line of credit agreement, which we expect to complete by December,
2002.
There were no short-term borrowings outstanding under our line of
credit at June 28, 2002. We believe that the line of credit and cash provided by
operating activities should allow us to meet foreseeable cash requirements and
provide the flexibility to fund future working capital growth. However, we would
need to seek additional debt or equity financing beyond our current $30 million
line of credit to fund any major business acquisitions or capital spending
projects. We are not currently planning any major capital projects beyond our
normal requirements of $2 to $3 million per year.
Our future contractual commitments consist entirely of payments due
under operating leases - See Note 5, Notes to Consolidated Financial Statements
in Item 14 of this Annual Report on Form 10-K.
25
RESTRICTED STOCK GRANTS
In August 2002, the Compensation Committee of the Board of Directors
approved restricted stock grants to our officers totaling 145,000 shares of
restricted common stock under our 2001 Stock Incentive Plan. These restricted
shares, valued at $682,950 based on our fair market value of $4.71 per common
share at the date of grant, will be recognized as compensation expense over the
four year vesting period of the grant, subject to an acceleration provision
based on increases in our stock price. Excluding the acceleration provision, the
expected financial impact of the stock grant will be approximately $106,000
annually, net of tax, or $0.01 per share.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement 141, "Business Combinations", which prohibits the use of the
pooling-of-interests method of accounting for business combinations, defines the
methodology to be used in measuring goodwill and other intangible assets, and
defines certain disclosure requirements for business combinations. Statement 141
became effective for all transactions initiated after June 30, 2001, and for all
purchase method transactions completed after June 30, 2001. Accordingly, we
adopted Statement 141 beginning July 1, 2001, resulting in no material effect to
the financial statements.
On that same date, the FASB also issued Statement 142, "Goodwill and
Other Intangible Assets". Under the new rules, goodwill (and intangible assets
deemed to have indefinite lives) is no longer being amortized but is subject to
annual impairment tests in accordance with the Statement. Other intangible
assets continue to be amortized over their useful lives. We applied the new
rules beginning in our first fiscal quarter of 2002 that began on June 30, 2001.
Application of the non-amortization provisions of the Statement resulted in a
decrease of approximately $2.3 million in amortization of existing goodwill and
an increase in after-tax net income of approximately $1.4 million ($0.12 per
share) in fiscal 2002. In fiscal 2001, goodwill amortization totaled $1.4
million, which would have amounted to after-tax net income of $0.9 million or
$0.07 per share. During fiscal 2002, we performed periodic impairment tests of
goodwill beginning June 30, 2001, resulting in no adjustments to the carrying
value of goodwill.
In October 2001, the FASB issued Statement 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". Statement 144, which replaces
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," requires long-lived assets to be measured
at the lower of carrying amount or fair value less the cost to sell. Statement
144 also broadens disposal transaction reporting related to discontinued
operations. The Statement is effective for financial statements issued for
fiscal years beginning after December 15, 2001. We will adopt Statement 144 in
fiscal 2003 and do not expect the adoption to have a material impact on our
financial statements.
In June 2002, the FASB issued Statement 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The Statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Prior guidance required that a liability for an
exit cost be recognized at the date of an entity's commitment to an exit plan.
This Statement also establishes that fair value is the objective for initial
measurement of the liability. Statement 146 is effective for exit or disposal
activities that are initiated after December 31, 2002.
IMPACT OF INFLATION
Changes in prices charged by biopharmaceutical manufacturers for the
drugs we dispense, along with increasing labor costs, freight and supply costs
and other overhead expenses, affect our cost of revenue and general and
administrative expenses. Historically, we have been able to pass a portion of
the effect of such increases to the payor and patient pursuant to automatic
price adjustments made under our payor contracts. As a result, changes due to
inflation have not had significant adverse effects on our operations.
26
FORWARD-LOOKING STATEMENTS
Information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, other than historical or current
facts, should be considered forward-looking statements as defined in the Private
Securities Litigation Reform Act of 1995. These statements reflect management's
current views of future events and financial performance that involve a number
of risks and uncertainties. These factors include, but are not limited to, the
following: our ability to maintain satisfactory on-going arrangements with drug
manufacturers and wholesalers, and their ability to satisfy our volume, pricing,
and product requirements; decrease in demand for drugs we handle; changes in
Medicare or Medicaid; loss of relationships with payors (including Aetna or
other large contracts); negative cost containment trends or financial
difficulties by our payors; changes in or unknown violations of various federal,
state, and local regulations; costs and other effects of legal or administrative
proceedings; the adoption of new or changes to existing accounting policies and
practices and the application of such policies and practices; the amount and
rate of growth in our selling, general and administrative expenses; the
impairment of a significant amount of our goodwill; the effects of and changes
in, trade, monetary and fiscal policies, laws and regulations; other activities
of government agencies; our ability to obtain competitive financing to fund
operations and growth; continuing qualifications to list our securities on a
national stock exchange; developments in medical research affecting the
treatment or cure of conditions for which we distribute medications; the ability
of management and accounting controls to assure accurate and timely information;
computer system, software, or hardware failures or malfunctions; heightened
competition; and loss or retirement of key executives or changes in ownership.
We urge you to read the cautionary statement filed as Exhibit 99.1. This
cautionary statement discusses specific factors which could affect our
operations and forward-looking statements contained in this Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk primarily through our borrowing
activities under our line of credit discussed in Item 7 of this report. Our
short-term borrowings bear interest at variable rates based on the prime rate. A
10% increase in interest rates would not have a significant effect on our
interest expense based on fiscal 2002 borrowing levels. We do not use financial
instruments for trading or other speculative purposes and are not a party to any
leveraged financial instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial information
required to be filed under this Item are presented on pages F-1 through F-23 of
this Annual Report on Form 10-K, and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The discussions under the sections captioned "SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE", "PROPOSAL 1 - ELECTION OF DIRECTORS", "PROPOSAL
2 - APPOINTMENT OF INDEPENDENT AUDITORS", and "EXECUTIVE OFFICERS" to be
included in our definitive proxy statement to be filed with the Securities and
Exchange Commission and delivered to our shareholders pursuant to Regulation 14A
promulgated under the Securities Exchange Act of 1934 with respect to the Annual
Meeting of Shareholders to be held on November 20, 2002 (the "2002 Proxy
Statement") are incorporated in this Form 10-K by reference in response to this
Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The discussions under the sections captioned "DIRECTOR COMPENSATION"
and "EXECUTIVE COMPENSATION" but excluding the discussions included under the
subsections captioned "EXECUTIVE COMPENSATION - Report of the Compensation
Committee of the Board of Directors on Executive Compensation", "EXECUTIVE
COMPENSATION - Equity Compensation Plan Information", and "EXECUTIVE
COMPENSATION - Comparable Stock Performance" to be included in the 2002 Proxy
Statement are incorporated in this Form 10-K by reference in response to this
Item 11.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The discussions under the sections captioned "OWNERSHIP OF CHRONIMED
COMMON STOCK BY CERTAIN BENEFICIAL OWNERS AND EXECUTIVE OFFICERS" to be included
in the 2002 Proxy Statement are incorporated in this Form 10-K by reference in
response to this Item 12.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The discussion under the section captioned "CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS" to be included in the 2002 Proxy Statement is incorporated
herein by reference in response to this Item 13.
28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
PAGE
(a) DOCUMENTS INCLUDED IN THIS REPORT
1. Financial Statements
Index to Financial Statements.................................................. F-1
Report of Independent Auditors................................................. F-2
Consolidated Balance Sheets as of June 28, 2002, and June 29, 2001............. F-3
Consolidated Statements of Operations for the years ended June 28, 2002,
June 29, 2001, and June 30, 2000 .............................................. F-4
Consolidated Statements of Shareholders' Equity for the years ended June 28, 2002,
June 29, 2001, and June 30, 2000 .............................................. F-5
Consolidated Statements of Cash Flows for the years ended June 28, 2002,
June 29, 2001, and June 30, 2000 .............................................. F-6
Notes to Consolidated Financial Statements..................................... F-8
2. Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts and Reserves.................. S-1
Financial Statement schedules not included in this Report have been
omitted because they are not applicable or the required information is
shown in the Audited Consolidated Financial Statements or Notes
thereto.
(b) REPORTS ON FORM 8-K
None
(c) EXHIBITS
Exhibits designated by the symbol * are filed with this Annual Report
on Form 10-K. All exhibits not so designated are incorporated by
reference to a prior filing as indicated.
We will furnish any shareholder a copy of any of the following exhibits
upon payment to us of the reasonable costs incurred by us in furnishing
any such exhibit.
Portions of the 2002 definitive Proxy Statement are incorporated herein
by reference as set forth in Items 10, 11, 12, and 13 of this Report.
Only those portions directly responsive to the Items of Form 10-K shall
be deemed filed with the Securities and Exchange Commission.
29
EXHIBIT
NUMBER DESCRIPTION
3.1 Articles of Incorporation of the Company, as amended. (6)
3.2 Bylaws of the Company, as amended. (7)
4.1 Specimen form of the Company's Common Stock certificate. (2)
4.2 Shareholder Rights Agreement between the Company and Wells
Fargo Bank, National Association (formerly Norwest Bank
Minnesota, N.A.) dated December 18, 1996.(5)
10.1* Form of Incentive Stock Option Agreement. (1)
10.2* Form of Nonstatutory Stock Option Agreement. (1)
10.3 Pharmacy Participation Agreement with Aetna Health Management,
Inc.(11)
10.4 Employment Agreement effective July 1, 2000, between the
Company and Henry F. Blissenbach.(1) (10)
10.5 Employment Agreement dated March 1, 2000, between the Company
and Gregory H. Keane. (1) (9)
10.6 Chronimed Inc. 1994 Stock Option Plan. (3)
10.7 Chronimed Inc. 1994 Stock Option Plan for Directors. (3)
10.8 Chronimed Inc. 1997 Stock Option Plan. (4)
10.9 Chronimed Inc. 1999 Stock Option Plan. (8)
10.10 Chronimed Inc. 2001 Stock Option Plan. (11)
10.11 Facility Lease Agreement with Red Circle L.L.P. dated November
1996. (5)
10.11a Amendments dated April 1997, December 1997, and July 1998 to
Facility Lease Agreement with Red Circle L.L.P. (8)
10.12 Separation and Release Agreement effective January 5, 2001,
between the Company and Maurice R. Taylor, II. (1) (12)
10.13 Promissory Note of Maurice R. Taylor, II, dated July 24, 2000.
(1) (12)
10.14 Asset Purchase Agreement dated December 1, 2000, between
Chronimed Inc. and Medisys PLC. (13) (Incorporated by
reference from Exhibit 2.1 to the Company's Form 8-K filed
December 18, 2000).
10.14a Amendment to Asset Purchase Agreement dated January 5, 2001,
between Chronimed Inc. and Medisys PLC. (14) (Incorporated by
reference to Exhibit 2.2 in the Company's Form 8-K filed
January 19, 2001).
10.15 Asset Purchase Agreement dated February 2, 2001, between
Chronimed Inc. and American Prescription Providers. (15)
10.16 Amended and Restated Credit Agreement dated as of January 17,
2002. (16)
30
EXHIBIT
NUMBER DESCRIPTION
21.1* List of Subsidiaries.
23.1* Consent of Ernst & Young LLP.
99.1* Cautionary Statements for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act.
99.2* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Executive Officer).
99.3* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Financial Officer).
- ------
(1) Management contract or compensatory plan or arrangement.
(2) Incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 33-45644), as amended.
(3) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on January 31, 1995, under file number
0-19952.
(4) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on September 26, 1996, under file number
0-19952.
(5) Incorporated by reference to the Company's 1997 Annual Report on Form
10-K filed with The Commission on September 25, 1997, under file number
0-19952.
(6) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with the Commission on February 6, 1998, under file number
0-19952.
(7) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on May 5, 1998, under file number
0-19952.
(8) Incorporated by reference to the Company's 1998 Annual Report on Form
10-K filed with The Commission on September 30, 1998, under file Number
0-19952.
(9) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on May 5, 2000, under file Number
0-19952.
(10) Incorporated by reference to the Company's 1998 Annual Report on Form
10-K filed with The Commission on September 27, 2000, under file Number
0-19952.
(11) Incorporated by reference from Exhibit A in the Company's Definitive
Proxy Statement filed with The Commission on Schedule 14A, October 13,
2000, under file Number 0-19952.
(12) Incorporated by reference from Exhibit 2.1 in the Company's Form 8-K
filed with The Commission December 18, 2000, under file Number 0-19952.
(13) Incorporated by reference from Exhibit 2.2 in the Company's Form 8-K
filed with The Commission January 19, 2001, under file Number 0-19952.
31
(14) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on May 14, 2001, under file Number
0-19952.
(15) Incorporated by reference to the Company's 2001 Annual Report on Form
10-K filed with The Commission on October 12, 2001, under file Number
0-19952.
(16) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on May 10, 2002, under file Number
0-19952.
32
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.
CHRONIMED INC.
Dated: September 19, 2002
By /s/ HENRY F. BLISSENBACH
----------------------------------
Henry F. Blissenbach
Chief Executive Officer and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ HENRY F. BLISSENBACH September 19, 2002
- --------------------------------------------------
Henry F. Blissenbach - Chief Executive Officer
(Principal Executive Officer and Chairman of the
Board of Directors)
/s/ GREGORY H. KEANE September 19, 2002
- --------------------------------------------------
Gregory H. Keane - Vice President, Chief Financial
Officer and Treasurer (Principal Financial and
Accounting Officer)
/s/ THOMAS A. CUSICK September 19, 2002
- --------------------------------------------------
Thomas A. Cusick (Director)
/s/ JOHN H. FLITTIE September 19, 2002
- --------------------------------------------------
John H. Flittie (Director)
/s/ THOMAS F. HEANEY September 19, 2002
- --------------------------------------------------
Thomas F. Heaney (Director)
/s/ DAVID R. HUBERS September 19, 2002
- --------------------------------------------------
David R. Hubers (Director)
/s/ CHARLES V. OWENS, JR. September 19, 2002
- --------------------------------------------------
Charles V. Owens, Jr. (Director)
/s/ STUART A. SAMUELS September 19, 2002
- --------------------------------------------------
Stuart A. Samuels (Director)
33
CERTIFICATIONS
I, Henry F. Blissenbach, certify that:
1. I have reviewed this annual report on Form 10-K of Chronimed
Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of material fact or omit to state a material
fact necessary to make the statement made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report.
Date: September 19, 2002
/s/ HENRY F. BLISSENBACH
- -----------------------------------------------------
Henry F. Blissenbach
Chief Executive Officer
I, Gregory H. Keane, certify that:
1. I have reviewed this annual report on Form 10-K of Chronimed
Inc.;
2. Based on my knowledge, this annual report does not
contain any untrue statement of material fact or omit to state
a material fact necessary to make the statement made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report; and
3. Based on my knowledge, the financial statements, and
other financial information included in this annual report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
annual report.
Date: September 19, 2002
/s/ GREGORY H. KEANE
- -----------------------------------------------------
Gregory H. Keane
Chief Financial Officer
34
INDEX TO FINANCIAL STATEMENTS
Report of Independent Auditors............................................................................ F-2
Consolidated Balance Sheets............................................................................... F-3
Consolidated Statements of Operations..................................................................... F-4
Consolidated Statements of Shareholders' Equity........................................................... F-5
Consolidated Statements of Cash Flows..................................................................... F-6
Notes to Consolidated Financial Statements................................................................ F-8
Schedule II - Valuation and Qualifying Accounts and Reserves.............................................. S-1
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Chronimed Inc.
We have audited the accompanying consolidated balance sheets of
Chronimed Inc. as of June 28, 2002 and June 29, 2001, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended June 28, 2002. Our audits also
included the financial statement schedule listed in Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Chronimed Inc. at June 28, 2002 and June 29, 2001, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended June 28, 2002, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects, the information set forth
therein.
As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for goodwill to conform to Statement of
Financial Accounting Standards No. 142 effective June 30, 2001.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
August 9, 2002
F-2
CHRONIMED INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 28, 2002 JUNE 29, 2001
------------- -------------
ASSETS
Current assets
Cash and cash equivalents........................................... $ 6,306 $ --
Accounts receivable (net of allowances of $8,923 and
$9,664 at June 28, 2002 and June 29, 2001, respectively)......... 44,461 40,322
Income taxes receivable............................................. -- 6,370
Inventory........................................................... 8,334 8,833
Prepaid expenses.................................................... 1,062 1,030
Deferred taxes...................................................... 3,437 3,918
-------- ---------
Total current assets............................................. 63,600 60,473
Property and equipment, net .......................................... 5,485 7,027
Goodwill, net of accumulated amortization of $5,340.................... 30,233 30,233
Deferred taxes......................................................... -- 1,030
Other assets, net...................................................... 177 230
-------- ---------
Total assets..................................................... $ 99,495 $ 98,993
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.................................................... $ 14,811 $ 15,524
Accrued expenses.................................................... 3,117 3,243
Accrued bonus....................................................... 1,174 624
Income taxes payable................................................ 648 --
Short-term debt..................................................... -- 4,100
-------- ---------
Total current liabilities........................................ 19,750 23,491
Deferred taxes......................................................... 344 --
Shareholders' equity
Preferred Stock..................................................... -- --
Common Stock, issued and outstanding shares--12,353
and 12,315, respectively......................................... 124 123
Additional paid-in capital.......................................... 55,122 54,961
Retained earnings................................................... 24,155 20,418
-------- ---------
Total shareholders' equity.................................... 79,401 75,502
-------- ---------
Total liabilities and shareholders' equity............................. $ 99,495 $ 98,993
======== =========
See notes to consolidated financial statements
F-3
CHRONIMED INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
YEAR ENDED
------------------------------------------------
JUNE 28, 2002 JUNE 29, 2001 JUNE 30, 2000
------------- ------------- -------------
Revenue ............................................ $ 397,437 $297,925 $ 222,497
Cost of revenue...................................... 349,705 262,232 185,606
--------- -------- ---------
Gross profit................................ 47,732 35,693 36,891
Operating expenses
Selling and marketing............................. 3,329 3,209 4,455
General and administrative........................ 39,041 31,118 28,897
Bad debt expense.................................. 3,504 7,140 7,154
Other expense - asset write down.................. -- -- 5,500
--------- -------- ---------
Total operating expenses.................... 45,874 41,467 46,006
Income (loss) from continuing operations............. 1,858 (5,774) (9,115)
Interest income ..................................... 493 673 39
Interest (expense)................................... (389) (105) (230)
Other income (loss).................................. 3,906 (1,837) --
--------- --------- ---------
Income (loss) from continuing operations
before income taxes............................... 5,868 (7,043) (9,306)
Income tax (expense) benefit ........................ (2,131) 2,585 3,398
---------- -------- ---------
Net income (loss) from continuing operations ........ 3,737 (4,458) (5,908)
Net income from discontinued operations, net of tax . -- 1,466 1,840
Gain on sale of discontinued operations, net of tax . -- 13,769 --
--------- -------- ---------
Net income from and gain on sale of discontinued
operations, net of tax............................ -- 15,235 1,840
--------- -------- ---------
Net income (loss).................................... $ 3,737 $ 10,777 $ (4,068)
========= ======== =========
Basic and diluted net income (loss) per share
Continuing operations............................. $ 0.30 $ (0.37) $ (0.49)
Discontinued operations........................... -- 1.25 0.15
-------- -------- ---------
Net income (loss)................................. $ 0.30 $ 0.88 $ (0.34)
======== ======== =========
Basic weighted-average shares........................ 12,321 12,206 12,116
Diluted weighted-average shares...................... 12,342 12,206 12,116
See notes to consolidated financial statements
F-4
CHRONIMED INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
OTHER
PAID-IN RETAINED COMPREHENSIVE
SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL
------ ------ ------- -------- ------ -----
Balance July 2, 1999 ................................... 12,088 $ 121 $ 52,499 $ 13,709 $ 158 $ 66,487
Shares issued for employee stock
purchase and option plans ........................ 59 -- 336 -- -- 336
Tax benefit of stock option exercises ............... -- -- 4 -- -- 4
Net loss ............................................ -- -- -- (4,068) -- (4,068)
Unrealized gain on available-
for-sale securities .............................. -- -- -- -- 298 298
-------- -------- -------- -------- -------- --------
Subtotal - comprehensive loss ....................... (3,770)
-------- -------- -------- -------- -------- --------
Balance June 30, 2000 .................................. 12,147 121 52,839 9,641 456 63,057
Shares issued for employee stock
purchase and option plans ........................ 168 2 1,029 -- -- 1,031
Non-cash charge to compensation expense ............. -- -- 938 -- -- 938
Tax benefit of stock option exercises ............... -- -- 155 -- -- 155
Net income .......................................... -- -- -- 10,777 -- 10,777
Unrealized loss on available-
for-sale securities .............................. -- -- -- -- (456) (456)
-------- -------- -------- -------- -------- --------
Subtotal - comprehensive income ..................... 10,321
-------- -------- -------- -------- -------- --------
Balance June 29, 2001 .................................. 12,315 123 54,961 20,418 -- 75,502
Shares issued for employee stock
purchase and option plans ........................ 38 1 161 -- -- 162
Net income and comprehensive income ................. -- -- -- 3,737 -- 3,737
-------- -------- -------- -------- -------- --------
Balance June 28, 2002 .................................. 12,353 $ 124 $ 55,122 $ 24,155 $ -- $ 79,401
======== ======== ======== ======== ======== ========
See notes to consolidated financial statements
F-5
CHRONIMED INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED
-------------------------------------------
JUNE 28, 2002 JUNE 29, 2001 JUNE 30, 2000
------------- ------------- -------------
Operating activities
Net income (loss) ..................................................... $ 3,737 $ 10,777 $(4,068)
Less income/gain from discontinued operations ......................... -- (15,235) (1,840)
------- -------- -------
Income (loss) from continuing operations ............................ 3,737 (4,458) (5,908)
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by (used in) operating activities:
Depreciation and amortization ................................... 2,871 4,056 4,084
Deferred income taxes ........................................... 1,855 (1,296) (2,710)
Gain on sale of Home Service Medical business ................... (3,797) (22) --
Loss on sale of available-for-sale securities ................... -- 1,844 --
Write-off of Clinical Partners contract
management line ............................................. -- -- 5,500
Income tax benefit of stock option exercises .................... -- 155 4
Changes in operating assets and liabilities:
Accounts receivable ......................................... (4,139) (1,440) (7,229)
Income taxes ................................................ 7,018 (4,469) (2,087)
Inventory ................................................... 499 (1,529) (716)
Accounts payable ............................................ (713) 5,017 (79)
Accrued expenses ............................................ 424 1,354 414
Other assets ................................................ (3) (469) 513
------- -------- -------
Net cash provided by (used in) operating activities ................. 7,752 (1,257) (8,214)
Investing activities
Acquisitions .......................................................... -- (24,777) --
Proceeds from sale of Home Service Medical business ................... 3,797 2,734 --
Purchases of property and equipment ................................... (1,305) (2,850) (1,229)
Sale of available-for-sale securities ................................. -- 7,656 --
------- -------- -------
Net cash provided by (used in) investing activities ............ 2,492 (17,237) (1,229)
Financing activities
Net proceeds from issuance of Common Stock ............................ 162 1,031 336
Net proceeds from (repayments of) borrowings .......................... (4,100) 1,600 2,500
------- -------- -------
Net cash (used in) provided by financing activities ................. (3,938) 2,631 2,836
Cash provided by discontinued operations ................................. -- 15,863 3,295
Increase (decrease) in cash and cash equivalents ...................... 6,306 -- (3,312)
Cash and cash equivalents at beginning of year ........................ -- -- 3,312
------- -------- -------
Cash and cash equivalents at end of year .............................. $ 6,306 $ -- $ --
======= ======== =======
SUPPLEMENTAL DISCLOSURES
Income taxes paid ..................................................... $ 401 $ 14,092 $ 2,466
Interest payments ..................................................... $ 389 $ 102 $ 233
F-6
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
- - In fiscal 2001, we received a $3.8 million note receivable from
Express-Med, Inc. in the sale of the Home Service Medical business to
be paid over 42 months through March 1, 2004. Because of uncertainty of
collection of the note, the Company recorded the note, offset by a
deferred gain of the same amount. In fiscal 2002, the note was
collected and the gain recognized.
- - We sold our MEDgenesis subsidiary to Medisys PLC in January 2001 for
$30.475 million in cash and $9.5 million in Medisys common stock.
See notes to consolidated financial statements
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Chronimed Inc. ("Chronimed" or the "Company") is a distributor of
prescription drugs for people with certain chronic health conditions. We
consider our business to be unique and refer to it as specialty pharmacy. We
serve patients with highly specialized pharmaceutical needs and help employers
and third-party payors manage patient care costs. We distribute pharmaceuticals
and provide specialized patient management services nationwide for people with
chronic conditions including HIV/AIDS, organ transplants, and diseases treated
with biotech injectable medications. We work directly with patients, physicians,
healthcare providers, insurance companies, health maintenance organizations,
preferred provider organizations, government agencies, and other third-party
payors to improve clinical and financial outcomes for patients with chronic,
complex and expensive pharmaceutical needs.
FISCAL YEAR
We use a four-week, four-week, five-week (4-4-5) quarterly accounting
cycle with the fiscal year ending on the Friday closest to June 30. The fiscal
years referenced herein are as follows:
FISCAL YEAR YEAR ENDED
----------- ----------
2002 June 28, 2002 (52 weeks)
2001 June 29, 2001 (52 weeks)
2000 June 30, 2000 (52 weeks)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All intercompany accounts and
transactions between consolidated entities have been eliminated.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year presentations to
conform to current year presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Those assumptions and estimates are subject to constant
revision, and actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue is recognized at the time prescriptions are dispensed by the
pharmacist and shipped to or picked up by the patient. We participate in various
third party provider networks and state Medicaid programs. Under a majority of
these networks, the amount to be paid for our products is determined (or
"adjudicated") through electronic connections with these networks at the time of
sale. However, for certain third party providers and state Medicaid programs for
which there is no electronic adjudication process available at the time of sale,
we determine an appropriate estimate for expected payor discount. Revenue is
then reported at the estimated net realizable amount and adjusted in future
periods as final settlements are determined.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SHIPPING AND HANDLING COSTS
Product shipping and handling costs are included in cost of revenue.
These costs were $3.1 million, $2.5 million, and $2.1 million in fiscal 2002,
2001, and 2000, respectively.
STOCK-BASED COMPENSATION
We have adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (Statement No. 123), "Accounting for
Stock-Based Compensation," but apply Accounting Principles Board Opinion No. 25
(APB 25) and related interpretations in accounting for our stock plans. Under
APB 25, when the exercise price of an employee stock option equals the market
price of the underlying stock on the date of grant, no compensation expense is
recognized. Disclosure of the impact of Statement No. 123, as if adopted, can be
found in Note 8, Notes to Consolidated Financial Statements.
CASH AND CASH EQUIVALENTS
We consider all investments with an original maturity of 90 days or
less when purchased to be cash equivalents. Cash equivalents are available for
sale, are carried at cost, which approximates fair market value, and consist
principally of money market accounts.
ACCOUNTS RECEIVABLE ALLOWANCES
Allowance for Doubtful Accounts
We determine an allowance for doubtful accounts amount based upon an
analysis of the collectability of specific accounts and the aging of the
accounts receivable. Bad debt expense is recorded as an operating expense in our
Consolidated Statements of Operations.
Allowance for Payor Discounts
We determine an allowance for payor discounts based on an analysis of
historical payment experience for both the retail and mail order businesses, and
in some cases, by an analysis of specific large payor discounts. Payor discount
allowances are recorded as offsets to revenue in our Consolidated Statements of
Operations.
INVENTORIES
Inventories consist of goods held for resale and are carried at the
lower of cost or market determined under the average cost method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation on property and
equipment is computed using the straight-line method. Depreciation occurs over
estimated useful lives of one to seven years. Depreciation expense for
continuing operations was $2,847,000, $2,597,000, and $2,456,000 in fiscal 2002,
2001, and 2000, respectively.
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Property and equipment consisted of the following at June 28, 2002 and
June 29, 2001:
(IN THOUSANDS) 2002 2001
---- ----
Leasehold improvements .......... $ 4,528 $ 4,868
Furniture and fixtures .......... 3,688 3,839
Computer hardware and software .. 9,048 8,235
-------- --------
Total property and equipment .... 17,264 16,942
Less: Accumulated depreciation .. (11,779) (9,915)
-------- --------
Net property and equipment ...... $ 5,485 $ 7,027
======== ========
GOODWILL
As of June 30, 2001, we adopted Statement of Financial Accounting
Standards No. 142 ("Statement 142"), "Goodwill and Other Intangible Assets",
which addresses the financial accounting and reporting standards for the
acquisition of intangible assets outside of a business combination and for
goodwill and other intangible assets subsequent to their acquisition. This
accounting standard requires that goodwill no longer be amortized, but tested
for impairment on an annual basis. The provisions of this accounting standard
also require the completion of a transitional impairment test within six months
of adoption, with any impairments identified treated as cumulative effect of a
change in accounting principle.
We completed the transitional and annual goodwill impairment tests as
required by Statement 142. Based on the results of the impairment tests, we were
not required to recognize an impairment of goodwill. We will continue to perform
future impairment tests as required by the Statement.
In accordance with Statement 142, we discontinued the amortization of
goodwill effective June 30, 2001. A reconciliation of previously reported net
income (loss) and net income (loss) per share to the amounts adjusted for the
exclusion of goodwill amortization, net of the related income tax effect,
follows:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
---- ---- ----
Reported net income (loss) ............................................. $ 3,737 $ 10,777 $ (4,068)
Add: goodwill amortization, net of tax ................................. -- 881 1,034
---------- ---------- ----------
Adjusted net income (loss) ............................................. $ 3,737 $ 11,658 $ (3,034)
========== ========== ==========
Reported basic and diluted net income (loss) per share ................. $ 0.30 $ 0.88 $ (0.34)
Add: goodwill amortization, net of tax, per basic and diluted share .... -- 0.07 0.09
---------- ---------- ----------
Adjusted basic and diluted net income (loss) per share ................. $ 0.30 $ 0.95 $ (0.25)
========== ========== ==========
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS
We evaluate our long-lived assets for impairment losses when indicators
of impairment are present by comparing the undiscounted cash flows to the
carrying amount of the assets. An impairment loss is recorded if necessary. In
fiscal 2000 we wrote off $5.5 million associated with the Clinical Partners case
management operation in accordance with our evaluation of long-lived asset
impairment.
INCOME TAXES
We account for income taxes using the liability method. Deferred income
taxes are provided for temporary differences between financial reporting and the
tax basis of assets and liabilities.
NEW ACCOUNTING PRONOUNCEMENTS
In July, 2001, the Financial Accounting Standards Board ("FASB") issued
Statement 141, "Business Combinations", which prohibits the use of the
pooling-of-interests method of accounting for business combinations, defines the
methodology to be used in measuring goodwill and other intangible assets, and
defines certain disclosure requirements for business combinations. Statement 141
became effective for all transactions initiated after June 30, 2001, and for all
purchase method transactions completed after June 30, 2001. Accordingly, we
adopted Statement 141 beginning July 1, 2001, resulting in no material effect to
the financial statements.
In October, 2001, the FASB issued Statement 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". Statement 144, which replaces
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," requires long-lived assets to be measured
at the lower of carrying amount or fair value less the cost to sell. Statement
144 also broadens disposal transaction reporting related to discontinued
operations. The Statement is effective for financial statements issued for years
beginning after December 15, 2001. We will adopt Statement 144 in fiscal 2003
and do not expect the adoption to have a material impact on our financial
statements.
In June, 2002, the FASB issued Statement 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The Statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Prior guidance required that a liability for an
exit cost be recognized at the date of an entity's commitment to an exit plan.
This Statement also establishes that fair value is the objective for initial
measurement of the liability. Statement 146 is effective for exit or disposal
activities that are initiated after December 31, 2002.
PER SHARE DATA
Earnings per share are calculated in accordance with Statement No. 128,
"Earnings Per Share." Potential common shares are included in the diluted net
income (loss) calculation when dilutive. Potential common shares consisting of
common stock issuable upon exercise of outstanding common stock options are
computed using the treasury stock method. Our basic net income (loss) per share
is computed by dividing income (loss) by the weighted average number of common
shares outstanding during the period. Diluted net income (loss) per share is
computed by dividing income (loss) by the weighted average number of common
shares outstanding during the period, increased to include dilutive potential
common shares issuable upon the exercise of stock options that were outstanding
during the period. For loss periods, basic and diluted share amounts are
identical, as the effect of potential common shares is antidilutive. A
reconciliation of the numerator and denominator in the basic and diluted
earnings per share calculation is as follows:
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2002 2001 2000
---- ---- ----
Numerator
Net income (loss) from continuing operations ........ $ 3,737 $ (4,458) $ (5,908)
Net income from discontinued operations ............. -- 15,235 1,840
------- -------- --------
Net income .......................................... $ 3,737 $ 10,777 $ (4,068)
======= ======== ========
Denominator
Denominator for basic net income (loss) per share -
weighted average shares outstanding .............. 12,321 12,206 12,116
Effect of dilutive stock options .................... 21 -- --
------- -------- --------
Denominator for diluted net income (loss) per share -
weighted average shares outstanding .............. 12,342 12,206 12,116
======= ======== ========
Basic and diluted net income (loss) per share
from continuing operations .......................... $ 0.30 $ (0.37) $ (0.49)
Basic and diluted net income (loss) per share
from discontinued operations ....................... -- 1.25 0.15
------- -------- --------
Basic and diluted net income (loss) per share ............ $ 0.30 $ 0.88 $ (0.34)
======= ======== ========
Employee stock options of 1,241,520, 2,404,252, and 2,229,809 for the
fiscal years ended 2002, 2001, and 2000, respectively, have been excluded from
the basic and diluted net income (loss) per share calculation because their
effect would be antidilutive.
2. DISCONTINUED OPERATIONS - SALE OF MEDGENESIS
On January 5, 2001, we sold substantially all the assets of our
diagnostic products business, MEDgenesis Inc., to Medisys PLC of Woodbridge,
Suffolk, England. We have classified all financial results concerning MEDgenesis
as discontinued operations for reporting purposes.
We received $39.975 million from the sale of MEDgenesis to Medisys,
consisting of $30.475 million in cash and $9.5 million in Medisys common stock,
for a gain of $13.8 million.
The $9.5 million in Medisys PLC securities were subsequently sold for
$7.7 million in cash, which resulted in a $1.8 million loss in fiscal 2001. This
loss has been included in the Other Expense line as a part of Operating Expenses
in the Consolidated Statements of Operations.
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following shows the calculation of the reported gain from the sales
transaction:
(in thousands)
Purchase price proceeds................................... $ 39,975
Less transaction and other related costs.................. (4,485)
Less net book value of assets............................. (11,591)
-------------
Gain before income taxes.................................. 23,899
Less income taxes......................................... (10,130)
-------------
Gain on sale.............................................. $ 13,769
=============
The following shows the transaction costs:
(in thousands)
Contract assignment costs................................. $ (1,000)
Miscellaneous acquisition costs........................... (1,321)
Severance (see Note 10)................................... (2,164)
-------------
Transaction and other related costs....................... $ (4,485)
=============
The following table summarizes revenue and net income from discontinued
operations for fiscal years 2001 and 2000. The activity shown for the year ended
June 29, 2001 includes activity through the sale date of January 5, 2001:
(IN THOUSANDS) 2001 2000
- -------------- ---- ----
Revenue from discontinued operations......................... $ 19,443 $ 32,949
Cost of revenue.............................................. 10,903 20,283
--------- ---------
Gross profit............................................. 8,540 12,666
Operating expenses
Selling and marketing.................................... 2,951 5,349
Research and development................................. 596 1,087
General and administrative............................... 2,713 3,751
--------- ---------
Total operating expenses.............................. 6,260 10,187
Income from discontinued operations.......................... 2,280 2,479
Other income................................................. 124 540
--------- ---------
Income from discontinued operations before income taxes...... 2,404 3,019
Income tax (expense)......................................... (938) (1,179)
--------- ---------
Net income from discontinued operations...................... $ 1,466 $ 1,840
========= =========
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. ACQUISITIONS
In February, 2001, we acquired the four retail pharmacies of American
Prescription Providers, Inc. for $16.0 million in cash. The excess of the
purchase price plus transaction costs over the fair value of the net assets was
$15.6 million, all of which has been classified as goodwill.
In April, 2001, we acquired the Transplant Pharmacy business of
SangStat Medical Corporation, which provides mail order distribution of drugs
and transplant patient management services. We acquired substantially all the
assets excluding inventory and accounts receivable for cash of $1.8 million. The
excess of the purchase price plus transaction costs over the fair value of the
net assets was $1.8 million, all of which has been classified as goodwill.
In April, 2001, we acquired Los Feliz Drugs, Inc., d/b/a Oaks Pharmacy
("Oaks"), a pharmacy that provides specialty pharmaceutical products for people
with HIV/AIDS and other chronic conditions for cash of $5.2 million. The excess
of the purchase price plus transaction costs over the fair value of the net
assets was $5.3 million, all of which has been classified as goodwill.
All acquisitions described above were accounted for as purchases and,
accordingly, operating results of these businesses subsequent to the date of
acquisition were included in our consolidated financial statements. The effect
of these acquisitions on our operations for 2001 was not material.
4. SALE OF HOME SERVICE MEDICAL BUSINESS
We sold our Home Service Medical ("HSM") business on September 1, 2000,
to Express-Med, Inc. of New Albany, Ohio for $6.5 million. HSM was a direct to
consumer, mail-order catalog business that contributed $15.0 million in revenue
and $1.3 million in pre-tax operating income to our total results for the fiscal
year ended June 30, 2000. We received $2.7 million in cash ($3.0 million at
close less a $0.3 million working capital adjustment paid to the buyer on
December 1, 2000) and a $3.8 million note maturing in 42 months and bearing an
annual interest rate of 11%.
We deferred the $3.8 million gain on the sale of HSM in accordance with
the SEC Staff Accounting Bulletin No. 81, "Gain Recognition on the Sale of a
Business or Operating Assets to a Highly Leveraged Entity." Because there was no
guarantee that Express-Med would be able to repay the note and due to the
long-term nature of the note, the gain was deferred until principal payments
under the promissory note were received or deemed to be fully collectable. In
June 2002, we received payment of $3.8 million in full satisfaction of this note
and recorded the gain in other income on the Statement of Operations.
5. OPERATING LEASES AND RENT EXPENSE
We lease our office space, distribution facilities, retail locations,
and various equipment under operating lease agreements. The remaining lease
terms range from one to eight years as of June 28, 2002.
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future minimum lease payments for continuing operations, including
current real estate taxes and operating expenses, under the operating leases
with lease terms in excess of one year at June 28, 2002, are approximately as
follows:
(IN THOUSANDS)
FISCAL YEAR AMOUNT
----------- ------
2003 $ 2,517
2004 2,296
2005 1,626
2006 592
2007 273
Beyond 199
-------
Total $ 7,503
=======
Total rent expense for continuing operations was $3,898,000,
$2,710,000, and $2,257,000 during fiscal 2002, 2001, and 2000, respectively.
6. LONG-TERM DEBT AND CREDIT ARRANGEMENTS
We had no long-term debt as of fiscal year end 2002 and 2001. We have a
secured line of credit totaling $30 million that will terminate on January 16,
2003. We were in full compliance with our line of credit covenants as of June
28, 2002. Under the terms of the line of credit agreement, the debt is secured
by receivables and inventory and bears interest at the Prime Rate. As of June
28, 2002, there was no short-term borrowing outstanding under this line of
credit.
7. INCOME TAXES
The components of the provision for income taxes for continuing
operations are as follows:
(IN THOUSANDS) 2002 2001 2000
---- ---- ----
Current....................................... $ 475 $ (1,288) $ (688)
Deferred...................................... 1,656 (1,297) (2,710)
---------- --------- -----------
Income tax expense (benefit) ................. $ 2,131 $ (2,585) $ (3,398)
========== ========= ===========
F-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Our income tax expense from continuing operations differs from the
applicable federal rate of 34% in fiscal 2002 and 2000, and 35% in fiscal 2001.
The reconciliation of differences is as follows:
(IN THOUSANDS) 2002 2001 2000
---- ---- ----
Federal income taxed at statutory rates.......... $ 1,995 $ (2,465) $ (3,165)
State taxes, net of federal benefit.............. 264 (260) (314)
Goodwill amortization............................ -- 61 7
Other, net....................................... (128) 79 74
---------- --------- -----------
Income tax expense (benefit)..................... $ 2,131 $ (2,585) $ (3,398)
========== ========= ===========
Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
our deferred tax assets and liabilities are as follows:
(IN THOUSANDS) 2002 2001
---- ----
Deferred tax assets
Allowance for doubtful accounts......... $ 2,003 $ 1,751
Inventory reserve....................... 69 70
Allowance for payor discounts........... 1,346 2,019
Other reserves.......................... 272 978
Vacation accrual........................ 155 134
Goodwill amortization................... -- 366
Depreciation............................ 11 32
Deferred tax liabilities
Prepaid assets.......................... (408) (402)
Goodwill amortization................... (355) --
--------- ---------
Net deferred tax assets...................... $ 3,093 $ 4,948
======== =========
8. SHAREHOLDERS' EQUITY
We have 5,000,000 shares of $.01 par value Preferred Stock authorized
and issuable in one or more series as the Board of Directors may determine, none
of which are outstanding. We have 40,000,000 authorized shares of $.01 par value
Common Stock. There are no restrictions on retained earnings.
In accordance with Statement No. 123, "Accounting for Stock-Based
Compensation," we continue to elect to utilize APB Opinion No. 25 and related
interpretations in accounting for our stock option plans and our employee stock
purchase plan. If we had elected to recognize compensation cost based on the
fair value of the options granted and shares sold pursuant to the purchase plan
as prescribed by Statement No. 123, compensation expense (net of tax) would have
been $1,371,000, $1,404,000 and $1,278,000 for fiscal years 2002, 2001, and
2000, respectively. Consolidated net income (loss) and earnings (loss) per
share, including continuing and discontinued operations, would have been the pro
forma amounts indicated in the table below.
F-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2002 2001 2000
---- ---- ----
Net income - as reported $ 3,737 $ 10,777 $ (4,068)
Net income - pro forma $ 2,366 $ 9,373 $ (5,346)
Earnings per share - basic as reported $ 0.30 $ 0.88 $ (0.34)
Earnings per share - basic pro forma $ 0.19 $ 0.77 $ (0.44)
Earnings per share - diluted as reported $ 0.30 $ 0.88 $ (0.34)
Earnings per share - diluted pro forma $ 0.19 $ 0.77 $ (0.44)
The fair value of each option grant is estimated on the date of the
grant using the Black-Scholes option-pricing model with the following
assumptions for the fiscal years shown:
2002 2001 2000
---- ---- ----
Expected dividend yield 0.0% 0.0% 0.0%
Expected stock price volatility 65% 55% 63%
Risk-free interest rate 4.4% 5.3% 6.2%
Expected life of options 5 years 5 years 5 years
The Black-Scholes option-pricing model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option pricing models require the input
of highly subjective assumptions. Because our employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, the existing models may not necessarily provide a reliable
single measure of the fair value of our employee stock options. Using the
foregoing assumptions, the weighted-average fair value of each option granted
during fiscal years 2002, 2001, and 2000, was $3.22, $4.06, and $5.07,
respectively.
We have five employee Stock Option Plans (1986, 1994, 1997, 1999, and
2001). Options to purchase Common Stock of the Company are granted to employees
at 100% of fair market value on the date of grant and generally become
exercisable at 20% of the total grant at the end of each year. The options are
cumulatively exercisable and expire seven years after the date of grant.
In August 2002, the Compensation Committee of the Board of Directors
approved restricted stock grants to our officers totaling 145,000 shares of
restricted common stock under our 2001 Stock Incentive Plan. These restricted
shares, valued at $682,950 based on our fair market value of $4.71 per common
share at the date of grant, will be recognized as compensation expense over the
four year vesting period of the grant, subject to an acceleration provision
based on increases in our stock price. Excluding the acceleration provision, the
expected financial impact of the stock grant will be approximately $106,000
annually, net of tax, or $0.01 per share.
We also have a director performance Stock Option Plan that reserved
300,000 shares of Common Stock for option grants. The options are granted with
exercise prices equal to market value on the date of grant. The options become
exercisable after seven years and expire ten years after the date of grant.
Certain acceleration provisions apply if the stock price increases significantly
prior to the end of seven years.
F-17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Stock option activity is summarized as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------- -----------------------
WEIGHTED WEIGHTED
SHARES AVERAGE AVERAGE
AVAILABLE NUMBER PRICE NUMBER PRICE
FOR GRANT OF SHARES PER SHARE OF SHARES PER SHARE
---------- --------- --------- --------- ----------
Balance July 2, 1999 840,299 2,886,227 $ 10.60 938,566 $ 11.24
Granted (33,000) 33,000 9.03
Exercised -- (49,038) 5.77
Cancelled 640,380 (640,380) 10.69
Expired (23,633) --
--------- ---------- ---------
Balance June 30, 2000 1,424,046 2,229,809 10.69 925,524 11.14
2001 Stock Option Plan 1,000,000 --
Granted (792,200) 792,200 7.63
Exercised -- (200,597) 8.89
Cancelled 417,160 (417,160) 10.30
Expired (97,960) --
--------- ---------- ---------
Balance June 29, 2001 1,951,046 2,404,252 9.90 1,271,303 10.97
Granted (591,900) 591,900 5.51
Exercised -- (2,000) 7.09
Cancelled 1,345,532 (1,345,532) 10.48
Expired (55,840) --
--------- ---------- ---------
Balance June 28, 2002 2,648,838 1,648,620 $ 7.85 598,588 $ 9.16
========= ========== =========
The following table summarizes information about stock options
outstanding at June 28, 2002.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- -------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL PRICE NUMBER PRICE
EXERCISE PRICES OF SHARES LIFE PER SHARE OF SHARES PER SHARE
--------------- --------- --------------- --------- --------- ---------
$ 4.33 - 6.21 451,100 6.2 yrs $ 5.24 720 $ 5.03
$ 6.23 - 7.38 446,950 5.4 yrs $ 7.21 126,353 $ 7.13
$ 7.50 - 8.28 389,115 3.6 yrs $ 7.98 264,874 $ 7.93
$ 8.63 - 21.88 361,455 2.7 yrs $ 11.74 206,641 $ 11.99
--------- -------
$ 4.33 - 21.88 1,648,620 4.6 yrs $ 7.85 598,588 $ 9.16
========= =======
F-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In fiscal 2001 we modified option terms in the Separation Agreement
entered into with Maurice R. Taylor, our former Chairman and Chief Executive
Officer. The modification caused all of Taylor's options to vest immediately and
to extend the exercise dates for all options through January 5, 2002. The
Company recognized $938,000 of compensation expense as a result of the
modification. The majority of these options expired unexercised. See Note 10,
Notes to Consolidated Financial Statements.
9. EMPLOYEE BENEFIT PLANS
We have a qualified 401(k) Employee Savings Plan covering substantially
all employees. Our required contributions to the Plan, representing 401(k)
matching contributions only, to employees of continuing and discontinued
operations, were $209,000, $188,000, and $165,000 in fiscal years 2002, 2001,
and 2000, respectively.
We have an Employee Stock Purchase Plan. There were 35,187, 29,172, and
35,467 shares of common stock issued under the plan during fiscal years 2002,
2001, and 2000, respectively. There were 91,951 shares available for purchase
under the Plan at June 28, 2002.
10. RELATED PARTY TRANSACTIONS
On April 9, 1997, we entered into a guaranty of a personal loan with
USBank on behalf of Maurice R. Taylor, at the time our Chairman and Chief
Executive Officer. Taylor's USBank loan allowed him to avoid liquidation of a
substantial number of our shares pledged as security. There was $675,000 of
indebtedness under the guarantee on June 30, 2000. On July 1, 2000, Taylor
resigned as Chairman and became Chairman and CEO of our wholly-owned subsidiary,
MEDgenesis Inc. MEDgenesis assumed our guaranty of Taylor's loan on that date
and subsequently loaned Taylor funds sufficient to pay off his debt to USBank.
USBank extinguished our guaranty at that time, and Taylor gave MEDgenesis a
promissory note, due December 31, 2001, a residential mortgage, and a pledge
agreement. Taylor's term as a Director ended on November 27, 2000.
When we sold the MEDgenesis assets to Medisys on January 5, 2001,
Medisys did not acquire the Taylor promissory note, pledge agreement, or
mortgage. Accordingly, these commitments remain assets belonging to us as parent
company. Taylor failed to pay the full balance due on the note when it came due
on December 31, 2001, and is in default under the terms of the note and
residential mortgage. We commenced a lawsuit against Taylor to obtain a judgment
for the sum due and an order permitting foreclosure of the residential mortgage.
The lawsuit is venued in the United States District Court in St. Paul, Minnesota
and is scheduled for trial commencing in June, 2003.
Concurrent with the sale of MEDgenesis assets, we entered into a
Separation Agreement with Taylor related to Taylor's Employment Agreement. Under
the terms of the Employment Agreement, we made a payment to Taylor of
$1,226,000. The Separation Agreement also created an immediate vesting of all of
Taylor's outstanding stock options and extended his period to exercise options
to January 5, 2002. The Separation Agreement also allowed for office space
access and health care insurance for twelve months.
The modification to Taylor's option terms created a new measurement
date requiring us to record compensation expense for the excess of the share
price on January 5, 2001 over the option exercise price at grant date. This
modification resulted in a $938,000 non-cash charge to compensation expense.
Both the $1,226,000 severance payment and the $938,000 non-cash charge were
charged against the gain on the sale of MEDgenesis, as part of discontinued
operations.
F-19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. SIGNIFICANT CONCENTRATIONS
Payor reimbursements from Aetna, Inc. represented 26.0%, 33.2%, and
26.1% of our revenue in fiscal years 2002, 2001, and 2000, respectively. No
other private payor or single government agency represented more than 10% of our
revenues.
We use McKesson Corporation, a large national distributor, to supply
pharmaceuticals for both the Retail and the Mail Order segments. This supplier
made up 91.7%, 85.2%, and 79.5% of our continuing operations inventory purchases
for fiscal years 2002, 2001, and 2000, respectively. In the event that we are
unable to purchase pharmaceuticals through this distributor, we believe we would
be able to purchase the same inventory through other national pharmaceutical
distributors under similar terms and conditions.
Our primary concentration of credit risk is third party payor accounts
receivable, which consist of amounts owed by various governmental agencies and
insurance companies. We manage our receivables by regularly reviewing accounts
and contracts and by providing appropriate allowances for uncollectable amounts.
Aetna, Inc. represents 19.4% and 25.1% of our accounts receivable balance for
the fiscal years ended 2002 and 2001, respectively. No other private payor or
single government agency represented more than 10% of our accounts receivable
balances. Concentration of credit risk relating to accounts receivable is
limited to some extent by the diversity and number of patients and payors and
the geographic dispersion of our operations. We grant credit without collateral
to our patients and payors.
12. BUSINESS SEGMENT INFORMATION
We have two reportable segments:
- Mail Order - provides prescription drug and ancillary medical
supplies via mail service to patients with a wide variety of
high-cost chronic conditions including solid organ
transplants, anemia, cancer, endometriosis, growth hormone
deficiency, hemophilia, Hepatitis B and C, immune deficiency
disorders, infertility, multiple sclerosis, neutropenia,
respiratory syncytial virus, and rheumatoid arthritis. We have
contracts with HMOs, major health insurers, Medicare and
Medicaid, and other managed health plans covering a
substantial population. We distribute these critical
medications directly to patients nationwide while ensuring
competitive prices to payors. We also distribute products
directly to physicians office, for administration at their
office. We coordinate our services with payors, physicians,
nursing services, and other members of a patient's healthcare
team. In addition, we work with physicians to develop therapy
management guidelines through ongoing monitoring and
evaluation of patient responsiveness and compliance to the
treatment.
- Retail - branded as StatScript Pharmacy, we believe it to be
the largest network of community-based HIV/AIDS pharmacies in
the country, currently with 27 pharmacies. Although committed
to the HIV/AIDS patient, StatScript also serves organ
transplant recipients and other patients with conditions
treated with biotech injectable medication. Key to the
successful care of patients is StatScript's efforts with
community resources, education of the patient, clinical team
communication, and complete patient tracking.
F-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Our reportable segments are made up of business lines that offer
related products and services to patients with chronic health conditions but
through separate distribution channels. We evaluate performance based on profit
or loss from operations before interest and income taxes. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies. All of our operations and assets are
located in the United States.
The table below presents information by reportable segment.
(IN THOUSANDS) MAIL ORDER RETAIL TOTAL
---------- -------- --------
For the Year Ended June 28, 2002
Revenues $173,202 $224,235 $397,437
Income from Operations 2,166 (308) 1,858
Depreciation and Amortization 1,051 1,820 2,871
Additions to Property and Equipment 519 1,601 2,120
Segment Assets 28,275 61,419 89,694
For the Year Ended June 29, 2001
Revenues $153,461 $144,464 $297,925
Income (Loss) from Operations (314) (5,110) (5,424)
Depreciation and Amortization 1,558 2,498 4,056
Additions to Property and Equipment 1,193 2,406 3,599
Segment Assets 31,210 55,612 86,822
For the Year Ended June 30, 2000
Revenues $119,170 $103,327 $222,497
Income (Loss) from Operations (213) (2,384) (2,597)
Depreciation and Amortization 1,486 2,598 4,084
Additions to Property and Equipment 801 654 1,455
Segment Assets 33,575 27,818 61,393
Income from operations for fiscal year 2002 includes special charges
totaling $3.6 million relating to the retail segment for transferring the
StatScript headquarters from Kansas City to Minneapolis, store closing costs,
and expenses associated with the fiscal 2001 financial restatement.
Income from operations for fiscal year 2000 includes $6.9 million of
corporate charges relating to a write-down of its investment in Clinical
Partners, costs to retain an investment banker to review corporate strategic
alternatives, and costs related to a contemplated spin-off of MEDgenesis, Inc.
F-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table is a reconciliation of reportable segment
information to our consolidated totals.
Fiscal Year Ended
-----------------------------------------------------------
(IN THOUSANDS) 2002 2001 2000
---- ---- ----
Total Consolidated Revenue $ 397,437 $ 297,925 $ 222,497
INCOME (LOSS) FROM CONTINUING OPERATIONS
Total for reportable segments $ 1,858 $ (5,424) $ (2,597)
Unallocated amounts:
- Corporate G&A (350) (1,018)
- Interest income (expense) 104 568 (191)
- Other income (expense) 3,906 (1,837) --
- Clinical Partners write-off -- (5,500)
--------- --------- ---------
Income (loss) from continuing operations before income taxes $ 5,868 $ (7,043) $ (9,306)
========= ========= =========
Depreciation and amortization $ 2,871 $ 4,056 $ 4,084
========= ========= =========
ASSETS
Total for reportable segments $ 89,694 $ 86,822 $ 61,393
Corporate assets 9,801 12,171 6,572
--------- --------- ---------
Total consolidated assets of continuing operations $ 99,495 $ 98,993 $ 67,965
========= ========= =========
Corporate assets consist primarily of deferred taxes, taxes receivable,
prepaid expenses, certain receivables and deposits, and unallocated Corporate
fixed assets.
13. LITIGATION
On June 15, 2001, a putative class action lawsuit captioned Judith
Barclay v. Chronimed Inc., et. al. (01-CV-1092 DWF) was commenced in the United
States District Court for the District of Minnesota against Chronimed and
certain of our current and former officers. The Complaint alleges that Chronimed
and individual defendants violated Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10(b)-5 promulgated thereunder, and that the individual
defendants violated Section 20(a) of the Exchange Act. Eight other lawsuits
asserting claims identical to the Barclay case were brought by other plaintiffs
during the weeks following the initial filing. The nine lawsuits have been
consolidated into a single case.
The Complaints allege in general terms that we made false and
misleading statements about its financial statements in violation of the
securities laws. The alleged violations arise out of the requirement to restate
previously issued financial statements. The Company issued public statements
regarding these matters on June 14, June 21, August 14, August 23, and September
25, 2001. Each plaintiff seeks compensatory damages in an unstated amount,
interest, fees, expenses, and unspecified equitable relief. We are unable to
reasonably quantify the alleged damages on the basis of the general allegations
of the Complaints. We believe that the above claims are wholly without merit and
will vigorously defend against the lawsuits.
14. QUARTERLY RESULTS - UNAUDITED
The following tables present our results of operations and earnings per
share on a quarterly basis for fiscal 2002 and 2001.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
QUARTERLY RESULTS
Fiscal Year 2002
------------------------------------------------------------------
QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 YEAR ENDED
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEPT 28, DEC 28, MAR 29, JUN 28, JUN 28,
2001 2001 2002 2002 2002
--------- --------- --------- --------- ----------
Revenue ................................. $93,428 $100,554 $102,360 $101,095 $397,437
Gross profit ............................ 11,544 12,042 12,025 12,121 47,732
Net income from continuing operations ... 3 328 866 2,540 3,737
Net income .............................. 3 328 866 2,540 3,737
Basic and diluted net income per share .. $ 0.00 $ 0.03 $ 0.07 $ 0.21 $ 0.30
Weighted average shares outstanding -
Basic ............................... 12,315 12,315 12,317 12,336 12,321
Diluted ............................. 12,315 12,316 12,394 12,371 12,342
Our results of operations for the first quarter ended September 28,
2001, include pre-tax charges of $1.4 million or $0.07 per share for the costs
of transferring Kansas City retail headquarters to Minneapolis and costs
associated with the fiscal 2001 financial restatement.
Our results of operations for the second quarter ended December 28,
2001, include pre-tax charges of $0.8 million or $0.04 per share for the costs
of transferring Kansas City retail headquarters to Minneapolis and costs
associated with closing five retail locations.
Our results of operations for the fourth quarter ended June 28, 2002,
include pre-tax charges of $1.4 million or $0.06 per share for costs associated
with closing nine retail locations. Also included in our results of operations
for the fourth quarter ended June 28, 2002 was a $3.8 million or $0.19 per share
gain from the collection of a previously reserved note receivable associated
with the sale of the Home Service Medical business.
Fiscal Year 2001
----------------------------------------------------------------------
QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 YEAR ENDED
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEPT 29, DEC 29, MAR 30, JUN 29, JUN 29,
2000 2000 2001 2001 2001
--------- --------- --------- --------- ----------
Revenue ................................... $ 62,844 $ 69,094 $ 77,991 $ 87,996 $ 297,925
Gross profit .............................. 8,148 8,349 9,128 10,068 35,693
Net (loss) from continuing operations ..... (703) (313) (411) (3,031) (4,458)
Net income (loss) ......................... (239) 768 13,282 (3,034) 10,777
Basic and diluted earnings per share -
continuing operations ................ $ (0.06) $ (0.03) $ (0.03) $ (0.25) $ (0.37)
Basic and diluted earnings per share ...... $ (0.02) $ 0.06 $ 1.09 $ (0.25) $ 0.88
Weighted average shares outstanding - basic
and diluted ........................... 12,147 12,155 12,222 12,299 12,206
Our net income for the third quarter ended March 30, 2001 includes an
after-tax gain of $13.8 million, or approximately $1.13 per share, on the sale
of our MEDgenesis subsidiary.
Our results of operations for the fourth quarter ended June 29, 2001
include a pre-tax loss on the sale of Available-for-Sale securities of $1.8
million, or approximately $0.09 per share on an after-tax basis.
F-23
CHRONIMED INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR CONTINUING OPERATIONS
(IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- -------- -------- -------- --------
CHARGED TO
BALANCE AT CHARGED TO OTHER
BEGINNING COSTS AND ACCOUNTS - DEDUCTIONS - BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE OF PERIOD
- ----------- ---------- ---------- ----------- ------------ --------------
Year ended June 28, 2002
Reserves and allowances deducted from asset
accounts:
Allowance for doubtful accounts ...... $4,490 $ 3,504 $ -- $ 2,566(3) $5,428
Allowance for payor discounts ........ 5,174 -- 23,051(1) 24,730(2) 3,495
------ ------- ------- ------- ------
$9,664 $ 3,504 $23,051 $27,296 $8,923
Year ended June 29, 2001
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts ...... $6,465 $ 7,140 $ -- $ 9,115(3) $4,490
Allowance for payor discounts ........ 1,994 -- 16,719(1) 13,539(2) 5,174
------ ------- ------- ------- ------
$8,459 $ 7,140 $16,719 $22,654 $9,664
Year ended June 30, 2000
Reserves and allowances deducted from asset
accounts:
Allowance for doubtful accounts ...... $1,158 $ 7,154 $ -- $ 1,847(3) $6,465
Allowance for payor discounts ........ 1,222 -- 7,524(1) 6,752(2) 1,994
------ ------- ------- ------- ------
$2,380 $ 7,154 $ 7,524 $ 8,599 $8,459
- --------------
(1) Estimated payor discounts charged to revenue
(2) Actual payor discounts taken
(3) Uncollectable accounts written off, net of recoveries
S-1