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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 27, 2003
[ ] 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. [ ]
Indicate by checkmark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [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 December 27,
2002, was approximately $74 million based on the closing price of $5.91 per
share reported on the NASDAQ National Market System. The number of shares of
Common Stock outstanding as of December 27, 2002, was 12,477,501.
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held November 19, 2003, to be filed with the
Commission are incorporated by reference in Part III of the Form 10-K.
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PART I
FORWARD-LOOKING STATEMENTS
Some of the information in this report contains forward-looking
statements that involve substantial risks and uncertainties. You can identify
these statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "intend," "estimate," and "continue" or similar words.
You should read statements that contain these words carefully for the following
reasons:
- the statements discuss our future expectations;
- the statements contain projections of our future earnings or of our
financial condition; and
- the statements state other "forward-looking" information.
It is important to communicate our expectations to our investors. There
may be events in the future, however, that we are not accurately able to predict
or over which we have no control. The risk factors noted in Exhibit 99.1 to this
report, as well as any cautionary language in this report, provide examples of
risks, uncertainties and events that may cause our actual results to differ
materially from expectations.
Before you invest in our common stock, you should be aware that the
occurrence of any of the events described in the risk factors, elsewhere in this
report, and other events that we have not predicted or assessed could have a
material adverse effect on our earnings, financial condition, and business. In
such case, the trading price of our common stock could decline, and you may lose
all or part of your investment.
ITEM 1. BUSINESS
GENERAL
Chronimed Inc. ("Chronimed" or the "Company"), a specialty pharmacy,
distributes prescription drugs and provides specialized therapy management
services for people with certain health conditions, including HIV/AIDS, organ
transplants, and diseases treated with biotech injectable medications. We work
with patients, physicians and other health care providers, pharmaceutical
manufacturers, health plans and insurers, and government agencies to improve
clinical and economic outcomes.
We distribute our products via our Chronimed mail service and our
nationwide StatScript Pharmacy retail chain. All sales are attributed to and all
assets are located in the United States. See Note 12, Notes to Consolidated
Financial Statements, Item 15 of this Annual report on Form 10-K, for
information regarding our business 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. These are all
reasons these medications are not routinely stocked in traditional mail and
retail pharmacies.
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 mail and 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
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- require a significant amount of self-management and ongoing
education where patient compliance is critical for improving
clinical and economic outcomes.
Our key relationships are with:
- Patients: 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-oriented
services include counseling by highly trained registered
pharmacists, nurses, and internally certified patient
specialists, 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.
- Physicians and Healthcare Providers: We believe our expertise
makes us a valuable partner for physicians and other
healthcare providers working with patients experiencing
complex 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 specific 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. We handle the patients'
pharmacy needs, we carry the specialized inventory, and we
manage the payor and patient billing, all designed to free up
time for the physician.
- Pharmaceutical Developers and Manufacturers: We believe our
system is well suited for developers and manufacturers of
pharmaceutical products who are targeting specific patient
disease populations. We provide these companies with
assistance in introducing new products to the proper
candidates, a cost-effective means for distributing products
to specific patient populations, specialized packaging for
shipping, secure warehousing facilities, wait list management,
and billing expertise. We also provide valuable data to the
manufacturers, including HIPAA compliant clinical information
about patients, compliance experience, and outcomes
assessments.
- Payors: Managed care plays a significant role in the provision
of healthcare in the United States and a significant number 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 cost-effectively.
We work directly with all of these constituents in a concerted effort
to improve clinical and economic outcomes while enhancing the quality of life
for the chronically ill.
Chronimed was founded in 1985 as a Minnesota corporation and has been
publicly traded on the NASDAQ National Market since 1992.
We make available free of charge, on or through our Internet website at
www.chronimed.com, our annual reports on Form 10-K, our quarterly reports on
Form 10-Q, our current reports on Form 8-K, and amendments to those reports
filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities
Exchange Act of 1934, as amended, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the Securities and
Exchange Commission.
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In this Form 10-K, fiscal 2003, fiscal 2002, and fiscal 2001 refer to
our fiscal years ended June 27, 2003, June 28, 2002, and June 29, 2001. In
addition, fiscal 2004 refers to our fiscal year ending July 2, 2004 which will
include 53 weeks.
BUSINESS STRATEGY
We believe that we have a competitive advantage because we are focusing
our business resources on specific diseases and because we possess both mail and
retail capabilities to serve our patients, physicians, manufacturers, and
payors. Our retail pharmacy, branded as StatScript, is believed to be the
largest specialty franchise that serves patients with HIV/AIDS. We intend to
leverage this position, as a leading provider of medications for patients with
HIV/AIDS, to grow our business and to deliver value-added 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
intend to continue our growth in the biotech injectable business primarily
through our mail service distribution channel. 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 Chronimed can leverage an already strong franchise or where our service
capabilities allow us to provide a competitive advantage to our customers.
Since contracts with pharmaceutical manufacturers are critical to our
gross margin performance, we intend to promote our world-class distribution
capability in an effort to obtain more exclusive or semi-exclusive arrangements.
We are committed to being a low cost provider and intend to increase
our technology and process improvement capabilities as a key driver in lowering
our operational expenses. Virtually all of our 33 facilities have the capacity
to handle more business without adding considerable resources.
Excellent drug distribution, although a core competency, is not enough
to assure managed care and pharmaceutical manufacturer contracts. Aspects of
therapy management including patient education, nurse lines, 24-hour emergency
access to a pharmacist, outgoing calls to patients and physicians, compliance
assurance, and outcomes analysis are part of the contract-winning process. We
intend to enhance our capabilities in therapy management to give us a further
edge on our competitors.
Due to the chronic nature of our patients' diseases and the high level
of drug expenditures per patient, our patients represent a high annuity revenue
source. We will continue to invest in building our customer service and pharmacy
fulfillment capabilities in order to not only attract but also retain these
patients over their medication lifetime.
Many new injectable products used in mental health, oncology,
respiratory disorders, neurologic conditions, viral infections, and other health
conditions are in the biotech pipeline for near-term release. We will continue
to investigate opportunities to establish market presence in select new disease
specialty areas.
Finally, 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. We will
be seeking acquisition opportunities to strengthen our position.
OUR DISEASE FOCUS
Our patient populations are concentrated among three areas.
Approximately 50% of our patients are persons living with HIV/AIDS, about 20% of
our patients have had organ transplants, and the remaining 30% of our patients
have other complex conditions treated with biotech injectable medications.
Descriptions of these diseases, markets, and our current services to these
populations follow.
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HIV/AIDS
Infection with human immunodeficiency virus (HIV) results in a
diminished immune system. HIV attacks and destroys T cells (a form of white
blood cell) 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 require treatment with complex
medication regimens and often face many long-term physical, financial, social,
and psychological challenges due to the often debilitating nature of the
disease.
The Centers for Disease Control and Prevention (CDC) estimate that as
many as 950,000 people in the U.S may be living with HIV/AIDS
(http://www.niaid.nih.gov/factsheets/aidsstat.htm). Approximately 40,000 people
are newly infected each year in the U.S. AIDS caused over 15,000 deaths in the
U.S. in 2001 and is the leading cause of death among African-American men aged
25 to 44.
Currently, industry estimates indicate that about 350,000 people in the
U.S. with HIV/AIDS are being treated. Treatment typically involves 3 to 4
medications, and often includes other drugs for managing side effects,
preventing potential infections, and helping with nutritional and mental health
challenges from AIDS. The combination of these drugs creates highly complex
regimens with a large number of side effects and adherence challenges. The
annual cost for the HIV/AIDS medications alone averages approximately $14,000
per year.
In March 2003, a brand new class of HIV/AIDS medication was introduced
in Fuzeon(R), an injectable drug that prevents HIV from invading white blood
cells. While a breakthrough medication with life-extending potential, it also
increased the cost of treating HIV/AIDS by up to $25,000 per year and added
another complicating factor in the regimen due to the complex procedures for
preparation and administration of the drug.
We began to serve people with HIV/AIDS through our StatScript Pharmacy
retail chain in 1996. Prescriptions for these patients now account for about 50%
of Chronimed's overall volume and revenue. Our stores are very different from
traditional retail pharmacies. They are designed to provide medications and
professional guidance and advice to patients in a comfortable, relaxed, and
confidential environment. StatScript Pharmacies dispense all the medications
used to treat HIV/AIDS including Fuzeon(R), and keep these items in inventory at
all times. Patients know that StatScript Pharmacy locations will have what they
need, when they need it. Our pharmacists are specially trained and certified in
HIV/AIDS treatment and work very closely with the HIV/AIDS doctors and other
caregivers in their areas.
Our stores are also experts in billing and coordinating insurance
benefits for HIV/AIDS medications. Unlike traditional pharmacies, where 95% of
their prescription business is covered by a drug card and electronically billed
to a Pharmacy Benefit Manager, many of StatScript Pharmacy's customers are
covered by government or indemnity health plans that pay for drugs under a
medical benefit (similar to doctors and hospitals) and use paper claim forms.
Many more have supplemental coverage with AIDS Drug Assistance Programs (ADAP)
or Ryan White funding. StatScript Pharmacy staff spend as much time as needed to
make sure the patients' benefits are realized in full and that the patient only
pays their required copayment or coinsurance amount. This helps many patients
afford their medications, keeping them on their therapies and maximizing their
outcomes.
Our goals in helping people with HIV/AIDS are to assist them in gaining
maximum control over their disease, lower the incidence of complications, remove
any barriers to receiving therapy, and improve their quality of life. Meeting
these goals creates a significant competitive advantage over traditional
pharmacies and allows StatScript Pharmacy to have strong customer relationships.
ORGAN TRANSPLANT
According to the United Network for Organ Sharing, as of July 2003
approximately 175,000 people were living with transplanted organs. During the
period January 2003 through May 2003, 10,489 transplants were performed in the
U.S., and 82,735 people are currently waiting for a transplant.
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After receiving an organ transplant, people are started on therapies to
suppress their immune systems to prevent organ rejection. These regimens usually
include 3 to 4 medications. In addition to these immunosuppressants, people are
often placed on other medications to manage the disease that ultimately caused
their original organ(s) to fail. These can include drugs to treat diabetes, high
blood pressure, high cholesterol, or other common chronic diseases. It is not
uncommon for some patients to take 15 to 20 medications a day immediately after
their transplant and still be on 8 to 10 drugs after the first year. These
combinations can create large numbers of side effects and drug interactions,
requiring close monitoring by the patients' transplant physicians and their
pharmacists.
Also, these drug therapies are expensive. Our experience has shown that
most transplant recipients require about $12,000 in prescription drugs during
the first year following transplantation and about $9,000 per year thereafter.
These drug regimens are generally taken for the remainder of the patients'
lives, creating challenges for many patients.
We have been serving people with organ transplants since 1990. We
provide medications through both our mail-service pharmacies and our
community-based StatScript Pharmacy retail chain. Our pharmacists and support
staff provide a "high-touch" program focused on optimizing the patients'
therapeutic outcome. We incorporate tools to enhance adherence and persistence
with the complex medication regimens, including monthly telephone or e-mail
refill reminders and routine telephone calls to monitor potential medication
problems.
Our staff also helps patients with insurance benefits. Many people with
organ transplants have multiple insurance plans, including their current
insurance, plus Medicare and Medicaid. Our pharmacy staff coordinates these
plans and attempts to get the patients as much of their insurance benefits as
possible. We also work with patients and insurance companies on copayment and
coinsurance issues to minimize the patients' out-of-pocket payments. All of
these services are considerably more than people would receive at traditional
pharmacies, creating a competitive advantage for our pharmacies and a lasting
relationship with our patients.
BIOTECH INJECTABLE MEDICATIONS
We began distributing biotech injectable medications through our mail
service pharmacies in 1994. Today we provide all medications through both our
mail and retail pharmacies. The biotech injectables we provide treat many
chronic conditions including hepatitis B and C, rheumatoid arthritis, cancer,
anemias, endometriosis, growth hormone deficiency, hemophilia, immune deficiency
disorders, infertility, and multiple sclerosis. A majority of our injectable
business revenue is derived from the following four diseases:
Hepatitis C. According to the US Department of Health and Human
Services in 2003, almost 4 million Americans may be infected with the hepatitis
C virus (HCV), of whom 2.7 million are chronically infected. Each year, there
are about 35,000 new cases of acute hepatitis C. HCV attacks the liver and can
cause long-term renal illnesses such as infection, cirrhosis, and cancer.
According to the National Institutes of Health, HCV is the leading cause of
liver transplantations in the United States and accounts for 10,000 to 12,000
deaths per year.
We sell injectable drugs used to treat HCV, including pegylated
interferons (PEG-Intron(R) and Pegasys(R)) with or without ribavirin.
Combination therapy with pegylated interferon and ribavirin is the treatment of
choice resulting in sustained response rates of 40%-80%. Our programs for these
patients reduce costs through lower acquisition costs, efficient medication
delivery in temperature controlled packaging, counseling, and side effects
management.
Rheumatoid Arthritis. According to the Arthritis Foundation, rheumatoid
arthritis (RA) affects 2.1 million Americans, mostly women. About 50,000 new
cases of RA are detected each year. Onset usually occurs in middle-age, but is
often detected in people in their 20s and 30s. RA is an auto-immune disease,
causing inflammation in the joint lining or other internal organs. It typically
affects many different joints, can be chronic, and is a disease of flares
(active) and remissions (little to no activity). The involved joint can lose its
shape and alignment, resulting in pain, stiffness, warmth, redness, swelling,
and loss of movement.
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Drug therapy for RA usually starts with medications to reduce the
inflammation and manage the pain. These include drugs like aspirin, ibuprofen,
naproxen, and other non-steroidal anti-inflammatory agents. As RA progresses,
many patients will be placed on disease-modifying antirheumatic drugs (DMARDs)
such as gold, methotrexate, and other immune system modulators. All of these
medications can be obtained at traditional pharmacies and are relatively
inexpensive.
After the anti-inflammatories and DMARDs lose effect, patients will
often start on drugs called biologic response modifiers (BRMs). These drugs
actually prevent the progression of RA and can lead to some improvements in
affected joints. The most common BRMs are Enbrel(R), Remicade(R), Kineret(R),
and Humira(R). All of these medications are injectable, and all but Remicade(R)
can be administered by the patient (Remicade(R) is given by intravenous
infusion, requiring the patient to go to a doctor's office). They all are very
expensive, costing approximately $15,000 per year.
We supply all required RA medications, from initial therapies to
injectables BRMs, to patients either from our mail service pharmacies or our
StatScript Pharmacy retail chain. We provide reimbursement assistance and
coordination of benefits to minimize our patients' out-of-pocket expenses. Our
pharmacists provide detailed and thorough consultations on the drugs, including
preparation and administration of the injection, to minimize side effects and
other complications. We also contact patients with routine refill reminders to
reduce or eliminate treatment interruptions.
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 reduce the amount of oxygen available in the body, resulting in
fatigue. We supply medications such as Epogen(R), Procrit(R), and Aranesp(R)
that increase the number of available red blood cells by supplementing the
body's natural erythropoietin production.
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 white blood cell production following chemotherapy treatments.
Multiple Sclerosis. The Multiple Sclerosis Association of America
estimates that more than 400,000 people in the United States have multiple
sclerosis (MS) and that 10,400 new cases are diagnosed every year. MS is a
disease of the central nervous system that damages or destroys the protective
layer surrounding nerve fibers. Once damaged, electrical nerve impulses are not
properly conducted to and from the brain, resulting in the various symptoms of
MS.
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).
PRODUCT DISTRIBUTION
We distribute our products through 33 distribution facilities. This
includes mail service facilities located in Minnesota, California, Texas,
Tennessee and Florida and our nationwide StatScript Pharmacy retail chain, which
consists of 28 company-owned, community pharmacies.
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MAIL SERVICE
We provide a full-service pharmacy to our patients. We routinely carry
over 4,000 brand name and generic prescription drugs in inventory, which we
distribute directly to the patients and physicians through our centralized mail
service system. What makes us different from traditional retail and mail order
pharmacies is that we stock hundreds of hard-to-find, specialty items at all
times. These include blood factor products for hemophilia, all self-administered
biotech injectables, and drugs used for HIV/AIDS and solid organ transplants. 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 primarily ship orders by FedEx
or UPS to ensure prompt delivery.
We have recently expanded and redesigned our primary mail service
facility in Minnetonka, Minnesota to meet the Federal Drug Administration's
current Good Manufacturing Practice (cGMP) standards for drug distribution. Our
new facility is secured and temperature-controlled, and all operational aspects
are documented to meet cGMP requirements. We also installed a motorized conveyor
system to enhance the speed and efficiency by which we distribute and process
prescription orders. These improvements allow us to handle significantly higher
volumes in our current location. We are able to distribute any product as needed
by specialty medication manufacturers or product distributors.
Our mail service 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, be
Medicare or Medicaid beneficiaries, or have a pharmacy benefit defined by their
managed care health plan. In fiscal 2003, mail service accounted for 42% of our
revenue.
COMMUNITY PHARMACIES
Our StatScript community pharmacies give us a significant presence in
the retail marketplace. The StatScript Pharmacy retail chain is the market
leader in providing prescription drugs to people with HIV/AIDS. StatScript
pharmacies support HIV/AIDS patients through physician referrals, patient
education, complete patient tracking, and interaction with community service
organizations. Our revenue growth in this business comes from the continued
rollout of the combination drug therapies of protease inhibitors and nucleoside,
nucleotide, and non-nucleoside reverse transcriptase inhibitors, as well as the
new fusion inhibitor, Fuzeon(R), introduced in March 2003 by Roche and Trimeris.
Future revenue growth may also be generated from pharmacy acquisitions, pharmacy
openings, and increased patient volumes at existing stores.
We have also 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 our
StatScript pharmacies to distribute biotech injectable medications, particularly
for hepatitis C. In fiscal 2003, StatScript sales accounted for 58% of our
revenue.
As of June 27, 2003, the StatScript chain consisted of 28 pharmacies
located in: Atlanta, Boston, Chicago, Dallas, Ft. Lauderdale, Houston (two
locations), Indianapolis (two locations), 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.
THERAPY MANAGEMENT
Chronimed provides a range of clinical services designed to educate
patients about their disease conditions, support therapy compliance and keep
patients healthier. These services include 24-hour emergency
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access to a pharmacist, patient counseling, educational material development and
distribution, and automated order and refill reminder calls. As a supporting
strategy to our disease-based business model, we are introducing a new and
expanded therapy management program for patients utilizing our mail pharmacy. In
addition to our traditional services, we will be providing regularly scheduled
nurse counseling calls to patients and providing them and their physicians with
customized therapy progress reports. Managing patient compliance to physician
prescribed regimens helps avoid additional therapy and costly medical procedures
and hospitalizations due to treatment failure, thereby improving outcomes and
reducing the overall costs of managing these diseases.
MANUFACTURER RELATIONSHIPS AND SERVICES
Developing relationships with drug manufacturers is a key element of
our business strategy. Our objective is to identify those manufacturers who are
developing drugs having product or market characteristics that fit, and could
benefit from, our specialized distribution and service model. Our goal is to
educate those manufacturers about the value of the services we provide, and by
doing so, gain access to these drugs on a preferred basis.
In general, we provide the following kinds of services for
manufacturers:
Distribution. We combine our mail service and retail capabilities to
offer specialized distribution services to drug manufacturers. This service is
best suited to companies requiring secured tracking, companies with limited
production capabilities (resulting in limited product supplies), or for products
intended for use in small or difficult-to-access patient populations. We also
distribute drugs that are in clinical trials and coordinate trial data
collection on adherence, side effect incidence, and other key attributes.
Data and Analysis. Our large, specialized patient base provides
valuable data on treatments, adherence, usage, and prescribing trends. This
information is generally provided to manufacturers as a fee-for-service product.
Data is shared only following de-identification in compliance with the privacy
requirements of HIPAA.
Promotion and Market Share Support. Due to our local presence and
highly qualified pharmacists, we help drug companies with product usage and
adoption. We support products that are appropriate for our patients and follow
clinical guidelines. We can be very effective in increasing market share for
appropriate target products.
Consultation. We work with drug manufacturers before and after their
product is launched. We provide advice on areas such as reimbursement,
packaging, distribution, marketing, promotion, and pricing. We represent the
views of patients, payors, and pharmacies to help manufacturers align their
sales and marketing efforts to achieve success.
PAYOR RELATIONSHIPS AND SERVICES
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. Because we provide unique pharmacy sources to
a defined population, our objective is to be included as a "network" pharmacy
provider in as many plans as possible, and to assist plans in creating specialty
pharmacy "carve-out" arrangements. These arrangements typically allow us to
provide significant savings to the plan due to the greater volume of patients
served through these arrangements.
Payors often have difficulty quantifying and controlling the cost of
the increasing number of costly, complex medications used to treat specific
chronic conditions. We help payors identify and lower their costs by reducing
product acquisition costs, offering efficient delivery systems, providing
accurate and efficient reporting of drugs and associated costs of their members'
usage, delivering 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
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customized programs designed to maximize patient 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 and nurses are experts in
the requirements and treatment patterns for the identified
patient populations. Our therapy management programs provide
not only the payors, but also the physicians and patients,
accurate and current reports of compliance, usage, and other
variables associated with a specific disease and its care.
- Distribution of educational materials designed to help
patients achieve maximum control over their chronic
conditions.
In fiscal 2003, Aetna, Inc. and its affiliates ("Aetna") accounted for
approximately 24% of our revenue. We entered into a Specialty Pharmacy Mail
Service Vendor Agreement with Aetna effective May 1, 2000. Our Agreement had an
initial term of three years and it was renewed effective May 1, 2003 until
December 31, 2004. Either party may terminate the Agreement on 90 days notice.
Other than Aetna, no private payor accounts for 10% or more of our revenue. In
fiscal 2003, approximately 35% of our revenue came from governmental programs,
primarily Medicare (a federal program) and Medicaid (numerous state programs).
The loss of a significant payor, including Aetna, or a significant reduction in
their rates of reimbursement, could have a material adverse effect on our
business and results of operations.
REIMBURSEMENT SERVICES
We have developed a significant level of expertise in managing the
complex world of pharmacy reimbursement. We have invested heavily in this
reimbursement process and our patient adherence rates and accounts receivable
performance have improved accordingly. Generally, before delivering products to
a patient, we contact the appropriate payor (electronically, by fax, or by
telephone) to determine the patient's health plan coverage and the portion of
costs that the payor will reimburse. Our patient service specialists review
issues such as lifetime limits, pre-existing condition clauses, prior
authorization requirements, and the availability of special funding programs. We
accept assignment of benefits from a large number of payors, which substantially
eliminates the claims submission process for many patients. Our goal is to
simplify the reimbursement process for our patients and to help them find
available sources of reimbursement assistance. Our reimbursement services are a
significant value-add offering to patients, payors, and manufacturers and help
differentiate us from our competition.
SALES AND MARKETING ACTIVITIES
This past year, we restructured our sales organization in order to
fully resource a new disease focused marketing strategy. We employ approximately
25 sales professionals to call on payors, physicians, case managers, and
manufacturers. Our local pharmacists also call on physicians and other key
influencers to grow the StatScript business. We have four primary sales
directives:
- Our HIV sales personnel are located in the high population
areas for HIV positive patients. They call physicians, AIDS
service organizations, and other key influencers.
10
- Our transplant sales personnel are calling primarily on transplant
centers and secondarily on transplant case managers.
- Our biotech injectables sales personnel call on high prescribing
physicians in specific disease areas. Our current focus here is on
hepatitis C and rheumatoid arthritis prescribers.
- Our managed care sales personnel call on large HMOs, insurance
companies, and at-risk physician groups. This is a
cost-containment focus, rather than a disease focus, and generally
reflects an exchange of the payor's employee prescription volume
for our product discount and value-added services.
We also have a pharmaceutical manufacturer sales team selling our
capabilities as a pre-launch advisor, exclusive product distributor, and patient
and product specific data supplier.
SUPPLIERS
We purchase prescription drugs and related products directly from
manufacturers and wholesalers. We inventory approximately 4,000 brand name and
generic prescription drugs and related products. We take advantage of special
discounts when offered by suppliers. When we receive a prescription for a drug
that we do not have in inventory, we generally obtain the required item from our
wholesaler the same or next 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. In March
2003, Chronimed signed a one year agreement with Roche to be the exclusive
distributor of Fuzeon(R), a new injectable HIV/AIDS medication developed by
Roche and Trimeris. We regularly purchase Fuzeon(R) directly from Roche. We
believe that Fuzeon(R) may represent more than 10% of Chronimed's fiscal 2004
purchases.
During fiscal 2003, we used McKesson Corporation, a national
distributor, to supply pharmaceuticals for our pharmacies. This supplier made up
89%, 92%, and 85% of our continuing operations inventory purchases for fiscal
2003, 2002, and 2001, respectively. Effective August 2003, we signed a new
three-year wholesaler agreement with Cardinal Health to cover the majority of
our pharmaceutical purchases replacing McKesson Corporation. We also
aggressively pursue programs with manufacturers and group purchasing
organizations to lower our drug acquisition costs.
INFORMATION SYSTEMS
Our mail service operations include an automated call center and a
fully integrated information system. The real time information system provides
our customer service representatives with the necessary on-line information to
service patients, caregivers, and providers including product purchase
histories, payor billing and account balances, inventory levels, and co-payment
amount requirements. Mail service distribution sites are fully integrated and
built around an order management process using inventory control, purchasing,
shipping, and receiving functions. Our mail operation 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.
Over 40% of new prescriptions are received by fax from providers. These
faxes are received into our e-mail system, where they are electronically date-
and time-stamped and stored. An automated response is generated and sent back to
the sender to confirm that we received their fax into our system. Faxes can be
immediately reproduced as needed.
We also offer internet ordering capabilities for our existing customers
directly through our automated secure web site at www.chronimed.com. The web
site provides them with convenient electronic confirmation messages and tracking
numbers for their shipped orders. We expect that the proportion of transactions
conducted by electronic commerce will increase each year.
11
The implementation of a new retail pharmacy system, originally planned
for fiscal 2003, was delayed to the second half of fiscal 2004. The delay was
due to a software release problem from the vendor. The new system will allow for
balancing the workload using automated work queues. It will also integrate
pharmacy operations with a point of sale system and will represent a significant
enhancement over the current system.
COMPETITION
The distribution of specialty prescription drugs is a highly
competitive business. The specialty pharmacy industry is experiencing both
horizontal and vertical consolidation. The industry is fragmented, with several
public and many small private companies focusing on different product or
customer niches. Some of our current and potential competitors include specialty
pharmacy distributors such as Accredo Health Inc., Caremark Rx, Priority
Healthcare Corporation, and ProCare (a division of CVS Corporation), national
wholesale drug distributors which operate their own specialty distribution
businesses such as Amerisource Bergen Corporation, Cardinal Health, Inc. and
McKesson Corporation, retail pharmacies, specialty pharmacy divisions of
pharmacy benefit managers, institutional pharmacies, hospital-based pharmacies,
and home infusion therapy companies. We compete on the basis of service,
convenience, product availability, price, and reputation. Some of our
competitors are larger than we are and have significantly greater financial,
technical and managerial 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 service and retail specialty
pharmacy distribution in the disease states we serve. Nonetheless, there can be
no assurance that competitive pressures will not have a material, adverse effect
on our business.
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. 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.
GOVERNMENT REGULATION
Our business is subject to substantial federal, state and local
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. We are routinely subject to periodic
audits regarding compliance with these governmental regulations.
Licensing. 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.
Labeling and Dispensing. Federal laws also establish standards
governing the labeling, packaging, advertising, and 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. Approximately half of our products are
shipped by commercial delivery services.
12
Fraud and Abuse Provisions. 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.
Referral Restrictions. 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, 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.
Patient Confidentiality. Various federal and state laws establish
minimum standards for the maintenance of medical records and the protection of
patient health information. We maintain medical records for each patient to whom
we dispense pharmaceuticals. As a result, we are subject to one or more of these
medical record and patient confidentiality laws. Of particular significance are
the Health Insurance and Portability and Accountability Act of 1996 (HIPAA)
security and privacy regulations. The HIPAA security regulations, which
establish certain standards for assuring the security and integrity of
electronically maintained health information, were issued as a final rule on
February 20, 2003. "Covered Entities" as defined in the final security rule,
which includes Chronimed, must comply with the requirements of the final
security rule by April 21, 2005. The HIPAA privacy regulations, which establish
standards for protecting the confidentiality and privacy of health information
in any form, were issued as a final rule on December 28, 2000. On August 17,
2002, the Department of Health issued an amended final rule modifying the
privacy rule standards for protecting the confidentiality of health information.
"Covered Entities" as defined in the final privacy rule, which includes
Chronimed, were required to comply with the final privacy rule as of April 14,
2003. We believe that we are in substantial compliance with this privacy rule.
The HIPAA regulations impose significant civil and criminal sanctions for
violations of the rules and improper use or disclosure of patient information.
The HIPAA privacy regulations have required us to make several changes
to our policies, procedures, forms, employee training and information handling
practices. The HIPAA security regulations require that we invest significant
capital in upgrading information systems hardware, software, and procedures.
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, creation and regulation of a comprehensive Medicare drug
benefit, and 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.
13
EMPLOYEES
As of September 5, 2003, we employed 408 full-time and 22 part-time
employees. None of our employees are represented by a labor union, and we
believe that our employee relations are good.
ITEM 2. PROPERTIES
Our properties provide a suitable work environment for our employees
and the necessary productive capacity to distribute our products and services.
We currently lease all of our properties. These properties are described below.
SIZE
FUNCTIONS LOCATIONS (SQUARE FEET) LEASE TERM
--------- --------- ------------- ----------
Corporate office and Minnetonka, MN 62,000 Through March 31, 2005
mail service pharmacy,
including
customer service and
distribution
Retail and mail service 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
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 filed and the nine lawsuits were consolidated
into a single class action case.
On July 11, 2003, we and plaintiffs agreed to settle the case and all
claims. Under the settlement, which is subject to court approval, we will pay
$2.2 million which will be distributed to the class members and counsel. The
settlement amount is being funded by our insurance.
We have been engaged in discussions with the United States Attorney for
the District of Columbia regarding certain claims for reimbursement we submitted
to DC Medicaid between January and April 2000. The U.S. Attorney has asserted
that these claims were a result of an attempt by a DC resident to defraud the
Medicaid system and divert pharmaceuticals. We have denied wrongdoing. Our
Medicaid billings associated with this individual's activities totaled
approximately $230,000. We have established a reserve against the possibility
that these billings could be subject to repayment. No formal action has been
taken by the government with respect to these billings, however such an action
could result in a greater loss.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
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 28, 2002, and June 27, 2003:
- ---------------------------------------------------
FISCAL YEAR 2002 HIGH LOW
- ---------------------------------------------------
First Quarter $ 5.35 $ 2.10
Second Quarter 7.20 2.72
Third Quarter 8.00 6.15
Fourth Quarter 6.79 4.80
- ---------------------------------------------------
FISCAL YEAR 2003 HIGH LOW
- ---------------------------------------------------
First Quarter $ 5.10 $ 4.41
Second Quarter 6.11 4.79
Third Quarter 8.80 5.82
Fourth Quarter 10.15 7.66
NUMBER OF SHAREHOLDERS OF RECORD
The number of shareholders of record of our Common Stock as of
September 5, 2003, was approximately 365. The number of beneficial owners of our
Common Stock was approximately 5,000 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.
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 27, 2003, and June 28, 2002, and for each of the fiscal years in the three
year period ended June 27, 2003, 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 29, 2001, June 30, 2000, and July 2, 1999, and for the
two-year periods ended June 30, 2000, 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.
15
FINANCIAL RESULTS JUNE 27, JUNE 28, JUNE 29, JUNE 30, JULY 2,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------
Revenue $ 435,713 $ 397,437 $ 297,925 $ 222,497 $ 168,624
Gross profit 53,122 47,732 35,693 36,891 31,179
Bad debt expense (3,204) (3,504) (7,140) (7,154) (945)
Income (loss) from continuing operations 7,727 1,858 (5,774) (9,115) 173
Interest income (expense), net 311 104 568 (191) 419
Other income (loss) - 3,906 (1,837) - 503
Income tax (expense) benefit (3,053) (2,131) 2,585 3,398 (427)
Net income (loss) from continuing operations 4,985 3,737 (4,458) (5,908) 668
Income from discontinued operations, net of tax - - 15,235 1,840 3,459
- -----------------------------------------------------------------------------------------------------------
Net income (loss) $ 4,985 $ 3,737 $ 10,777 $ (4,068) $ 4,127
===========================================================================================================
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ 0.40 $ 0.30 $ (0.37) $ (0.49) $ 0.06
Income from discontinued operations - - 1.25 0.15 0.28
- -----------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.40 $ 0.30 $ 0.88 $ (0.34) $ 0.34
===========================================================================================================
Weighted average shares outstanding -- diluted 12,512 12,342 12,206 12,116 12,256
FINANCIAL POSITION
Working capital $ 51,685 $ 43,850 $ 36,982 $ 36,393 $ 31,472
Total assets 110,000 99,495 98,993 78,430 78,542
Shareholders' equity 85,513 79,401 75,502 63,057 66,487
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.
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 gain:
- 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.
16
- 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
Chronimed Inc. ("Chronimed" or the "Company"), a specialty pharmacy,
distributes prescription drugs and provides specialized therapy management
services for people with certain health conditions, including HIV/AIDS, organ
transplants, and diseases treated with biotech injectable medications. We work
with patients, physicians and other health care providers, pharmaceutical
manufacturers, health plans and insurers, and government agencies to improve
clinical and economic outcomes.
We distribute our products via our Chronimed mail service and our
nationwide StatScript Pharmacy retail chain. See Note 12, Notes to Consolidated
Financial Statements, Item 15 of this Annual report on Form 10-K, for
information regarding our business segments.
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.
Revenue Recognition
Revenue is recognized at the time prescriptions are 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 bill a
standard list price (versus a known contracted price) and then simultaneously
determine an appropriate estimate for expected payor discount based on our
reimbursement history for each payor class. This reimbursement history is
updated quarterly. Revenue is then reported net of the estimated payor discounts
and adjusted in future periods as final settlements are determined.
Collectibility of Accounts Receivable
Accounts receivable consist primarily of amounts due from third-party
payors (the Medicare and Medicaid programs, other government programs,
prescription benefits managers, managed care health plans, commercial insurance
companies) and to a lesser extent from 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 for reasons other than
discounts taken by payors at the time of payment.
In evaluating the collectibility of accounts receivable, we consider a
number of factors, including the age of the accounts and historical write-off
experience. Actual collections of accounts receivable in subsequent periods may
require changes in the estimated provision for loss. Changes in these estimates
are charged or credited to the results of operations in the period of the
change. Bad debt expense was $3.2 million, $3.5 million, and $7.1 million in
fiscal 2003, 2002, and 2001, respectively. We believe this decrease reflects
improvements in our billing and collection processes. However, subsequent
changes in estimates could be unfavorable.
17
Goodwill
We have $30.2 million of goodwill on our balance sheet at June 27,
2003. The annual impairment tests of these assets under FAS 142 involves the use
of a third-party valuation firm and requires estimates of future cash flows by
reporting unit.. We 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.
RESULTS OF OPERATIONS
INCOME AND EXPENSE ITEMS AS A PERCENTAGE OF REVENUE
FISCAL YEAR 2003 2002 2001
- ----------------------------------------------------------------------------------
Revenue
Mail service 41.7% 43.6% 51.5%
Retail 58.3 56.4 48.5
- ----------------------------------------------------------------------------------
Total revenue 100.0 100.0 100.0
Cost of revenue 87.8 88.0 88.0
- ----------------------------------------------------------------------------------
Gross profit 12.2 12.0 12.0
Operating expenses
Selling and marketing 0.9 0.8 1.1
General and administrative 8.8 9.8 10.4
Bad debt 0.7 0.9 2.4
- ----------------------------------------------------------------------------------
Total operating expenses 10.4 11.5 13.9
Income (loss) from operations 1.8 0.5 (1.9)
Interest income (expense), net - - 0.2
Other income (loss) - 1.0 (0.6)
Income tax (expense) benefit (0.7) (0.6) 0.8
- ----------------------------------------------------------------------------------
Net income (loss) from continuing operations 1.1 0.9 (1.5)
Income from discontinued operations, net of tax - - 5.1
- ----------------------------------------------------------------------------------
Net income (loss) 1.1% 0.9% 3.6%
==================================================================================
FISCAL 2003 COMPARED TO FISCAL 2002
Revenue
Total revenue for fiscal 2003 grew 9.6% to $435.7 million from $397.4
million in fiscal 2002 primarily resulting from the growth in sales from
HIV/AIDS, organ transplant, and hepatitis C medications. Fiscal 2003 revenues by
disease compared to fiscal 2002 as follows:
FISCAL YEAR
-------------------------------------------
% OF % OF %
(DOLLAR AMOUNTS IN THOUSANDS) 2003 TOTAL 2002 TOTAL CHANGE
- -------------------------------------------------------------------------------------------
HIV/AIDS $ 233,964 53.7% $ 208,428 52.4% 12.3%
Transplant 77,536 17.8 68,388 17.2 13.4
Other Disease States 124,213 28.5 120,621 30.4 3.0
- -------------------------------------------------------------------------------------------
Total $ 435,713 100.0% $ 397,437 100.0% 9.6%
===========================================================================================
The Mail Service segment revenue for fiscal 2003 grew 4.9% to $181.8
million from $173.2 million in fiscal 2002. This growth was due to the addition
of new biotech injectable patients from several payors and price inflation.
Payor reimbursements from Aetna represented 58.3% and 59.7% of our Mail Service
revenues for fiscal
18
2003 and 2002, respectively. Except for Aetna, no other private payor accounted
for 10% or more of our revenues in fiscal 2003 and 2002.
The Retail segment revenue for fiscal 2003 grew 13.2% to $253.9 million
from $224.2 million in fiscal 2002. This increase was due to continued additions
of new patients at existing stores and 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 certain biotech injectable medications. A single
uncontracted private payor represented approximately 5.6% and 6.1% of our Retail
segment revenues for fiscal 2003 and 2002, respectively.
Gross Profit and Gross Margin
Total gross profit dollars increased $5.4 million or 11.3%, from $47.7
million in fiscal 2002 to $53.1 million in fiscal 2003. Gross margins as a
percentage of revenue improved slightly from 12.0% in fiscal 2002 to 12.2% in
fiscal 2003.
Mail Service 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 44.9% and 37.4% of our Mail Service margins
for fiscal 2003 and 2002, respectively.
Retail margins as a percentage of revenue decreased slightly from the
year ago period primarily due to a reduction in reimbursement rates by several
payors, particularly state Medicaid programs, in selected markets we serve. A
single uncontracted private payor represented 7.4% and 10.0% of our Retail
margins for fiscal 2003 and 2002, respectively. We expect this private payor to
reduce its reimbursement rate in fiscal 2004, which will result in lower gross
margins in the Retail segment.
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 Service segments, and enhanced programs with manufacturers, wholesalers,
and group purchasing organizations to reduce product costs.
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
Our selling and marketing expenses increased $0.5 million, or 13.8%,
from $3.3 million in fiscal 2002 to $3.8 million in fiscal 2003. This increase
in expenses is primarily due to the recent fourth quarter additions to our sales
force and increased travel and promotion activities. This higher level of
selling and marketing expenses is expected to continue during fiscal 2004.
General and Administrative Expenses
Our general and administrative expenses decreased $0.6 million, or
1.6%, from $39.0 in fiscal 2002 to $38.4 million in fiscal 2003. Included in
fiscal 2003 general and administrative expenses was compensation expense for
restricted stock grants of $0.6 million and higher payroll costs, legal fees,
and insurance costs. 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
19
financial restatement. Excluding these charges, fiscal 2002 general and
administrative expenses were $35.5 million, or 8.9% of revenues.
Bad Debt Expenses
Our bad debt expense decreased $0.3 million, or 8.6% in fiscal 2003.
Bad debt expenses represented 0.7% and 0.9% of revenues for fiscal 2003 and
fiscal 2002, respectively. Fiscal 2003 and 2002 results are representative of
our expectation for future bad debt expense of approximately 0.7% to 1.0% of
revenue. The allowance for bad debt expense has been reduced from $5.4 million
as of June 28, 2002, to $4.5 million as of June 27, 2003, commensurate with our
declining accounts receivable balance, improved agings, and lower write-off
experience.
Interest Income
Interest income, net of interest expense, increased $0.2 million, from
$0.1 million in fiscal 2002 to $0.3 million in fiscal 2003. Interest income
decreased from fiscal 2002 due to the declining interest rate environment
partially offset by our increased invested asset levels. Interest expense
declined in fiscal 2003 due to no short-term borrowing costs on our line of
credit. Included in interest income for fiscal 2002 was $0.4 million of interest
on a note receivable with the buyer of our Home Service Medical (HSM) business
in September 2000. This note was paid in full during fiscal 2002 and as a result
did not generate interest income in fiscal 2003.
Other Income
Other income of $3.9 million in fiscal 2002 includes a $3.8 million
gain on the collection of a previously reserved note receivable due from the
buyer of our HSM business.
Income Taxes
In fiscal 2003 and 2002 the effective income tax rate was 38.0% and
36.3%, respectively. See Note 7, Notes to Consolidated Financial Statements for
the reconciliation to our statutory rate. Looking forward to fiscal 2004, we
expect our combined Federal and State tax rate to approximate 38.0%.
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 Service 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 2001, we disposed of or shut down certain lines of
business (together, the "Disposed Businesses"). Within the Mail Service segment,
the HSM business was sold and the diabetes service centers were closed in the
first quarter of fiscal 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.
20
FISCAL YEAR
------------------------
(DOLLAR AMOUNTS IN THOUSANDS) 2002 2001 % CHANGE
- --------------------------------------------------------------------------
Mail Service 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 Service 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 2002 compared to 45.9% in fiscal 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(R) and the Hepatitis-C drug Peg-Intron(R). Payor reimbursements from
Aetna represented 59.7% and 65.5% of our Mail Service revenues for fiscal 2002
and 2001, respectively. Except for Aetna, no other private payor accounted for
10% or more of our revenues in fiscal 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. A single private payor represented approximately
6.1% and 7.0% of our Retail revenues for fiscal 2002 and 2001, respectively.
Gross Profit and Gross Margin
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 Service 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 Service margins
for fiscal 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 store locations and a
large uncontracted payor's decision to reduce reimbursement in the middle of
fiscal 2001. A single private payor represented 10.0% and 13.6% of our Retail
margins for fiscal 2002 and 2001, respectively.
21
Selling and Marketing Expenses
The following chart shows the year-to-year comparisons of selling and
marketing expenses.
FISCAL YEAR
------------------------
(DOLLAR AMOUNTS IN THOUSANDS) 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
$0.5 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 was
primarily due to head count additions and increased travel and promotion
activities.
General and Administrative Expenses
The following chart shows the year-to-year comparisons of general and
administrative expenses, excluding bad debt expense.
FISCAL YEAR
------------------------
(DOLLAR AMOUNTS IN THOUSANDS) 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.
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 ("Goodwill and Other Intangible Assets"). 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 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 improvement in fiscal 2002 reflected our consolidation of billing and
collection operations to our Minneapolis headquarters and related process
changes.
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 increased
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.
22
Other Income (Loss)
Other income of $3.9 million in fiscal 2002 includes 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 effective income tax rate was 36.3% and
36.7%, respectively. See Note 7, Notes to Consolidated Financial Statements for
the reconciliation to our statutory rate.
LIQUIDITY AND CAPITAL RESOURCES
As of June 27, 2003, we had $51.7 million of working capital, compared
to $43.9 million as of June 28, 2002. During fiscal 2003, we generated $17.5
million of cash from operating activities. The average days sales outstanding
(DSO) of our accounts receivable improved from 44 days at June 28, 2002, to 34
days at June 27, 2003. Faster payment from our larger payors and active
collection efforts led to this improvement. This improvement in DSO generated
$4.5 million in cash during the year. We expect our receivables to perform at or
better than the current 34 days sales outstanding in fiscal 2004. The average
days inventory on hand also improved from 9 days at June 28, 2002, to 8 days at
June 27, 2003. This improvement partially offset the growth in inventory
required to support the business growth. We expect our inventory to perform at
or below the current 8 days on hand in fiscal 2004. Working capital generated
from higher trade payables provided a $4.3 million source of cash for the year.
Approximately $1.3 million of cash was used in investing activities
during fiscal 2003 for purchases of property and equipment.
We had no outstanding borrowings as of fiscal year end 2003 and 2002.
Shareholders' equity as of fiscal year end 2003 and 2002 was $85.5 million and
$79.4 million, respectively. Net tangible assets, an indicator of borrowing
capacity, as of fiscal years ended 2003 and 2002 were $55.3 million and $49.2
million, respectively. As of June 27, 2003, we had a secured line of credit
totaling $30 million. We had no borrowings under our line of credit during
fiscal 2003. We are in compliance with the debt covenants of the line of credit
as of June 27, 2003. Under the terms of the agreement, the debt is secured by
receivables and inventory and bears interest at the Eurodollar rate plus an
applicable margin depending on our covenant calculation (approximately 2.85% at
June 27, 2003). The line of credit expires in April 2006.
We believe that our cash and cash equivalents, 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 expect our capital project requirements to be
between $2 to $3 million in fiscal 2004.
Our future contractual commitments consist entirely of payments due
under operating leases are as follows:
LESS THAN ONE TO THREE FOUR TO FIVE AFTER FIVE
(IN THOUSANDS) TOTAL ONE YEAR YEARS YEARS YEARS
- ------------------------------------------------------------------------------------------------------------
Total contractual cash obligations $ 5,959 $ 2,728 $ 2,714 $ 359 $ 158
23
RESTRICTED STOCK GRANTS
In August 2002, the Compensation Committee of the Board of Directors
granted 145,000 restricted shares of common stock to our officers under our 2001
Stock Incentive Plan. These restricted shares, valued at $0.7 million based on
our fair market value of $4.71 per common share at the date of grant, were to be
recognized as compensation expense over a four year vesting period, subject to
an acceleration provision based on an increase in our stock price to $7.54 or
more for five consecutive trading days. In October 2002, 20,000 of these shares
were cancelled. The remaining 125,000 restricted shares vested on March 7, 2003,
as provided by the acceleration provision and we recognized compensation expense
of $0.6 million during fiscal 2003.
NEW ACCOUNTING PRONOUNCEMENTS
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 initiated after December 31, 2002. The adoption of Statement 146 did
not have any impact on our financial position, results of operations or cash
flows.
In December 2002, the FASB issued Statement 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." The Statement provides
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based employee compensation. In addition, the
Statement amends the previous disclosure requirements of SFAS No. 123 to require
prominent disclosures about the method of accounting for stock-based employee
compensation and the effect of the method used on reported financial results and
requires these disclosures in interim financial information. We continue to
account for stock-based employee compensation under APB Opinion 25 but have
adopted the new disclosure requirements of Statement 148.
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.
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
biopharmaceutical 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 material 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; increased competition; our ability to obtain competitive financing
to fund operations and growth; loss or retirement of key executives;
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 recognition of revenue and earnings; and
adverse publicity, news
24
coverage, and reporting by independent analysts. 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 would bear interest at variable rates based on the
Eurodollar rate plus an applicable margin depending on our covenant calculation.
A 10% increase in interest rates would not have a significant effect on our
interest expense based on the fact that we had no borrowings in fiscal 2003. 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.
ITEM 9A. CONTROLS AND PROCEDURES
Our management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")) as of the end of the period covered by this report. Based on
such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective.
There have not been any changes in our internal controls over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during our most recent quarter that have materially affected, or
are reasonably likely to materially affect, our internal controls over financial
reporting.
25
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 19, 2003 (the "2003 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," and "EXECUTIVE
COMPENSATION - Comparable Stock Performance" to be included in the 2003 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" and "EXECUTIVE
COMPENSATION - Equity Compensation Plan Information" to be included in the 2003
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 2003 Proxy Statement is incorporated
herein by reference in response to this Item 13.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
This item is first effective for annual reports for fiscal years ending
after December 15, 2003, and therefore is not included in this filing.
26
PART IV
ITEM 15. 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 27, 2003 and June 28, 2002..................... F-3
Consolidated Statements of Income for the years ended June 27, 2003,
June 28, 2002, and June 29, 2001 ..................................................... F-4
Consolidated Statements of Shareholders' Equity for the years ended June 27, 2003,
June 28, 2002, and June 29, 2001 ..................................................... F-5
Consolidated Statements of Cash Flows for the years ended June 27, 2003,
June 28, 2002, and June 29, 2001 ..................................................... 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
A Current Report on Form 8-K with a report date of April 24, 2003, was
filed during the fourth quarter of fiscal 2003 to provide the full text of the
third quarter financial results press release dated April 23, 2003.
(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 2003 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.
27
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 Restricted Stock Grant Agreement. (1)
10.2 Pharmacy Participation Agreement with Aetna Health Management,
Inc. (9)
10.2a* Amendment to Pharmacy Services Agreement between Chronimed and
Aetna Inc. dated May 1, 2003 (without exhibits or schedules).
10.3 Employment Agreement effective July 1, 2000, between the
Company and Henry F. Blissenbach. (1) (9)
10.4 Chronimed Inc. 1994 Stock Option Plan. (3)
10.5 Chronimed Inc. 1994 Stock Option Plan for Directors. (3)
10.6 Chronimed Inc. 1997 Stock Option Plan. (4)
10.7 Chronimed Inc. 1999 Stock Option Plan. (8)
10.8 Chronimed Inc. 2001 Stock Incentive Plan. (10)
10.9 Facility Lease Agreement with Red Circle L.L.P. dated November
1996. (5)
10.9a Amendments dated April 1997, December 1997, and July 1998 to
Facility Lease Agreement with Red Circle L.L.P. (8)
10.10 Separation and Release Agreement effective January 5, 2001,
between the Company and Maurice R. Taylor, II. (1) (13)
10.11 Promissory Note of Maurice R. Taylor, II, dated July 24, 2000.
(1) (13)
10.12 Asset Purchase Agreement dated December 1, 2000, between
Chronimed Inc. and Medisys PLC. (11)
10.12a Amendment to Asset Purchase Agreement dated January 5, 2001,
between Chronimed Inc. and Medisys PLC. (12)
10.13 Asset Purchase Agreement dated February 2, 2001, between
Chronimed Inc. and American Prescription Providers. (14)
10.14 Specialty Pharmacy Fuzeon(R)Agreement between Chronimed Inc.
and Roche Laboratories dated March 7, 2003 (without exhibits
or schedules). (15)
10.15 Prime Vendor Agreement between Chronimed Inc. and Cardinal
Health dated April 24, 2003. (15)
10.16* Amended and Restated Revolving Credit Agreement between
Chronimed Inc. and U.S. Bank National Association, M&I
Marshall and Ilsey Bank, and UMB Bank, N.A. dated April 17,
2003 (without exhibits or schedules).
10.17* Employment agreement effective February 1, 2003 between the
Company and Anthony J. Zappa. (1)
21.1* List of Subsidiaries.
28
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
23.1* Consent of Ernst & Young LLP.
31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (Chief Executive Officer).
31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (Chief Financial Officer).
32.1* 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).
32.2* 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).
99.1* Cautionary Statements for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act.
- ---------------------
* Filed herewith.
(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 November 5, 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 2000 Annual Report on Form
10-K filed with The Commission on September 27, 2000, under file Number
0-19952.
(10) 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.
(11) 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.
29
(12) 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.
(13) 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.
(14) 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.
(15) Incorporated by reference to the Company's quarterly report on Form
10-Q filed with The Commission on May 9, 2003, under file Number
0-19952.
30
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 18, 2003
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 18, 2003
- --------------------------------------------------
Henry F. Blissenbach - Chief Executive Officer
(Principal Executive Officer and Chairman of the
Board of Directors)
/s/ GREGORY H. KEANE September 18, 2003
- --------------------------------------------------
Gregory H. Keane - Vice President, Chief Financial
Officer and Treasurer
(Principal Financial and Accounting Officer)
/s/ THOMAS A. CUSICK September 18, 2003
- --------------------------------------------------
Thomas A. Cusick (Director)
/s/ THOMAS F. HEANEY September 18, 2003
- --------------------------------------------------
Thomas F. Heaney (Director)
/s/ MYRON Z. HOLUBIAK September 18, 2003
- --------------------------------------------------
Myron Z. Holubiak (Director)
/s/ DAVID R. HUBERS September 18, 2003
- --------------------------------------------------
David R. Hubers (Director)
/s/ KAREN GILLES LARSON September 18, 2003
- --------------------------------------------------
Karen Gilles Larson (Director)
/s/ CHARLES V. OWENS, JR. September 18, 2003
- --------------------------------------------------
Charles V. Owens, Jr. (Director)
/s/ STUART A. SAMUELS September 18, 2003
- --------------------------------------------------
Stuart A. Samuels (Director)
31
INDEX TO FINANCIAL STATEMENTS
Report of Independent Auditors............................................................................ F-2
Consolidated Balance Sheets............................................................................... F-3
Consolidated Statements of Income......................................................................... 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 27, 2003 and June 28, 2002, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended June 27, 2003. Our audits also included
the financial statement schedule listed in Item 15(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 27, 2003 and June 28, 2002, and the consolidated results
of its income and its cash flows for each of the three years in the period ended
June 27, 2003, 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.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
August 4, 2003
F-2
CHRONIMED INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 27, JUNE 28,
2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 22,854 $ 6,306
Accounts receivable (net of allowances of $5,940 and 40,001 44,461
$8,923 at June 27, 2003, and June 28, 2002, respectively)
Inventory 8,614 8,334
Prepaid expenses 1,071 1,062
Deferred taxes 2,607 3,437
- --------------------------------------------------------------------------------------------------------------------------------
Total current assets 75,147 63,600
Property and equipment, net 4,487 5,485
Goodwill 30,233 30,233
Other assets, net 133 177
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 110,000 $ 99,495
================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 19,085 $ 14,811
Accrued expenses 2,136 3,117
Accrued bonus 1,420 1,174
Income taxes payable 821 648
- --------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 23,462 19,750
Deferred taxes 1,025 344
Shareholders' equity
Preferred stock - -
Common stock, issued and outstanding shares--
12,541 and 12,353 respectively 125 124
Additional paid-in capital 56,248 55,122
Retained earnings 29,140 24,155
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 85,513 79,401
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 110,000 $ 99,495
================================================================================================================================
See notes to consolidated financial statements
F-3
CHRONIMED INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 27, JUNE 28, JUNE 29,
YEAR ENDED 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Revenue $ 435,713 $ 397,437 $ 297,925
Cost of revenue 382,591 349,705 262,232
- ---------------------------------------------------------------------------------------------------------------
Gross profit 53,122 47,732 35,693
Operating expenses
Selling and marketing 3,790 3,329 3,209
General and administrative 38,401 39,041 31,118
Bad debt 3,204 3,504 7,140
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 45,395 45,874 41,467
Income (loss) from continuing operations 7,727 1,858 (5,774)
Interest income 311 493 673
Interest expense - (389) (105)
Other income (loss) - 3,906 (1,837)
- ---------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
income taxes 8,038 5,868 (7,043)
Income tax (expense) benefit (3,053) (2,131) 2,585
- ---------------------------------------------------------------------------------------------------------------
Net income (loss) from continuing operations 4,985 3,737 (4,458)
Net income from discontinued operations, net of tax - - 1,466
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
- ---------------------------------------------------------------------------------------------------------------
Net income $ 4,985 $ 3,737 $ 10,777
===============================================================================================================
Basic and diluted net income (loss) per share:
Continuing operations $ 0.40 $ 0.30 $ (0.37)
Discontinued operations - - 1.25
- ---------------------------------------------------------------------------------------------------------------
Net income per share $ 0.40 $ 0.30 $ 0.88
===============================================================================================================
Basic weighted-average shares 12,356 12,321 12,206
Diluted weighted-average shares 12,512 12,342 12,206
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 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
Shares issued for employee stock
purchase, restricted stock, and
option plans 188 1 957 - - 958
Tax benefit of restricted stock vesting - - 169 - - 169
Net income and comprehensive income - - - 4,985 - 4,985
- -----------------------------------------------------------------------------------------------------------------------
Balance June 27, 2003 12,541 $ 125 $ 56,248 $ 29,140 $ - $ 85,513
=======================================================================================================================
See notes to consolidated financial statements
F-5
CHRONIMED INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
JUNE 27, JUNE 28, JUNE 29,
YEAR ENDED 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 4,985 $ 3,737 $ 10,777
Less income/gain from discontinued operations - - (15,235)
- ----------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 4,985 3,737 (4,458)
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by (used in) operating activities:
Depreciation and amortization 2,351 2,871 4,056
Amortization of restricted stock 592 - -
Deferred income taxes 1,511 1,855 (1,296)
Gain on sale of Home Service Medical business - (3,797) (22)
Loss on sale of available-for-sale securities - - 1,844
Income tax benefit of stock option exercises and restricted
stock vesting 169 - 155
Changes in operating assets and liabilities:
Accounts receivable 4,460 (4,139) (1,440)
Income taxes 173 7,018 (4,469)
Inventory (280) 499 (1,529)
Accounts payable 4,274 (713) 5,017
Accrued expenses (735) 424 1,354
Other assets 15 (3) (469)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 17,515 7,752 (1,257)
Investing activities
Acquisitions - - (24,777)
Proceeds from sale of Home Service Medical business - 3,797 2,734
Purchases of property and equipment (1,333) (1,305) (2,850)
Sale of available-for-sale securities - - 7,656
- ----------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (1,333) 2,492 (17,237)
Financing activities
Net proceeds from issuance of Common Stock 366 162 1,031
Net proceeds from (repayments of) borrowings - (4,100) 1,600
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 366 (3,938) 2,631
Cash provided by discontinued operations - - 15,863
Increase in cash and cash equivalents 16,548 6,306 -
Cash and cash equivalents at beginning of period 6,306 - -
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 22,854 $ 6,306 $ -
================================================================================================================
SUPPLEMENTAL DISCLOSURES
Income taxes paid $ 2,290 $ 401 $ 14,092
Interest payments $ - $ 389 $ 102
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, we 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"), a specialty pharmacy,
distributes prescription drugs and provides specialized therapy management
services for people with certain health conditions, including HIV/AIDS, organ
transplants, and diseases treated with biotech injectable medications. We work
with patients, physicians and other health care providers, pharmaceutical
manufacturers, health plans and insurers, and government agencies to improve
clinical and economic outcomes.
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. Fiscal 2004
will include 53 weeks. The fiscal years referenced herein are as follows:
FISCAL YEAR YEAR ENDED
- ------------------------------------------------------
2003 June 27, 2003 (52 weeks)
2002 June 28, 2002 (52 weeks)
2001 June 29, 2001 (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.
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 periodically reassessed,
and actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue is recognized at the time prescriptions are 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 bill a
standard list price (versus a known contracted price) and then simultaneously
determine an appropriate estimate for expected payor discount based on our
reimbursement history for each payor class. This reimbursement history is
updated quarterly. Revenue is then reported net of the estimated payor discounts
and adjusted in future periods as final settlements are determined.
SHIPPING AND HANDLING COSTS
Product shipping and handling costs are included in cost of revenue.
These costs were $3.2 million, $3.1 million, and $2.5 million in fiscal 2003,
2002, and 2001, respectively.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
STOCK-BASED COMPENSATION
At June 27, 2003, we have various stock-based employee compensation
plans which are described more fully in Note 8. We have adopted the
disclosure-only provisions of Statement of Financial Accounting Standards No.
123 (Statement No. 123), "Accounting for Stock-Based Compensation," as amended
by Statement of Financial Accounting Standards No. 148 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.
In fiscal 2001, modification to the option terms in the Separation
Agreement entered into with Maurice R. Taylor, II, our former Chairman and Chief
Executive Officer, 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
$610,000 non-cash charge, net of related tax effects, to compensation expense.
In fiscal 2003, the Compensation Committee of the Board of Directors approved
restricted stock grants to our officers under our 2001 Stock Incentive Plan. The
125,000 non-canceled restricted shares fully vested in fiscal 2003, and we
recognized compensation expense of $367,000, net of related tax effects (see
Note 8, "Shareholders' Equity"). The following table illustrates the effect on
net income and earnings per share if we had applied the fair value recognition
provisions of Statement No. 123 to stock-based employee compensation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- -----------------------------------------------------------------------------------------
Net income - as reported $ 4,985 $ 3,737 $ 10,777
Plus reported stock-based employee
compensation cost, net of related tax effects 367 - 610
Deduct pro forma stock-based employee
compensation cost, net of related tax effects (2,063) (1,371) (2,014)
- -----------------------------------------------------------------------------------------
Net income - pro forma $ 3,289 $ 2,366 $ 9,373
=========================================================================================
Earnings per share - basic as reported $ 0.40 $ 0.30 $ 0.88
Earnings per share - basic pro forma $ 0.27 $ 0.19 $ 0.77
Earnings per share - diluted as reported $ 0.40 $ 0.30 $ 0.88
Earnings per share - diluted pro forma $ 0.26 $ 0.19 $ 0.77
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:
2003 2002 2001
- -----------------------------------------------------------------------------------------
Expected dividend yield -% -% -%
Expected stock price volatility 66.4% 65.4% 55.3%
Risk-free interest rate 3.2% 4.4% 5.3%
Expected life of options (in years) 5.4 5.0 5.0
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 2003, 2002, and 2001, was $3.13, $3.22 and $4.06, respectively.
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 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 aging of the accounts receivable and historical write-off
experience. Bad debt expense is recorded as an operating expense in our
Consolidated Statements of Income.
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 service businesses.
Payor discount allowances are recorded as offsets to revenue in our Consolidated
Statements of Income.
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 over the estimated useful
lives of one to seven years. Depreciation expense for continuing operations was
$2,330,000, $2,847,000, and $2,597,000 in fiscal 2003, 2002, and 2001,
respectively.
Property and equipment consisted of the following at June 27, 2003, and
June 28, 2002:
FISCAL YEAR
-----------------------
(IN THOUSANDS) 2003 2002
- -----------------------------------------------------------------------------------------
Leasehold improvements $ 4,885 $ 4,528
Furniture and fixtures 3,437 3,688
Computer hardware and software 8,479 9,048
- -----------------------------------------------------------------------------------------
Total property and equipment 16,801 17,264
Less: accumulated depreciation (12,314) (11,779)
- -----------------------------------------------------------------------------------------
Net property and equipment $ 4,487 $ 5,485
=========================================================================================
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
GOODWILL
As of June 30, 2001, we adopted Statement of Financial Accounting
Standards No. 142 ("Statement 142"), "Goodwill and Other Intangible Assets",
which changes the accounting for goodwill and intangibles with indefinite lives
from an amortization method to an impairment-only approach. Goodwill and other
intangible assets with indefinite lives will remain on the consolidated balance
sheet and not be amortized. On an annual basis, and when there is reason to
suspect that their values have been diminished or impaired, these assets must be
tested for impairment, and write-downs may be necessary. Based on the results of
our impairment tests, we have not been required to recognize an impairment of
goodwill.
In accordance with Statement 142, we discontinued the amortization of
goodwill effective June 30, 2001. A reconciliation of previously reported net
income and net income per share to the amounts adjusted for the exclusion of
goodwill amortization, net of the related income tax effect, follows:
FISCAL YEAR
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Reported net income $ 4,985 $ 3,737 $ 10,777
Add: goodwill amortization, net of tax - - 881
- ------------------------------------------------------------------------------------------------------------------
Adjusted net income $ 4,985 $ 3,737 $ 11,658
==================================================================================================================
Reported basic and diluted net income per share $ 0.40 $ 0.30 $ 0.88
Add: goodwill amortization, net of tax, per basic and diluted share - - 0.07
- ------------------------------------------------------------------------------------------------------------------
Adjusted basic and diluted net income per share $ 0.40 $ 0.30 $ 0.95
- ------------------------------------------------------------------------------------------------------------------
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.
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 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 established that fair value is the objective for initial
measurement of the liability. Statement 146 was effective for exit or disposal
activities initiated after December 31, 2002. The adoption of Statement 146 did
not have any impact on our financial position, results of operations, or cash
flows.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In December 2002, the FASB issued Statement 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." The Statement provides
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based employee compensation. In addition, the
Statement amends the previous disclosure requirements of SFAS No. 123 to require
prominent disclosures about the method of accounting for stock-based employee
compensation and the effect of the method used on reported financial results and
requires these disclosures in interim financial information. We continue to
account for stock-based employee compensation under APB Opinion 25 but have
adopted the new disclosure requirements of Statement 148.
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 per share is computed
by dividing income 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 periods with net losses from continuing operations, 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:
FISCAL YEAR
----------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- ------------------------------------------------------------------------------------------------
Numerator
Net income (loss) from continuing operations $ 4,985 $ 3,737 $ (4,458)
Net income from discontinued operations - - 15,235
- ------------------------------------------------------------------------------------------------
Net income $ 4,985 $ 3,737 $ 10,777
================================================================================================
Denominator
Denominator for basic net income (loss) per share -
weighted average shares outstanding 12,356 12,321 12,206
Effect of dilutive stock options 156 21 -
- ------------------------------------------------------------------------------------------------
Denominator for diluted net income (loss) per share -
weighted average shares outstanding 12,512 12,342 12,206
================================================================================================
Basic and diluted net income (loss) per share
from continuing operations $ 0.40 $ 0.30 $ (0.37)
Basic and diluted net income per share
from discontinued operations - - 1.25
- ------------------------------------------------------------------------------------------------
Basic and diluted net income per share $ 0.40 $ 0.30 $ 0.88
- ------------------------------------------------------------------------------------------------
Employee stock options of 1,048,795, 1,241,520, and 2,404,252 for
fiscal 2003, 2002, and 2001, respectively, have been excluded from the basic and
diluted net income (loss) per share calculation because their effect would be
antidilutive.
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 in fiscal 2001.
We received $40.0 million from the sale of MEDgenesis to Medisys,
consisting of $30.5 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 Other income (loss) on the Consolidated Statements of
Income.
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 2001. The activity shown for the year ended June 29, 2001
includes activity through the sale date of January 5, 2001:
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEAR
(IN THOUSANDS) 2001
- -------------------------------------------------------------------------------------------
Revenue from discontinued operations $ 19,443
Cost of revenue 10,903
- -------------------------------------------------------------------------------------------
Gross profit 8,540
- -------------------------------------------------------------------------------------------
Operating expenses
Selling and marketing 2,951
Research and development 596
General and administrative 2,713
- -------------------------------------------------------------------------------------------
Total operating expenses 6,260
Income from discontinued operations 2,280
Other income 124
- -------------------------------------------------------------------------------------------
Income from discontinued operations before income taxes 2,404
Income tax expense (938)
- -------------------------------------------------------------------------------------------
Net income from discontinued operations $ 1,466
- -------------------------------------------------------------------------------------------
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 service 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%.
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 we had 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 Income.
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 seven years as of June 27, 2003.
Future minimum lease payments, including current real estate taxes and
operating expenses, under the operating leases with original lease terms in
excess of one year at June 27, 2003, are approximately as follows:
(IN THOUSANDS)
- -------------------------------------------------------------------------------------------
FISCAL YEAR AMOUNT
- -------------------------------------------------------------------------------------------
2004 $ 2,728
2005 1,958
2006 756
2007 286
2008 73
Beyond 158
- -------------------------------------------------------------------------------------------
Total $ 5,959
===========================================================================================
Total rent expense for continuing operations was $2,774,000,
$3,898,000, and $2,710,000, during fiscal 2003, 2002, and 2001, respectively.
6. LONG-TERM DEBT AND CREDIT ARRANGEMENTS
We had no long-term debt as of fiscal year end 2003 and 2002. We have a
secured line of credit totaling $30 million that will terminate in April 2006.
We were in compliance with our line of credit covenants as of June 27, 2003.
Under the terms of the line of credit agreement, the debt is secured by
receivables and inventory and bears interest at the Eurodollar rate plus the
applicable margin dependant on our covenant calculation. During 2003 and as of
June 27, 2003, we had no short-term borrowings outstanding under this line of
credit.
F-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES
The components of the provision for income taxes for continuing
operations are as follows:
FISCAL YEAR
-------------------------------
(IN THOUSANDS) 2003 2002 2001
- ----------------------------------------------------------------
Current
Federal $ 1,380 $ 438 $(1,156)
State 162 37 (132)
Deferred
Federal 1,352 1,525 (1,164)
State 159 131 (133)
- ----------------------------------------------------------------
Income tax expense (benefit) $ 3,053 $ 2,131 $(2,585)
- ----------------------------------------------------------------
Our income tax expense from continuing operations differs from the
applicable federal rate of 34% in fiscal 2003 and 2002, and 35% in fiscal 2001.
The reconciliation of differences is as follows:
FISCAL YEAR
--------------------------------
(IN THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------
Federal income tax at statutory rates $ 2,733 $ 1,995 $(2,465)
State taxes, net of federal benefit 241 264 (260)
Goodwill amortization - - 61
Other, net 79 (128) 79
- --------------------------------------------------------------------------
Income tax expense (benefit) $ 3,053 $ 2,131 $(2,585)
==========================================================================
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:
FISCAL YEAR
--------------------
(IN THOUSANDS) 2003 2002
- -----------------------------------------------------------
Deferred tax assets
Allowance for doubtful accounts $ 1,720 $ 2,003
Inventory reserve 114 69
Allowance for payor discounts 538 1,346
Other reserves 301 272
Vacation accrual 191 155
Accrued expenses 202 -
Depreciation 79 11
Deferred tax liabilities
Sales tax refunds receivable (52) -
Prepaid assets (407) (408)
Goodwill amortization (1,104) (355)
- -----------------------------------------------------------
Net deferred tax assets $ 1,582 $ 3,093
- -----------------------------------------------------------
F-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
We have four employee Stock Option Plans (1994, 1997, 1999 and 2001).
Options to purchase our Common Stock are granted to employees at 100% of fair
market value on the grant date and generally become exercisable at 20% of the
total grant at the end of each year. In addition, the August 2002 option grants
included an accelerated vesting provision based on defined increases in the
price of the Company's common stock. The options are cumulatively exercisable
and expire seven years after the grant date. In fiscal 2004 options to purchase
common stock granted to employees will become exercisable at 34%, 33%, and 33%
of the total grant at the end of each of three consecutive years and will expire
ten years after the grant date.
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 $683,000 based on our fair market value of $4.71 per common
share at the date of grant, were to 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. In October 2002, 20,000 of these shares
were cancelled. The remaining 125,000 restricted shares vested by March 2003 as
provided by the grant acceleration provision. We recognized compensation expense
of $367,000, net of tax, or $0.03 per share in fiscal 2003.
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. We
recognized $938,000, before tax, of non-cash compensation expense as a result of
the modification. The majority of these options expired unexercised. See Note
10, Notes to Consolidated Financial Statements.
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 the 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. Grants under this plan are made
upon a director's first election to our Board. Thereafter, directors receive
annual grants under one of the four option plans available to employees.
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 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
Options granted (604,867) 604,867 5.25
Restricted stock granted (125,000) -
Exercised - (45,700) 6.33
Cancelled 235,925 (235,925) 8.50
- ------------------------------------------------------------------------------------------------------------
Balance June 27, 2003 2,154,896 1,971,862 $ 7.01 1,187,504 $ 7.15
============================================================================================================
The following table summarizes information about stock options
outstanding at June 27, 2003.
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 - 5.03 542,967 6.1 yrs $ 4.87 470,160 $ 4.87
$ 5.24 - 6.00 333,100 5.1 yrs $ 5.27 63,580 $ 5.27
$ 6.21 - 7.38 432,450 4.5 yrs $ 7.14 184,840 $ 7.15
$ 7.50 - 8.63 396,510 3.0 yrs $ 8.02 270,196 $ 7.96
$ 9.00 - 20.00 266,835 1.7 yrs $ 11.78 198,728 $ 12.02
- -----------------------------------------------------------------------------------------
$ 4.33 - 20.00 1,971,862 4.4 yrs $ 7.01 1,187,504 $ 7.15
=========================================================================================
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 $216,000, $209,000, and $188,000 in fiscal 2003, 2002, and
2001, respectively.
We have an Employee Stock Purchase Plan. We issued 18,115 shares,
35,187 shares, and 29,172 shares of common stock under the plan during fiscal
2003, 2002, and 2001, respectively. We had 73,836 shares available for purchase
under the Plan at June 27, 2003.
F-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. RELATED PARTY TRANSACTIONS
On April 9, 1997, we entered into a guaranty of a personal loan with
U.S. Bank on behalf of Maurice R. Taylor, at the time our Chairman and Chief
Executive Officer. Taylor's U.S. Bank loan allowed him to avoid liquidation of a
substantial number of our shares pledged as security. The balance of
indebtedness under the guaranty was $675,000 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 U.S. Bank. U.S. Bank 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 remained 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 defaulted under the terms of the note and
residential mortgage. As a result we fully reserved for this note. We commenced
a lawsuit against Taylor to obtain a judgment for the sum due and an order
permitting foreclosure of the residential mortgage. On August 15, 2003 the
parties agreed to a settlement and pursuant to the settlement, the Court
dismissed the lawsuit. The Settlement Agreement and its terms are confidential.
Because we fully reserved for this note, any subsequent collections from Mr.
Taylor will be recognized as a gain.
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, before taxes, 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.
11. SIGNIFICANT CONCENTRATIONS
Payor reimbursements from Aetna, Inc., included in the Mail Service
segment, represented 24.3%, 26.0%, and 33.2% of our revenue in fiscal 2003,
2002, and 2001, respectively. No other private payor or single government agency
represented more than 10% of our revenues.
We used McKesson Corporation, a large national distributor, to supply
pharmaceuticals for both the Retail and Mail Service segments. This supplier
made up 88.7%, 91.7%, and 85.2% of our continuing operations inventory purchases
for fiscal 2003, 2002, and 2001, respectively. We signed a new three-year
wholesale agreement with Cardinal Health to cover the majority of our
pharmaceutical purchases effective August 2003. 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 uncollectible amounts.
Aetna, Inc. represents 16.0% and 19.4% of our accounts receivable balance for
the fiscal years ended 2003 and 2002,
F-19
respectively. No other private payor or single government agency represented
more than 10% of our accounts receivable balances. Concentration of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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
Our two reportable segments are Mail Service and Retail.
- Mail Service provides prescription drugs and ancillary medical
supplies via mail service to patients with a wide variety of
high-cost conditions. These conditions include 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,
Medicaid, and other managed healthcare 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, for administration to patients at
their office. We coordinate our services with payors,
physicians, nursing services, and other members of a patient's
healthcare team. In addition, we utilize therapy management
guidelines as we monitor patient progress (responsiveness and
compliance) to the treatment.
- Retail is branded as StatScript Pharmacy and includes 28
HIV/AIDS pharmacies across the country. Although committed to
the HIV/AIDS patient, StatScript also serves organ transplant
recipients and other patients with conditions treated with
biotech injectable medication. StatScript's efforts with
community resources, patient education, clinical team
communication, and complete patient tracking are all key to
the successful care of our patients.
Our reportable segments are distinct distribution channels that offer
related products and services to patients with chronic health conditions. 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.
F-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The table below presents information by reportable segment.
(IN THOUSANDS) MAIL ORDER RETAIL TOTAL
- -------------------------------------------------------------------------------------------
For the Year Ended June 27, 2003
Revenues $ 181,773 $ 253,940 $ 435,713
Income from Operations 2,021 5,706 7,727
Depreciation & Amortization 917 1,434 2,351
Additions to Property and Equipment 525 820 1,345
Segment Assets 25,885 57,714 83,599
For the Year Ended June 28, 2002
Revenues $ 173,202 $ 224,235 $ 397,437
Income (Loss) from Operations 2,166 (308) 1,858
Depreciation & 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
Loss from Operations (314) (5,110) (5,424)
Depreciation & 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
Income (loss) from operations for fiscal 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.
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) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------
TOTAL CONSOLIDATED REVENUE $ 435,713 $ 397,437 $ 297,925
INCOME (LOSS) FROM CONTINUING OPERATIONS
Total for reportable segments $ 7,727 $ 1,858 $ (5,424)
Unallocated amounts:
- - Corporate G&A - - (350)
- - Interest income 311 104 568
- - Other income (expense) - 3,906 (1,837)
- ------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before income taxes $ 8,038 $ 5,868 $ (7,043)
============================================================================================================
ASSETS
Total for reportable segments $ 83,599 $ 89,694 $ 86,822
Corporate assets 26,401 9,801 12,171
- ------------------------------------------------------------------------------------------------------------
Total consolidated assets of continuing operations $ 110,000 $ 99,495 $ 98,993
============================================================================================================
Corporate assets consist primarily of cash, deferred taxes, prepaids,
and certain receivables.
13. CONTINGENCIES
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 filed and the nine lawsuits
were consolidated into a single case.
On July 11, 2003, the Company and plaintiffs agreed to settle the case
and all claims. Under the settlement, which is subject to court approval, the
Company will pay $2.2 million which will be distributed to the class members and
counsel. The settlement amount is being funded by Company insurance.
We have been engaged in discussions with the United States Attorney for
the District of Columbia regarding certain claims for reimbursement we submitted
to DC Medicaid between January and April 2000. The U.S. Attorney has asserted
that these claims were a result of an attempt by a DC resident to defraud the
Medicaid system and divert pharmaceuticals. We have denied wrongdoing. Our
Medicaid billings associated with this individual's activities totaled
approximately $230,000. We have established a reserve against the possibility
that these billings could be subject to repayment. No formal action has been
taken by the government with respect to these billings, however such an action
could result in a greater loss.
Healthcare payors, whether private insurers or government funded
programs, routinely audit providers' billing processes, records, and legal or
contractual compliance. Audits frequently can and do result in requests for
repayment of previously recorded revenues. We have established a reserve to
reflect the possibility that revenues could be subject to repayment as a result
of payor audits.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. QUARTERLY RESULTS - UNAUDITED
The following tables present our results of operations and earnings per
share on a quarterly basis for fiscal 2003 and 2002.
QUARTERLY RESULTS
FISCAL 2003
--------------------------------------------------------------------
QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 YEAR ENDED
SEP 27, DEC 27, MAR 28, JUN 27, JUN 27,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2002 2003 2003 2003
- ------------------------------------------------------------------------------------------------------------------
Revenue $ 99,893 $108,636 $111,804 $115,380 $435,713
Gross profit 11,976 13,660 13,602 13,884 53,122
Net income 975 1,387 1,229 1,394 4,985
=================================================================================================================
Basic and diluted net income per share $ 0.08 $ 0.11 $ 0.10 $ 0.11 $ 0.40
=================================================================================================================
Weighted average shares outstanding -
Basic 12,353 12,353 12,400 12,368 12,356
Diluted 12,363 12,444 12,644 12,754 12,512
Our net income for the third quarter ended March 28, 2003, includes a
$327,000 compensation charge, net of tax, relating to the accelerated vesting of
restricted stock grants.
FISCAL 2002
---------------------------------------------------------------------
QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 YEAR ENDED
SEP 28, DEC 28, MAR 29, JUN 28, JUN 28,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 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 3 328 866 2,540 3,737
=================================================================================================================
Basic and diluted net income per share $ - $ 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.
F-23
CHRONIMED INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(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 27, 2003
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts $ 5,428 $ 3,204 $ - $ 4,107 (3) $ 4,525
Allowance for payor discounts 3,495 - 10,119 (1) 12,199 (2) 1,415
- --------------------------------------------------------------------------------------------------------------------
$ 8,923 $ 3,204 $ 10,119 $ 16,306 $ 5,940
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
(1) Estimated payor discounts charged to revenue
(2) Actual payor discounts taken
(3) Uncollectible accounts written off, net of recoveries
S-1