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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File No. 0-19842
PolyMedica Corporation
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Massachusetts 04-3033368
- ---------------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11 State Street, Woburn, Massachusetts 01801
- ---------------------------------------- -------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (781) 933-2020
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 [ ]
As of November 14, 2002, there were 12,296,217 shares of the registrant's
Common Stock outstanding and an additional 1,018,765 shares held in treasury.
POLYMEDICA CORPORATION
TABLE OF CONTENTS
PAGE
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets as of
September 30 (unaudited) and March 31, 2002 3
Unaudited Consolidated Statements of Operations
for the three and six months ended
September 30, 2002 and 2001 5
Unaudited Consolidated Statements of Cash Flows
for the six months ended September 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 18
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 38
Item 4 - Controls and Procedures 39
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 40
Item 4 - Submission of Matters to a Vote of Security Holders 41
Item 6 - Exhibits and Reports on Form 8-K 42
Signatures 43
Certifications 44
Exhibit Index 47
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYMEDICA CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
SEPTEMBER 30,
2002 MARCH 31,
ASSETS (UNAUDITED) 2002
------------- --------
Current assets:
Cash and cash equivalents $ 26,834 $ 27,884
Accounts receivable (net of allowances of
$19,272 and $15,539 as of September 30 and
March 31, 2002, respectively) 46,038 44,059
Inventories 20,644 21,663
Deferred tax asset 10,622 10,622
Prepaid expenses and other
current assets 3,617 1,727
-------- --------
Total current assets 107,755 105,955
Property, plant and equipment, net 44,519 34,603
Goodwill 29,748 29,748
Intangible assets, net 330 698
Direct response advertising, net 58,251 52,112
Other assets 2,206 1,276
-------- --------
Total assets $242,809 $224,392
======== ========
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
3
POLYMEDICA CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
SEPTEMBER 30,
2002 MARCH 31,
(UNAUDITED) 2002
------------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,459 $ 10,270
Amounts due to Medicare and others 2,566 4,798
Accrued expenses 14,359 12,990
Current portion, capital lease obligations 702 742
--------- ---------
Total current liabilities 27,086 28,800
Long-term note payable, capital lease and other obligations 2,579 1,485
Deferred income taxes 20,524 20,524
--------- ---------
Total liabilities 50,189 50,809
Commitments and contingencies (Note 12)
Shareholders' equity:
Preferred stock, $0.01 par value; 2,000,000 shares
authorized, none issued or outstanding -- --
Common stock, $0.01 par value; 50,000,000 shares
authorized; 13,314,982 and 13,300,477 shares issued as of September 30 and
March 31, 2002, respectively 133 133
Treasury stock, at cost (1,103,173 and 1,143,158 shares as of September 30
and March 31, 2002, respectively) (21,574) (22,185)
Additional paid-in capital 119,350 119,891
Retained earnings 94,711 75,744
--------- ---------
Total shareholders' equity 192,620 173,583
--------- ---------
Total liabilities and shareholders' equity $ 242,809 $ 224,392
========= =========
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
4
POLYMEDICA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
---- ---- ---- ----
Net revenues $ 88,012 $ 68,851 $ 169,613 $ 131,872
Cost of sales 31,208 23,555 60,065 44,820
-------- -------- --------- ---------
Gross margin 56,804 45,296 109,548 87,052
Selling, general and administrative
expenses 40,977 38,059 79,005 65,964
-------- -------- --------- ---------
Income from operations 15,827 7,237 30,543 21,088
Other income and expense:
Investment income/(loss) (12) 234 32 774
Interest expense (34) (44) (70) (87)
Minority interest -- 174 -- (140)
Other income and expense -- (1) (12) (1)
-------- -------- --------- ---------
(46) 363 (50) 546
Income before income taxes 15,781 7,600 30,493 21,634
Income tax provision 5,965 2,918 11,526 8,307
-------- -------- --------- ---------
Net income $ 9,816 $ 4,682 $ 18,967 $ 13,327
======== ======== ========= =========
Net income per weighted average
share:
Basic $ .81 $ .37 $ 1.56 $ 1.04
Diluted $ .79 $ .36 $ 1.52 $ 1.02
Weighted average shares, basic 12,171 12,680 12,169 12,818
Weighted average shares, diluted 12,439 12,949 12,509 13,116
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
5
POLYMEDICA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
SIX MONTHS ENDED
SEPTEMBER 30,
2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 18,967 $ 13,327
Adjustments to reconcile net income to net cash flows:
Depreciation and amortization 2,791 2,700
Amortization of direct-response advertising 17,358 13,978
Direct-response advertising (23,497) (21,090)
Minority interest -- 140
Provision for bad debts 12,508 9,998
Provision for sales allowances 8,202 5,813
Provision for inventory obsolescence 539 186
Stock-based compensation 6 --
Changes in assets and liabilities:
Accounts receivable (22,689) (24,932)
Inventories 480 3,087
Prepaid expenses and other assets (1,716) (1,096)
Accounts payable (811) (2,682)
Amounts due to Medicare and others (2,232) 5,702
Accrued expenses and other liabilities 2,700 6,096
-------- --------
Total adjustments (6,361) (2,100)
-------- --------
Net cash flows from operating activities 12,606 11,227
-------- --------
Cash flows from investing activities:
Purchase of marketable securities -- (5,499)
Proceeds from sale of marketable securities -- 5,499
Purchase of property, plant and equipment (12,077) (4,850)
-------- --------
Net cash flows from investing activities (12,077) (4,850)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 724 295
Repurchase of common stock (659) (13,357)
Contributions to deferred compensation plans (1,274) (1,103)
Payment of obligations under capital leases and note payable (370) (315)
-------- --------
Net cash flows from financing activities (1,579) (14,480)
-------- --------
Net decrease in cash and cash equivalents (1,050) (8,103)
Cash and cash equivalents at beginning of period 27,884 39,571
-------- --------
Cash and cash equivalents at end of period $ 26,834 $ 31,468
======== ========
Supplemental disclosure of cash flow information:
Disposal of equipment $ 77 $ --
Assets purchased under capital lease 281 323
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
6
POLYMEDICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The unaudited consolidated financial statements included herein have been
prepared by PolyMedica Corporation ("PolyMedica" or the "Company") pursuant to
the rules and regulations of the Securities and Exchange Commission (the "SEC")
and include, in the opinion of management, all adjustments, consisting of
normal, recurring adjustments, necessary for a fair presentation of interim
period results. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The results for the interim periods presented are not necessarily
indicative of results to be expected for the full fiscal year. It is suggested
that these interim consolidated financial statements be read in conjunction with
the audited consolidated financial statements included in our Annual Report on
Form 10-K for the fiscal year ended March 31, 2002, and our unaudited
consolidated financial statements included in our Quarterly Report on Form 10-Q
for the period ended June 30, 2002.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reported period. Estimates and judgments are used for,
including, but not limited to, determination of appropriate Medicare
reimbursement rates, the allowance for doubtful accounts and sales returns,
goodwill, valuation of inventory, accrued expenses, amounts due to Medicare and
others, uncertainties that management determines are estimable and probable, and
depreciation and amortization. Actual results could differ from those estimates.
In addition, certain amounts in the prior period consolidated financial
statements have been reclassified to conform with the current period
presentation.
2. We recognize revenue on product shipments to customers who have placed
orders, upon shipment, provided that risk of loss has passed to the customer and
that, if applicable, we have received and verified the required written
Authorization of Benefits and Doctor's Order to bill Medicare, other third-party
payers, and customers. We record revenue at the amounts expected to be collected
from Medicare, other third-party payers, and directly from customers. Revenue
recognition is delayed for product shipments for which we have not yet received
a written Authorization of Benefits and Doctor's Order, if applicable, until the
period in which those documents are collected and verified.
Approximately $60.56 million and $44.35 million of net revenues for the
three months ended September 30, 2002 and 2001, respectively, were reimbursable
by Medicare for products and services provided to Medicare beneficiaries.
Approximately $117.46 million and $90.60 million of net revenues for the six
months ended September 30, 2002 and 2001, respectively, were reimbursable by
Medicare for products and services provided to Medicare beneficiaries.
3. Sales allowances are recorded for estimated product returns using
historical return trends and are recorded as a reduction of revenue. These
allowances are adjusted to reflect actual returns and collection history. During
the three months ended September 30, 2002 and 2001, we provided for
7
sales allowances at a rate of approximately 4.9% and 3.9% of gross revenues,
respectively. During the six months ended September 30, 2002 and 2001, we
provided for sales allowances at a rate of approximately 4.6% and 4.2% of gross
revenues, respectively. We analyze sales allowances using historical data
adjusted for significant changes in volume, customer demographics, and business
conditions. At the time of revenue recognition, we follow the
government-distributed list containing reimbursement prices for Medicare-covered
products (the "Medicare Fee Schedule") and exclude from revenue amounts billed
in excess of the Medicare (Durable Medical Equipment Prosthetics Orthotics
Supplies) Fee Schedule. As a result, our contractual allowances are immaterial.
The reimbursements that Medicare pays us are subject to review by appropriate
government regulators. Medicare reimburses at 80% of the Medicare Fee Schedule
for reimbursable supplies and we bill the remaining balance to either
third-party payers or directly to customers.
4. Inventories consist of the following:
(In thousands)
Sept. 30, March 31,
2002 2002
---- ----
Raw materials $ 997 $ 616
Work in process 597 832
Finished goods 19,050 20,215
------- -------
$20,644 $21,663
======= =======
Due to the medical nature of the products we provide, customers sometimes
request supplies before we have received the required documents, if applicable,
to bill Medicare, other third-party payers and customers. Because we do not
recognize revenue until we have received and verified such documents, included
in inventories as of September 30 and March 31, 2002, is $3.51 million and $3.77
million, respectively, of net inventory shipped to customers for which we have
received an order but have not yet received the required written documents.
5. In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 requires that ratable amortization of
goodwill and certain intangible assets be replaced with periodic tests of the
goodwill's impairment and that other intangible assets be amortized over their
useful lives unless these lives are determined to be indefinite. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001, and thus was
adopted by us on April 1, 2002.
Effective April 1, 2002, in accordance with the provisions of SFAS No.
142, we ceased amortizing goodwill. Under SFAS No. 142, goodwill is no longer
amortized but is tested for impairment under a two-step process. Under the first
step, an entity's net assets are broken down into reporting units and compared
to their fair value. If the carrying amount of a reporting unit exceeds its fair
value, the second step of the goodwill impairment test is performed to measure
the amount of impairment loss, if any. The second step compares the implied fair
value, determined using a discounted cash flows approach, of a reporting unit's
goodwill with the carrying amount of that goodwill. If the carrying amount of a
reporting unit's goodwill exceeds the implied fair value of that goodwill, an
impairment loss is recognized in an amount equal to that excess. Upon adoption
of SFAS No. 142 effective April 1, 2002, we are required to perform an initial
transitional impairment test. Step one of the impairment test must be
8
completed within six months of adoption and step two must be completed within
one year of adoption. Within six months of adopting the accounting standard, any
impairments identified in the transitional impairment test are treated as a
cumulative effect of a change in accounting principle. Additionally, new
criteria have been established that determine whether an acquired intangible
asset should be recognized separately from goodwill. We adopted the provisions
of SFAS No. 142, as required, on April 1, 2002. As a result of adopting SFAS No.
142 effective April 1, 2002, approximately $385,000 and $770,000 of goodwill
amortization was not recognized in the three and six months ended September 30,
2002, respectively.
During the quarter ended September 30, 2002 we performed the first step of
an impairment review of our goodwill as of April 1, 2002, under the transitional
provisions of SFAS No. 142. We identified our reporting units, allocated assets
and liabilities to the reporting units and compared each of the reporting unit's
net book value to its estimated fair value. Assets and liabilities, including
goodwill, were allocated to the reporting units based on factors such as
specific identification, percentage of net revenues and square footage. The fair
value of the reporting units was estimated using the discounted cash flows
approach. Based on this analysis, the carrying amounts for the two reporting
units included in our Pharmaceuticals segment exceeded their fair values, while
carrying amounts for the reporting unit included in our Liberty Diabetes segment
did not exceed fair value. During the fiscal year ended March 31, 2002, net
revenues generated from the two reportable units in our Pharmaceuticals segment
represented approximately 5% of our consolidated net revenues.
The second step will measure the amount of goodwill impairment loss in our
Pharmaceuticals segment. We will complete the second step of this transitional
test in the third quarter of fiscal 2003 and expect to recognize a goodwill
impairment charge related to the urological products reported in our
Pharmaceuticals segment as a cumulative effect of a change in accounting
principle retroactive to April 1, 2002 that will be recorded only in the
year-to-date results in our Quarterly Report on Form 10-Q for the quarter ending
December 31, 2002. The original goodwill related to these products was recorded
in December 1992 in connection with the purchase of certain product lines. As of
March 31, 2002, the net book value of the goodwill related to these products was
$24.80 million.
Subsequent to the transitional impairment test, we are required to perform
impairment tests under SFAS No. 142 annually and whenever events or changes in
circumstance suggest that the carrying value of an asset may not be recoverable.
The adoption of SFAS No. 142 will have a material impact on our consolidated
financial statements, as we will record an impairment charge in an amount to be
determined upon the completion of the second step of the transitional impairment
test which we expect to complete in the quarter ending December 31, 2002.
The following is a reconciliation of reported net income to adjusted net
income and reported earnings per share to adjusted earnings per share had SFAS
No. 142 been in effect for the three and six months ended September 30, 2001,
respectively (table in thousands, except per share amounts):
9
Three Months Six Months
Ended Ended
Sept. 30, 2001 Sept. 30, 2001
-------------- --------------
Net income $4,682 $13,327
Add back: Impact of goodwill amortization, net of tax
benefit of $148 and $296 for the three and six months ended
September 30, 2001, respectively 237 474
------ -------
Adjusted net income $4,919 $13,801
====== =======
Net income per share, basic $ 0.37 $ 1.04
Add back: Impact of goodwill amortization, net of taxes 0.02 0.04
------ -------
Adjusted net income per share, basic $ 0.39 $ 1.08
====== =======
Net income per share, diluted $ 0.36 $ 1.02
Add back: Impact of goodwill amortization, net of taxes 0.02 0.04
------ -------
Adjusted net income per share, diluted $ 0.38 $ 1.06
====== =======
We have three reporting units with goodwill: Liberty Medical Supply, Inc.
("Liberty"), included in the Liberty Diabetes reporting segment, and PolyMedica
Pharmaceuticals (U.S.A.), Inc. and PolyMedica Healthcare, Inc., both included in
the Pharmaceuticals reporting segment. The carrying amounts of goodwill and
intangible assets as of September 30, 2002 and March 31, 2002, by reportable
segment, are as follows (table in thousands):
Sept. 30, March 31,
2002 2002
--------- ---------
LIBERTY DIABETES:
Goodwill $ 4,951 $ 4,951
======== ========
Customer list $ 1,816 $ 1,816
Accumulated amortization (1,578) (1,448)
-------- --------
$ 238 $ 368
======== ========
PHARMACEUTICALS:
Goodwill $ 24,797 $ 24,797
======== ========
Covenant not to compete $ 6,800 $ 6,800
Accumulated amortization (6,708) (6,470)
-------- --------
$ 92 $ 330
======== ========
Consolidated goodwill $ 29,748 $ 29,748
======== ========
Amortizable intangible assets 8,616 8,616
Accumulated amortization (8,286) (7,918)
-------- --------
$ 330 $ 698
======== ========
10
Amortization expense for intangible assets was approximately $184,000 for
each of the three months ended September 30, 2002 and 2001 and approximately
$368,000 for each of the six months ended September 30, 2002 and 2001. As of
September 30, 2002, amortization expense on existing intangibles for the
remainder of fiscal 2003 and the next four fiscal years is expected to be as
follows (table in thousands):
Fiscal year 2003 $222
Fiscal year 2004 108
Fiscal year 2005 --
Fiscal year 2006 --
Fiscal year 2007 --
----
Total $330
====
6. Included in other assets are restricted investments of $1.97 million and
$868,000 as of September 30 and March 31, 2002, respectively, which represent
amounts we set aside under the executive deferred compensation plans (the
"Plans"). The related liability is included in long-term liabilities ("long-term
note payable, capital lease and other obligations" as captioned on the balance
sheet). Changes in the fair value of investments held in the Plans are recorded
as investment income or loss ("investment income/(loss)" as captioned on the
statements of operations) with a corresponding adjustment to compensation
expense, included in selling, general and administrative expenses, and to other
assets and long-term liabilities ("long-term note payable, capital lease and
other obligations" as captioned on the balance sheet). As of September 30, 2002,
the fair value of these investments was not materially different from cost.
Amounts set aside for the Plans in the six months ended September 30, 2002 and
2001 totaled $1.27 million and $1.10 million, respectively. The investments held
in the Plans, which are accounted for pursuant to SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," have been classified as
trading, are included in other assets, and are recorded at fair value.
7. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of SFAS No. 146 are effective for exit or disposal activities that are initiated
after December 31, 2002. We do not expect adoption of this statement to have a
material impact on our financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Nos. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS
No. 145 rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of
Debt," an amendment of that statement, and FASB Statement No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No.
145 also rescinds FASB Statement No. 44, "Accounting for Intangible Assets of
Motor Carriers" and FASB No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. Adoption of certain provisions of this standard was required after
May 15, 2002, while other provisions must be adopted with financial statements
issued after May 15, 2002 or the year beginning after May 15,
11
2002. We do not expect adoption of this statement to have a material impact on
our financial position or results of operations.
In October 2001 the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance on
the accounting for the impairment or disposal of long-lived assets. The
objectives of SFAS No. 144 are to address issues relating to the implementation
of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," and to develop a model for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired. We adopted SFAS No. 144 on April 1, 2002, as required. The adoption
did not have a material impact on our financial position or results of
operations in the three or six months ended September 30, 2002, but could have a
significant impact on our financial position or results of operations should
there be future asset impairments or disposals.
In August 2001, the FASB issued SFAS No. 143 "Accounting for Obligations
Associated with the Retirement of Long-Lived Assets." The provisions of SFAS No.
143 apply to all entities that incur obligations associated with the retirement
of tangible long-lived assets. SFAS No. 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002 and thus will
be adopted, as required, on April 1, 2003. This accounting pronouncement is not
expected to have a significant impact on our financial position or results of
operations.
8. In accordance with Statement of Position 93-7 ("SOP 93-7"), we incurred
and capitalized direct-response advertising of $11.98 million and $11.78 million
in the three months ended September 30, 2002 and 2001, respectively. A total of
$8.85 million and $7.40 million in direct-response advertising was amortized and
charged to selling, general and administrative expenses for the three months
ended September 30, 2002 and 2001, respectively. As a result, $3.13 million was
added to the direct-response advertising net asset in the quarter ended
September 30, 2002. A total of $23.50 million and $21.09 million of
direct-response advertising was capitalized in the six months ended September
30, 2002 and 2001, respectively. A total of $17.36 million and $13.98 million
was amortized and charged to selling, general and administrative expenses for
the six months ended September 30, 2002 and 2001, respectively. As a result,
$6.14 million was added to the direct-response advertising net asset in the six
months ended September 30, 2002. Management assesses the realizability of the
amounts of direct-response advertising costs reported as assets at each balance
sheet date by comparing the carrying amounts of such assets to the probable
remaining future net cash flows expected to result directly from such
advertising. We expense in the period all other advertising that does not meet
the capitalization requirements of SOP 93-7.
Any business change that reduces revenues or earnings or that shortens or
eliminates the expected period of benefit of our direct-response advertising
costs, currently four years for our diabetes products and two years for our
respiratory products, could result in accelerated charges against our earnings.
9. Amounts due to Medicare and others of $2.57 million as of September 30,
2002, represent probable amounts due to Medicare and related amounts due to
insurers and Medicare beneficiaries, related to a change in interpretation of
the reimbursement formula for albuterol and ipratropium combinations used in our
Liberty Respiratory segment. Beginning September 6, 2001 through November 8,
2001, we received administrative overpayment notices from one Durable Medical
Equipment Regional Carrier ("DMERC") relating to this reimbursement formula that
has resulted in
12
$1.06 million of refunds or credits to the DMERC and others. No administrative
overpayment notices have been received from November 8, 2001 to November 14,
2002. DMERCs are private insurance companies used by Medicare to administer
reimbursement payments. The liability of $2.57 million is the remaining
difference between reimbursement under the two interpretations of the
reimbursement formula and assumes that two of the other DMERCs issue similar
administrative overpayment notices. When we established the liability in the
quarter ended September 30, 2001, $5.03 million was charged to selling, general
and administrative expenses for billing adjustments prior to July 1, 2001 and
$823,000 represented billing adjustments related to the quarter ended September
30, 2001.
During the quarter ended September 30, 2002, we recorded a benefit of
$2.22 million, or $0.11 per share (diluted), related to a reduction in Amounts
due to Medicare and others, following a favorable determination by one of the
four DMERCs that our original method of billing for albuterol and ipratropium
combinations was proper. This benefit, recorded as a reduction of selling,
general and administrative expenses in the quarter ended September 30, 2002,
reduced the liability from $4.80 million as of March 31, 2002, to $2.57 million
as of September 30, 2002.
10. Effective for the quarter ended September 30, 2002, we changed the way we
segment our business for reporting purposes, in order to reflect how management
currently views operations. The new segments are as follows:
Liberty Diabetes - Through our Liberty Diabetes segment, we sell diabetes
testing supplies and related products and services to customers suffering from
diabetes and related chronic diseases. We offer a wide array of diabetes
products from a broad range of manufacturers.
Liberty Respiratory - Through our Liberty Respiratory segment, we sell
prescription respiratory medications and supplies to customers suffering from
chronic obstructive pulmonary disease ("COPD").
Pharmaceuticals - Through our Pharmaceuticals segment, we sell
prescription oral medications not covered by Medicare to existing Liberty
customers, over-the-counter female urinary discomfort products, home medical
diagnostic kits, and prescription urology and suppository products.
Depreciation and amortization expense attributable to our corporate
headquarters is allocated to the operating segments according to each segment's
relative percentage of total net revenues. However, segment assets belonging to
our corporate headquarters are not allocated, as management evaluates these
separately from the assets of the reportable segments. As a result of these
allocations, the segment information may not be indicative of the financial
position or results of operations that would have been achieved had these
segments operated as unaffiliated entities. The depreciation and amortization
amounts below include amortization of direct-response advertising. We do not
organize our units geographically, as our products and services are sold
throughout the United States only. There are no intersegment sales for the
periods presented. Information concerning the operations in these reportable
segments, restated to reflect the way we currently segment our business, is as
follows:
13
Three months ended Six months ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
(In thousands) 2002 2001 2002 2001
---- ---- ---- ----
NET REVENUES:
Liberty Diabetes $60,962 $ 51,765 $119,476 $ 98,459
Liberty Respiratory 18,609 12,055 35,189 24,037
Pharmaceuticals 8,441 5,031 14,948 9,376
------- -------- -------- --------
Total $88,012 $ 68,851 $169,613 $131,872
======= ======== ======== ========
DEPRECIATION AND AMORTIZATION:
Liberty Diabetes $ 5,910 $ 4,626 $ 11,426 $ 8,940
Liberty Respiratory 4,098 3,636 8,163 6,739
Pharmaceuticals 302 500 560 999
------- -------- -------- --------
Total $10,310 $ 8,762 $ 20,149 $ 16,678
======= ======== ======== ========
INCOME BEFORE INCOME TAXES:
Liberty Diabetes $ 7,366 $ 8,169 $ 16,632 $ 17,308
Liberty Respiratory (see Note 9) 7,528 (2,496) 12,072 693
Pharmaceuticals 887 1,927 1,789 3,633
------- -------- -------- --------
Total $15,781 $ 7,600 $ 30,493 $ 21,634
======= ======== ======== ========
Sept. 30, March 31,
2002 2002
---- ----
SEGMENT ASSETS:
Liberty Diabetes $144,918 $133,009
Liberty Respiratory 30,578 31,242
Pharmaceuticals 36,440 33,205
Corporate Headquarters 30,873 26,936
-------- --------
Total $242,809 $224,392
======== ========
11. In June 2000, our Board of Directors (the "Board") authorized the
repurchase of up to 1,000,000 shares of our common stock on the open market,
with any shares repurchased to be held in treasury. In August 2001, our Board
authorized the repurchase of an additional 1,000,000 shares. In the six months
ended September 30, 2002, 25,000 shares of common stock were repurchased for
$659,000 at an average repurchase price of $26.37 per share. In total,
1,271,000 shares had been repurchased for $25.30 million at an average
repurchase price of $19.91 per share, as of September 30, 2002. Of the
2,000,000 shares originally authorized by the Board, 729,000 shares remained
authorized for repurchase as of November 14, 2002.
12. The regulations that govern Medicare reimbursement are complex and our
compliance with those regulations may be reviewed by federal agencies, including
the Department of Health and Human Services, the Department of Justice ("DOJ"),
and the Food and Drug Administration ("FDA"). The U.S. Attorney's Office for the
Southern District of Florida, with the assistance of the Federal Bureau of
Investigation ("FBI") and Department of Health & Human Services' Office of
Inspector General ("OIG"), is investigating allegations of healthcare fraud,
improper revenue recognition and obstruction of justice by Liberty and Liberty
Home Pharmacy Corporation ("Liberty Home Pharmacy"). Both civil and criminal
investigations are being
14
conducted. We are cooperating with the investigations. We cannot accurately
predict the outcome of these proceedings at this time, and have therefore not
recorded any charges relating to their outcome.
We and three individuals who are or were officers of PolyMedica are
defendants in a lawsuit alleging violations of certain sections and rules of the
Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a
derivative action against the directors and two individuals who are or were
officers in Massachusetts state court alleging certain breaches of fiduciary
duty. We, the named individuals, and the Board believe that we have meritorious
defenses to the claims made against us in the actions in which we are defendants
and intend to contest the claims vigorously. Although we do not consider an
unfavorable outcome to the various claims probable, we cannot accurately predict
their ultimate disposition, and have therefore not recorded any charges related
to their outcome. Please see Item 1 of Part II, Legal Proceedings, for a more
complete description of these claims.
If any of these investigations or legal proceedings result in a
determination that we have failed to comply with the regulations governing
Medicare reimbursement or financial reporting or have otherwise committed
healthcare fraud or securities law violations, we could be subject to delays or
loss of reimbursement, substantial fines or penalties, and other sanctions. An
adverse determination could have a material effect on our financial position and
results of operations.
In June 2002, Liberty received an administrative subpoena from the U.S.
Attorney's Office for the Southern District of Illinois seeking documents
relevant to an ongoing investigation of Medicare reimbursement of "depth shoes
and inserts." Liberty has been informed that it is not a target of that
investigation.
We have certain contingent liabilities that arise in the ordinary course
of our business activities, in addition to those described above.
We accrue contingent liabilities when it is probable that future
expenditures will be made and such expenditures can be reasonably estimated.
13. Our total net income and comprehensive income were $9.82 million and $4.68
million for the three months ended September 30, 2002 and 2001, respectively.
For the six months ended September 30, 2002 and 2001, total net income and
comprehensive income was $18.97 million and $13.33 million, respectively.
15
14. Calculations of earnings per share are as follows:
(In thousands, except per share data) Three Months Ended Six Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2002 2001 2002 2001
---- ---- ---- ----
Net income $ 9,816 $ 4,682 $18,967 $13,327
BASIC:
Weighted average common stock outstanding, net of
treasury stock, end of period 12,171 12,680 12,169 12,818
Net income per weighted average share, basic $ .81 $ .37 $ 1.56 $ 1.04
======= ======= ======= =======
DILUTED:
Weighted average common stock outstanding, net of
treasury stock, end of period 12,171 12,680 12,169 12,818
Weighted average dilutive common stock equivalents 268 269 340 298
------- ------- ------- -------
Weighted average common stock and dilutive common
stock equivalents outstanding, net of treasury stock 12,439 12,949 12,509 13,116
Net income per weighted average share, diluted $ .79 $ .36 $ 1.52 $ 1.02
======= ======= ======= =======
Options to purchase 1,050,663 and 1,033,456 shares of common stock were
outstanding during the three months ended September 30, 2002 and 2001,
respectively, but were not included in the computation of diluted earnings per
share, because the options' exercise prices were greater than the average market
price of the common shares. During the six months ended September 30, 2002 and
2001, options to purchase 660,954 and 661,370 shares of common stock,
respectively, were outstanding, but were not included in the computation of
diluted earnings per share, because the options' exercise prices were greater
than the average market price of the common shares.
15. On August 4, 2002, Steven J. Lee, Chief Executive Officer, Chairman and a
director of PolyMedica, informed the Board of his intention to retire as Chief
Executive Officer, effective as of that date. Mr. Lee has agreed to continue
serving as Chairman and a director through December 31, 2002. In connection with
Mr. Lee's termination of employment agreement, we incurred a one-time severance
charge included in selling, general and administrative expenses of approximately
$1.30 million in the quarter ended September 30, 2002. Pursuant to this
agreement, this amount will be paid in cash over a twenty four-month period.
Samuel L. Shanaman, a director since November 2001, has been elected to
the new position of Lead Director, and will perform the functions of the chief
executive officer on an interim basis until a successor is named. As
compensation for his services as Interim Chief Executive Officer, we will pay
Mr. Shanaman minimum wage and he will vest in eighty shares of restricted common
stock, $0.01 par value, for every day he works, up to a maximum of 8,345 shares.
16. On September 12, 2002, the Board adopted a shareholder rights plan ("the
Plan") declaring a dividend of one Right for each outstanding share of our
common stock to stockholders of record at the close of business on September 24,
2002. The Plan provides our shareholders with the
16
opportunity to vote to either remove the Plan or keep it in place at the first
annual meeting following resolution of the current ongoing investigations
discussed in Note 12. The Plan is intended to protect and maximize the value of
shareholders' interests in the event of an unsolicited offer. We did not adopt
the Plan in response to any specific effort to acquire control of PolyMedica and
are presently unaware of any takeover plans.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS
We are a leading provider of direct-to-consumer medical products and
services, conducting business through our Liberty Diabetes, Liberty Respiratory
and Pharmaceutical segments. We sell diabetes testing supplies and related
products and provide services to primarily Medicare-eligible customers suffering
from diabetes and related chronic diseases through our Liberty Diabetes segment.
Through our Liberty Respiratory segment we provide direct-to-consumer
prescription respiratory medications, supplies and services to primarily
Medicare-eligible customers suffering from chronic obstructive pulmonary disease
("COPD"). Through our Pharmaceuticals segment we sell prescription oral
medications not covered by Medicare to existing Liberty customers, market,
manufacture and distribute a broad line of prescription urology and suppository
products, and sell over-the-counter female urinary discomfort products and home
medical diagnostic kits. For selected financial information about our operating
segments, see Note 10 to the consolidated financial statements.
Liberty Diabetes
As of September 30, 2002, we had approximately 500,000 active
diabetes customers, many of whom suffer from other chronic diseases, to whom we
sell name-brand products. We define a person as an active customer if that
person has placed an order and we have shipped supplies to that person in the
past twelve months. We deliver products to customers' homes and, as a service to
our customers, bill Medicare and private insurance companies (if applicable)
directly for those supplies that are reimbursable. We meet the needs of
customers suffering from diabetes by:
- providing mail order delivery of supplies direct to our customers'
homes;
- billing Medicare and/or private insurance companies directly;
- providing 24-hour telephone support to customers; and
- using sophisticated software and advanced order fulfillment systems
to provide products and support.
In the United States, there are approximately seventeen million people
with diabetes, including at least seven million seniors. Of the seventeen
million people with diabetes, it is estimated that approximately eleven million
people are diagnosed, with the remaining six million people unaware that they
have the disease. While a portion of the seven million seniors with diabetes are
covered by managed care or reside in extended care facilities, we believe that
the balance are potential customers of ours.
Liberty Respiratory
Our Liberty Respiratory segment operates similar to our Liberty Diabetes
segment, as we deliver products to customers' homes and bill Medicare and
private insurance companies (if applicable) directly for those prescription
respiratory medications and supplies that are reimbursable. As a participating
Medicare provider and third-party insurance biller, we provide a simple,
reliable way for customers to obtain their supplies for respiratory disease
treatment. As of September 30,
18
2002, we had approximately 55,000 active customers for our prescription
respiratory medications and supplies. In the United States, there are
approximately sixteen million people with COPD, including at least five million
seniors.
Pharmaceuticals
Through our Pharmaceuticals segment we sell prescription oral medications
not covered by Medicare to existing Liberty customers, market, manufacture and
distribute a broad line of prescription urology and suppository products, and
sell over-the-counter female urinary discomfort products and home medical
diagnostic kits. We sell our female urinary discomfort products and home medical
diagnostic kits under our AZO brand name through an extensive network of large
drug store chains, major supermarkets, mass merchandisers and drug wholesalers
in the United States. Our broad line of prescription urology products includes
urinary analgesics, antispasmodics, local anesthetics and analgesic
suppositories. Our primary customers for these urology products are large drug
wholesalers in the United States.
Business Strategies
Our principal strategy is to leverage our technology-based operating
platform and compliance management protocol to expand our business while
maintaining strict adherence to all applicable regulations. This strategy
includes the following elements:
Continue growth in our Liberty Diabetes and Liberty Respiratory businesses
by expanding our customer base. Since the August 1996 acquisition of Liberty
Medical Supply, Inc. ("Liberty"), we have invested in an ongoing program of
direct-response television advertising to reach a larger portion of the
Medicare-eligible patient market. This campaign has resulted in a significant
increase in sales as we have expanded our active diabetes customers from
approximately 17,000 at the time of our acquisition of Liberty to approximately
500,000 active customers. In addition, we now have approximately 55,000 active
customers for our prescription respiratory medications and supplies. We also use
radio and print advertising to further broaden our customer base. We continue to
seek opportunities to deliver new products to a broader customer base by
leveraging our mail-order distribution system and software for billing and
customer monitoring. To manage our growth effectively, we are continually
expanding and upgrading our operations, information systems, and regulatory
compliance activities.
Expand non-Medicare initiatives. During fiscal year 2002 we leveraged our
core business expertise and technology base with the launch of Liberty's
non-Medicare operation, Liberty Medical Supply Pharmacy ("LMSP"). LMSP, which is
part of our Pharmaceuticals segment, offers prescription oral medications not
covered by Medicare to existing Liberty customers.
Continue adding complementary products and businesses. New business
initiatives, in various stages of development, include offering therapeutic
footwear for diabetics deemed at risk for developing lower extremity
complications, and the creation of a new clinical laboratory that offers a
glycohemoglobin ("HbA1c") test, the results of which tell the patient and/or
physician what the patient's blood glucose level has averaged over the previous
two or three months. In order to take advantage of economies of scale in
production and marketing, we continue to evaluate opportunities for the
acquisition of businesses and products to complement our existing product lines
or new business initiatives underway. In selecting and evaluating acquisition
candidates, we examine the
19
potential market opportunities for products that can be distributed through our
existing marketing infrastructure and which utilize our strengths in sales,
marketing and distribution. We will also continue to consider adding businesses,
manufacturing capabilities and new products that capitalize upon our established
brand franchises.
STATUS OF CHIEF EXECUTIVE OFFICER SEARCH
Following the retirement of our former Chief Executive Officer, Steven J.
Lee, effective August 4, 2002, we retained the executive recruitment firm of
Heidrick & Struggles to assist our Board in its search for a new chief executive
officer. We have spoken to a number of high-caliber candidates to date.
OTHER
Advertising rates may fluctuate during the year which may affect our
acquisition of new customers. We may purchase less advertising when rates are
higher. As a result, our acquisition of new customers during these periods
is generally reduced and our net revenues may fluctuate accordingly.
Non-direct-response advertising, promotional, and marketing costs are
charged to earnings in the period in which they are incurred.
We operate from manufacturing and distribution facilities located in
Massachusetts and Florida. Virtually all of our product sales are denominated in
U.S. dollars.
Expense items include cost of sales and selling, general and
administrative expenses.
- Cost of sales consists primarily of purchased finished goods for
sale in our markets and, to a lesser extent, materials, direct
labor, and overhead costs for products that we manufacture in our
facility and shipping and handling fees.
- Selling, general and administrative expenses consist primarily of
expenditures for personnel and benefits, as well as legal and
related expenses, allowances for bad debts, rent, amortization of
capitalized direct-response advertising costs and other amortization
and depreciation.
Period-to-period comparisons of changes in net revenues are not
necessarily indicative of results to be expected for any future period.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of these consolidated financial statements requires us to make
significant estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. These items are regularly monitored and analyzed by management
for changes in facts and circumstances, and material
20
changes in these estimates could occur in the future. Changes in estimates are
recorded in the period in which they become known. We base our estimates on
historical experience and various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from our estimates
if past experience or other assumptions do not turn out to be substantially
accurate.
The following summaries of our critical accounting policies should be read
in conjunction with our consolidated financial statements and the related notes
included in our Annual Report on Form 10-K for the fiscal year ended March 31,
2002 and our unaudited consolidated financial statements included in our
Quarterly Report on Form 10-Q for the period ended June 30, 2002. While all of
our accounting policies impact the consolidated financial statements, certain
policies may be viewed to be critical. Critical accounting policies are those
that are both most important to the portrayal of our financial condition and
results of operations and that require management's most subjective or complex
judgments and estimates. Management believes the policies that fall within this
category are the policies on revenue recognition and sales allowances, accounts
receivable and the allowance for doubtful accounts, goodwill, inventories,
direct-response advertising, amounts due to Medicare and others, and
uncertainties.
Revenue Recognition
We recognize revenue related to product sales to customers who have placed
orders upon shipment, provided that risk of loss has passed to the customer and
we have received and verified the required written forms, if applicable, to bill
Medicare, other third-party payers, and customers. We record revenue at the
amounts expected to be collected from Medicare, other third-party payers, and
directly from customers. We analyze various factors in determining revenue
recognition, including a review of specific transactions, current Medicare
regulations and reimbursement rates, historical experience, and the
credit-worthiness of customers. The determination of appropriate Medicare rates
for billing and revenue recognition are complex and sometimes subjective and
therefore may require management's interpretation. Sales allowances are recorded
for estimated product returns as a reduction of revenue. We analyze sales
allowances using historical data adjusted for significant changes in volume,
customer demographics, and business conditions. These allowances are adjusted to
reflect actual returns. Changes in these factors could affect the timing and
amount of revenue and costs recognized.
Accounts Receivable and Allowance for Doubtful Accounts
The valuation of accounts receivable is based upon the credit-worthiness
of customers and third-party payers as well as our historical collection
experience. Allowances for doubtful accounts are recorded as a selling, general
and administrative expense for estimated amounts expected to be uncollectible
from third-party payers and customers. We base our estimates on our historical
collection and write-off experience, current trends, credit policy, and on our
analysis of accounts receivable by aging category. Changes in judgment regarding
these factors could affect the timing and amount of costs recognized.
Goodwill
Subsequent to the transitional impairment test, as prescribed under
SFAS No. 142, we are required to perform impairment tests annually and whenever
events or changes in circumstance suggest that the carrying value of an asset
may not be recoverable. Step one of the impairment test is performed to
determine whether an impairment exists, step two of the impairment test is
performed to determine the amount of the charge to be recorded as a result of
the impairment.
21
See Note 5 to the consolidated financial statements. Changes in assumptions used
and forecasted results of operations of the reporting units carrying goodwill
could affect the determination of whether an impairment exists as well as the
quantification of the impairment value, should one exist.
Inventories
The carrying value of inventories represents the lower of cost or market
value. Market value or the net realizable value to the Company is impacted by
the types and levels of inventory held, forecasted demand, and pricing. Due to
the medical nature of the products we provide, customers sometimes request
supplies before we have received the required written forms, if applicable, to
bill Medicare, other third-party payers, and customers. As a result, included in
inventories are items shipped to customers for which we have received an order
but have not yet received the required written documents and therefore have not
recognized revenue. The carrying value of inventory shipped to customers is
based upon historical experience of collection of documents required to bill
Medicare (if applicable), other third-party payers, and customers. Changes in
judgment regarding the recoverability of inventories, including the carrying
value of inventory shipped to customers, could result in the recording of
additional income or expense.
Direct-Response Advertising
In accordance with Statement of Position 93-7("SOP 93-7") we capitalize
and amortize direct-response advertising and related costs when we can
demonstrate that customers have directly responded to our advertisements. We
assess the realizability of the amounts of direct-response advertising costs
reported as assets at each balance sheet date by comparing the carrying amounts
of such assets to the probable remaining future net cash flows expected to
result directly from such advertising. A business change, including a change in
reimbursement rates, that reduces expected net cash flows or that shortens the
period over which such net cash flows are estimated to be realized could result
in accelerated charges against our earnings.
Amounts due to Medicare and others
The government's Medicare regulations are complex and sometimes subjective
and therefore may require management's interpretation. Amounts due to Medicare
and others are recorded when, based upon our assessment of the facts and
circumstances, we believe that the amounts due are probable and estimable.
Changes in judgment regarding Amounts due to Medicare and others could result in
income or expenses that are different from our estimates.
Uncertainties
Our compliance with Medicare regulations may be reviewed by federal or
state agencies, including the Department of Health and Human Services, the DOJ,
and the FDA. The U.S. Attorney's Office for the Southern District of Florida,
with the assistance of the FBI and OIG, is investigating allegations of health
care fraud, improper revenue recognition and obstruction of justice by Liberty
and Liberty Home Pharmacy. Both civil and criminal investigations are being
conducted. We are cooperating with the investigations. Since July 1, 2001 we
have spent in excess of $8.00 million on legal and accounting fees primarily
preparing to respond, and responding to, the investigations and the two lawsuits
described below. This work has been conducted under the direction of legal
counsel who report to the Oversight Committee, a special Board committee made up
of three outside directors, which was established to oversee our response to the
investigations and the related litigation.
22
During this period we have continued to expand the size and capabilities
of our compliance and regulatory affairs department. We believe our
understanding of Medicare regulations, and our ability to work within them, are
important core competencies that allow us to deliver products and services to
our customers in an effective and compliant manner. We also believe these
capabilities represent an important barrier to entry for our core Liberty
Diabetes and Liberty Respiratory segments.
In December 2001 we received a formal order of investigation by the
Securities and Exchange Commission ("SEC") in connection with accounting
matters, financial reports, other public disclosures and sales of PolyMedica's
securities. In April 2002 we received a letter from the SEC notifying us that
the Commission's present staff inquiry into PolyMedica had been terminated and
that no enforcement action had been recommended to the Commission.
We and three individuals who are or were officers of PolyMedica are
defendants in a lawsuit alleging violations of certain sections and rules of the
Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a
derivative action against the directors and two individuals who are or were
officers in Massachusetts state court alleging certain breaches of fiduciary
duty. We, the named individuals, and the Board believe that we have meritorious
defenses to the claims made against us in the actions in which we are defendants
and intend to contest the claims vigorously. Although we do not consider an
unfavorable outcome to the various claims probable, we cannot accurately predict
their ultimate disposition, and have therefore not recorded any charges related
to their outcome. An unfavorable outcome could have a material effect on our
financial position and results of operations. Please see Item 1 of Part II,
Legal Proceedings, for a more complete description of these claims.
If any of the investigations or legal proceedings referred to above
results in a determination that we have failed to comply with the regulations
governing Medicare reimbursement or financial reporting or have otherwise
committed healthcare fraud or securities law violations, we could be subject to
delays or loss of reimbursement, substantial fines or penalties, and other
sanctions. An adverse determination could have a material effect on our
financial position and results of operations. At this time, we cannot accurately
predict the outcome of these proceedings, and have therefore not recorded any
charges relating to their outcome.
In June 2002, Liberty received an administrative subpoena from the U.S.
Attorney's Office for the Southern District of Illinois seeking documents
relevant to an ongoing investigation of Medicare reimbursement of "depth shoes
and inserts." Liberty has been informed that it is not a target of that
investigation.
We have certain contingent liabilities that arise in the ordinary course
of our business activities, in addition to those described above.
23
We accrue contingent liabilities when it is probable that future
expenditures will be made and such expenditures can be reasonably estimated.
COMPLIANCE AND REGULATORY AFFAIRS
We have a Compliance and Regulatory Affairs Department that is comprised
of five groups: corporate compliance, monitoring, compliance/external responses,
compliance/internal reviews and contracts and licensing. Although each group is
distinct, the Vice President of Regulatory Affairs coordinates activities within
the department in order to promote the common goal of ensuring compliance with
all federal, state and local laws and regulations applicable to the businesses
of these companies.
The corporate compliance group administers a formal healthcare compliance
program to assist us in meeting our compliance obligations. The compliance
program is designed to prevent violations of applicable fraud and abuse laws
and, if such violations occur, to promote early and accurate detection and
prompt resolution. This objective is achieved through education, monitoring,
disciplinary action and other appropriate remedial measures. All personnel, as a
condition of employment, are required to attend corporate compliance
certification classes annually. In addition, each employee receives a compliance
manual that has been developed to communicate standards of conduct and
compliance policies and procedures.
The monitoring group performs oversight functions to ensure compliance
with policies and procedures and applicable laws. These functions include
telephonic monitoring of contacts between employees and customers, healthcare
professionals, payers and other outside contacts.
The compliance/external communications group monitors communications with
third parties to ensure timely responses to document and other requests and
oversees the receipt and timely dissemination of supplier bulletin information.
The compliance/internal reviews group is responsible for conducting a
variety of internal reviews of operations to ensure compliance with healthcare
program requirements and applicable laws.
The contracts and licensing group monitors compliance with provider
contracting and licensing requirements, which includes random, internal onsite
inspections. As appropriate, we also use external audit resources to supplement
our internal auditing and monitoring activities.
CORPORATE GOVERNANCE
In August 2001, our Board established an Oversight Committee, a special
Board committee made up of three outside directors, which was established to
oversee our response to the investigations and the related litigation described
in Item 1 of Part II, Legal Proceedings. The Oversight Committee is advised on
legal matters by our legal counsel and other appropriate independent advisors.
The Oversight Committee will continue to play an active role as these
investigations proceed. Its authority includes monitoring the Compliance and
Regulatory Affairs Department (the "Department") and the Department's compliance
program to ensure compliance with Medicare and internal Company policies.
24
Over the past year, we have expanded and strengthened our Board through
the addition of four new directors. We have also recently established the
position of Lead Director, to be elected annually by our outside directors.
Samuel Shanaman, Interim Chief Executive Officer, currently holds that position.
The role of the Lead Director is to chair regular meetings of the outside
directors, providing a strong focal point for both the Board and our
shareholders.
In addition, we have reconstituted two important Board committees; the
Corporate Governance Committee, made up of three outside directors, to
coordinate our efforts in that area, and the Executive Committee, an active,
decision-making sub-set of the Board.
25
RESULTS OF OPERATIONS
Three Months Ended September 30, 2002 Compared to Three Months Ended September
30, 2001
Total net revenues increased 27.8% to $88.01 million in the three months
ended September 30, 2002, as compared with $68.85 million in the three months
ended September 30, 2001. This increase was primarily the result of the growth
in net revenues from our Liberty Diabetes and Liberty Respiratory segments,
which increased 17.8% and 54.4%, respectively, in the three months ended
September 30, 2002, as compared with the three months ended September 30, 2001.
Net revenues in the Liberty Diabetes segment increased 17.8% to $60.96
million in the three months ended September 30, 2002, as compared with $51.76
million in the three months ended September 30, 2001. This increase was due
primarily to the growth in our customer base as a result of our direct-response
advertising spending. We currently expect our promotional and direct-response
advertising spending to continue in order to further the expansion of our
Liberty Diabetes segment. Revenue growth was hindered, however, by an
incremental 3.28% cost of living adjustment in effect for the quarter ended
September 30, 2001, due to the late implementation of the January 1, 2001 cost
of living adjustment which went into effect July 1, 2001, which was not in
effect for the quarter ended September 30, 2002. The increase in net revenues
for the fiscal 2003 second quarter as compared with the prior year second
quarter, would have been greater without the incremental reimbursement which
added 3.28% to the revenues of many of our Liberty Diabetes segment products in
the quarter ended September 30, 2001.
Net revenues in the Liberty Respiratory segment increased 54.4% to $18.61
million in the three months ended September 30, 2002, as compared with $12.06
million in the three months ended September 30, 2001. This increase was due
primarily to the growth in our customer base as a result of our direct-response
advertising spending. As with our Liberty Diabetes segment, we currently expect
our promotional and direct-response advertising spending to continue in order to
further the expansion of our Liberty Respiratory segment.
Net revenues in the Pharmaceuticals segment increased 67.8% to $8.44
million in the three months ended September 30, 2002, as compared with $5.03
million in the three months ended September 30, 2001, due primarily to the
growth in our LMSP reporting unit, selling oral medications not covered by
Medicare to existing customers.
As a percentage of total net revenues, overall gross margins were 64.5% in
the three months ended September 30, 2002, down from 65.8% in the three months
ended September 30, 2001. This decrease was due primarily to the late
implementation of the January 1, 2001 cost of living adjustment, implemented by
the government for certain durable medical equipment products and services under
the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of
2000, which went into effect July 1, 2001. The late implementation added an
incremental reimbursement of 3.28% to the revenues of many of our Liberty
Diabetes segment products in the quarter ended September 30, 2001. Increasing
sales from new business initiatives, including LMSP in our Pharmaceuticals
segment, that have lower margins than our consolidated business, contributed to
the gross margin decline. Also contributing to the decline was a change in the
product mix for our Liberty Diabetes and Liberty Respiratory segments.
26
As a percentage of total net revenues, selling, general and administrative
expenses were 46.6% in the three months ended September 30, 2002, as compared
with 55.3% in the three months ended September 30, 2001. Selling, general and
administrative expenses increased 7.7% in the three months ended September 30,
2002 to $40.98 million, as compared with $38.06 million in the three months
ended September 30, 2001. The decrease in selling, general and administrative
expenses as a percentage of net revenues was primarily attributable to an
additional $5.03 million of selling, general and administrative expenses in the
quarter ended September 30, 2001 in the Liberty Respiratory segment related to
the establishment of the Amounts due to Medicare and others liability, coupled
with a $2.22 million decrease in selling, general and administrative expenses in
the quarter ended September 30, 2002 in the Liberty Respiratory segment related
to a reduction in this liability based upon a favorable determination by one of
the four Medicare carriers that our original method of billing for albuterol and
ipratropium combinations was proper. The $2.22 million benefit reported in the
quarter ended September 30, 2002, was partially offset by a $1.30 million
one-time charge to selling, general and administrative expenses related to the
retirement of the Company's former Chief Executive Officer. Selling, general and
administrative expenses, excluding the above items, totaled $41.90 million and
$33.03 million or 47.6% and 48.0% of net revenues in the three months ended
September 30, 2002 and 2001, respectively.
Investment income/(loss) decreased to $(12,000) in the three months ended
September 30, 2002, as compared with $234,000 in the three months ended
September 30, 2001, due primarily to greater losses realized in the holdings of
the executive deferred compensation plans and a lower average cash balance and
lower interest rates in the quarter ended September 30, 2002, as compared with
the quarter ended September 30, 2001. Interest expense decreased 24.9% to
$34,000 in the three months ended September 30, 2002, as compared with $44,000
in the three months ended September 30, 2001.
Net income increased 109.7% to $9.82 million for the quarter ended
September 30, 2002, as compared with $4.68 million for the quarter ended
September 30, 2001. The increase in net income was primarily attributable to a
$3.60 million reduction in net income in the quarter ended September 30, 2001
related to the establishment of the Amounts due to Medicare and others liability
(net of related taxes) coupled with a $1.38 million increase to net income in
the quarter ended September 30, 2002 related to a reduction in this liability
based upon a favorable determination by one of the four Medicare carriers that
our original method of billing for albuterol and ipratropium combinations in our
Liberty Respiratory segment was proper. The $1.38 million increase to net income
in the quarter ended September 30, 2002, was partially offset by a $810,000
one-time decrease to net income in the quarter ended September 30, 2002 related
to the retirement of the Company's former Chief Executive Officer (net of
related taxes). Growth in our customer base as a result of our direct-response
advertising also contributed to the increase in net income in the quarter ended
September 30, 2002, as compared with the quarter ended September 30, 2001.
Six Months Ended September 30, 2002 Compared to Six Months Ended September 30,
2001
Total net revenues increased 28.6% to $169.61 million in the six months
ended September 30, 2002, as compared with $131.87 million in the six months
ended September 30, 2001. This increase was primarily the result of the growth
in net revenues from our Liberty Diabetes and Liberty Respiratory segments,
which increased 21.3% and 46.4%, respectively, in the six months ended September
30, 2002, as compared with the six months ended September 30, 2001.
27
Net revenues in the Liberty Diabetes segment increased 21.3% to $119.48
million in the six months ended September 30, 2002, as compared with $98.46
million in the six months ended September 30, 2001. This increase was due
primarily to the growth in our customer base as a result of our direct-response
advertising spending. We currently expect our promotional and direct-response
advertising spending to continue in order to further the expansion of our
Liberty Diabetes segment. Revenue growth was hindered, however, by an
incremental 3.28% cost of living adjustment in effect for the quarter ended
September 30, 2001, due to the late implementation of the January 1, 2001 cost
of living adjustment which went into effect July 1, 2001, which was not in
effect for the quarter ended September 30, 2002. The increase in net revenues
for the six months ended September 30, 2002 as compared with the six months
ended September 30, 2001, would have been greater without the incremental
reimbursement which added 3.28% to the revenues of many of our Liberty Diabetes
segment products in the quarter ended September 30, 2001.
Net revenues in the Liberty Respiratory segment increased 46.4% to $35.19
million in the six months ended September 30, 2002, as compared with $24.04
million in the six months ended September 30, 2001. This increase was due
primarily to the growth in our customer base as a result of our direct-response
advertising spending. As with our Liberty Diabetes segment, we currently expect
our promotional and direct-response advertising spending to continue in order to
further the expansion of our Liberty Respiratory segment.
Net revenues in the Pharmaceuticals segment increased 59.4% to $14.95
million in the six months ended September 30, 2002, as compared with $9.38
million in the six months ended September 30, 2001, due primarily to the growth
in our LMSP reporting unit, selling oral medications not covered by Medicare to
existing customers.
As a percentage of total net revenues, overall gross margins were 64.6% in
the six months ended September 30, 2002, down from 66.0% in the six months ended
September 30, 2001. This decrease was due primarily to the late implementation
of the January 1, 2001 cost of living adjustment, implemented by the government
for certain durable medical equipment products and services under the Medicare,
Medicaid and SCHIP Benefits Improvement and Protection Act of 2000, which went
into effect July 1, 2001. The late implementation added an incremental
reimbursement of 3.28% to the revenues of many of our Liberty Diabetes segment
products in the quarter ended September 30, 2001. Increasing sales from new
business initiatives that have lower margins than our average and a change in
the product mix for our Liberty Diabetes and Liberty Respiratory segments also
contributed to the gross margin decline. Partially offsetting this decline was
the existence of a 3.7% cost of living adjustment which added 3.7% to the
revenues of many of our Liberty Diabetes segment products for the full six
months ended September 30, 2002, as compared with only three months, July 2001
through September 2001, of the six months ended September 30, 2001.
As a percentage of total net revenues, selling, general and administrative
expenses were 46.6% in the six months ended September 30, 2002, as compared with
50.0% in the six months ended September 30, 2001. Selling, general and
administrative expenses increased 19.8% in the six months ended September 30,
2002 to $79.00 million, as compared with $65.96 million in the six months ended
September 30, 2001. The decrease in selling, general and administrative expenses
as a percentage of net revenues was primarily attributable to an additional
$5.03 million of selling, general and administrative expenses in the six months
ended September 30, 2001 in the Liberty Respiratory
28
segment related to the establishment of the Amounts due to Medicare and others
liability, coupled with a $2.22 million decrease in selling, general and
administrative expenses in the quarter ended September 30, 2002 in the Liberty
Respiratory segment related to a reduction in this liability based upon a
favorable determination by one of the four Medicare carriers that our original
method of billing for albuterol and ipratropium combinations was proper. The
$2.22 million benefit reported in the quarter ended September 30, 2002, was
offset by a $1.30 million one-time charge to selling, general and administrative
expenses related to the retirement of the Company's former Chief Executive
Officer. Selling, general and administrative expenses, excluding the above
items, totaled $79.93 million and $60.94 million or 47.1% and 46.2% of net
revenues in the six months ended September 30, 2002 and 2001, respectively.
Investment income/(loss) decreased 95.9% to $32,000 in the six months
ended September 30, 2002, as compared with $774,000 in the six months ended
September 30, 2001, due primarily to greater losses realized in the holdings of
the executive deferred compensation plans and a lower average cash balance and
lower interest rates in the six months ended September 30, 2002, as compared
with the six months ended September 30, 2001. Interest expense decreased 19.5%
to $70,000 in the six months ended September 30, 2002, as compared with $87,000
in the six months ended September 30, 2001.
Net income increased 42.3% to $18.97 million for the six months ended
September 30, 2002, as compared with $13.33 million for the six months ended
September 30, 2001. The increase in net income was primarily attributable to
$3.60 million reduction in net income in the six months ended September 30, 2001
related to the establishment of the Amounts due to Medicare and others liability
(net of related taxes) coupled with a $1.38 million increase to net income in
the six months ended September 30, 2002 related to a reduction in this liability
based upon a favorable determination by one of the four Medicare carriers that
our original method of billing for albuterol and ipratropium combinations in our
Liberty Respiratory segment was proper. The $1.38 million increase to net income
in the quarter ended September 30, 2002, was offset by a $810,000 one-time
decrease to net income in the six months ended September 30, 2002 related to the
retirement of the Company's former Chief Executive Officer (net of related
taxes). Growth in our customer base as a result of our direct-response
advertising also contributed to the increase in net income in the six months
ended September 30, 2002, as compared with the six months ended September 30,
2001.
Liquidity and Capital Resources
Our business and its sustained growth is currently funded through cash
flow from operations. We have generated positive cash flow from operations in
each of the last fifteen quarters and have reported positive annual cash flows
from operations in each of the last 4 fiscal years, with $22.90 million, $14.62
million, $10.08 million, and $539,000 generated in the fiscal years ended March
31, 2002, 2001, 2000, and 1999, respectively. Our cash and cash equivalents
balance decreased $1.05 million to $26.83 million as of September 30, 2002, as
compared with $27.88 million as of March 31, 2002, due primarily to cash used
for capital expenditures, offset by cash flows generated from operations. Cash
flows from operations of $12.61 million for the six months ended September 30,
2002 were generated by net income of $18.97 million, offset by cash used to fund
certain areas of our operations, such as increased spending for direct-response
advertising of $2.41 million to $23.50 million in the six months ended September
30, 2002, as compared with $21.09 million in the six months ended September 30,
2001, to further expand our customer base, both for our Liberty Diabetes and
Liberty Respiratory segments.
29
Our contractual obligations for future annual minimum lease and rental
commitments as of September 30, 2002, were not materially different from those
as of March 31, 2002, disclosed in our Annual Report on Form 10-K for the fiscal
year ended March 31, 2002.
In the six months ended September 30, 2002 and 2001, we used $12.08
million and $4.85 million of cash for investing activities, respectively. The
$7.23 million increase in total cash used for investing activities was due to an
increase in capital expenditures of $7.23 million in the six months ended
September 30, 2002, as compared with the six months ended September 30, 2001.
Property, plant and equipment purchases totaled $12.08 million and $4.85 million
for the six months ended September 30, 2002 and 2001, respectively. Higher
spending in the current fiscal year for capital expenditures is related to the
recently completed construction of two new facilities in Port St. Lucie, Florida
to meet our expansion needs. The cumulative amount spent through September 30,
2002 related to this construction was $13.37 million, which we will begin
depreciating in the quarter ending December 31, 2002. In the quarter ending
December 31, 2002, we estimate that we will spend an additional $1.00 million on
the construction of these two new facilities, for which no liability has been
recorded as of September 30, 2002, because we have no contractual obligation to
complete the construction.
In the six months ended September 30, 2002, we used $1.58 million of cash
for financing activities, $1.27 million of which we set aside for executive
deferred compensation plans with an additional $659,000 used to repurchase
25,000 shares of our common stock at an average repurchase price of $26.37 per
share. In June 2000, the Board authorized the repurchase of up to 1,000,000
shares of our common stock on the open market, with any shares repurchased to be
held in treasury. In August 2001, the Board authorized the repurchase of an
additional 1,000,000 shares. As of November 14, 2002, 1,271,000 shares had been
repurchased in total for $25.30 million at an average repurchase price of $19.91
per share. Of the 2,000,000 shares originally authorized by the Board, 729,000
shares remained authorized for repurchase as of November 14, 2002. Other
financing activities included the receipt of proceeds from the issuance of
common stock and repayments of capital lease obligations.
In November 2000, we filed an amendment to a shelf registration statement
we originally filed in April 2000, to enable us to offer from time to time,
shares of our common stock having an aggregate value of up to $100 million. The
SEC declared the shelf registration statement effective during the quarter ended
December 31, 2000. No shares of common stock had been sold under this shelf
registration statement as of September 30, 2002.
We believe that our cash and cash equivalents balance as of September 30,
2002 of $26.83 million and cash flows generated from operations, will be
sufficient to meet working capital, capital expenditure and financing needs for
future business operations for the foreseeable future. In the event that we
undertake to make acquisitions of complementary businesses, products or
technologies, we may require substantial additional funding beyond currently
available working capital and funds generated from operations. Other factors
which could negatively impact our liquidity include a reduction in the demand
for our products, an unfavorable outcome of pending litigation and
investigations, or a reduction in Medicare reimbursement for our products.
We hold certain investments related to executive deferred compensation
plans, see Note 6 to the consolidated financial statements, which are accounted
for pursuant to SFAS No. 115,
30
"Accounting for Certain Investments in Debt and Equity Securities." Investments
related to the executive deferred compensation plans, which have been classified
as trading, are included in other assets and are recorded at fair value. As of
September 30, 2002, the fair value of these investments was not materially
different from cost.
Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of SFAS No. 146 are effective for exit or disposal activities that are initiated
after December 31, 2002. We do not expect adoption of this statement to have a
material impact on our financial position or results of operations.
In October 2001 the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance on
the accounting for the impairment or disposal of long-lived assets. The
objectives of SFAS No. 144 are to address issues relating to the implementation
of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," and to develop a model for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired. We adopted SFAS No. 144 on April 1, 2002, as required. The adoption
did not have a material impact on our financial position or results of
operations in the three or six months ended September 30, 2002, but could have a
significant impact on our financial position or results of operations should
there be future asset impairments or disposals.
In August 2001, the FASB issued SFAS No. 143 "Accounting for Obligations
Associated with the Retirement of Long-Lived Assets." The provisions of SFAS No.
143 apply to all entities that incur obligations associated with the retirement
of tangible long-lived assets. SFAS No. 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002 and thus will
be adopted, as required, on April 1, 2003. This accounting pronouncement is not
expected to have a significant impact on our financial position or results of
operations.
31
FACTORS AFFECTING FUTURE OPERATING RESULTS
The statements contained in this Quarterly Report on Form 10-Q that are
not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, including, but not limited to, statements regarding our
expectations, hopes, intentions or strategies regarding the future.
Forward-looking statements include, among others: statements regarding future
benefits from our advertising and promotional expenditures; statements regarding
future net revenue levels; statements regarding product development,
introduction and marketing; and statements regarding future acquisitions. All
forward-looking statements included in this Quarterly Report on Form 10-Q are
based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. It is important to
note that our actual results could differ materially from those in such
forward-looking statements.
Our future operating results remain difficult to predict. We continue to
face many risks and uncertainties which could affect our operating results,
including without limitation, those described below.
We could experience significantly reduced profits if Medicare changes, delays or
denies reimbursement
Sales of a significant portion of our Liberty Diabetes and Liberty
Respiratory medications and supplies depend on the continued availability of
reimbursement of our customers by government and private insurance plans. Any
reduction in Medicare reimbursement currently available for our products would
reduce our revenues. Without a corresponding reduction in the cost of such
products, the result would be a reduction in our overall profit margin.
Similarly, any increase in the cost of such products would reduce our overall
profit margin unless there was a corresponding increase in Medicare
reimbursement. Our profits could also be affected by the imposition of more
stringent regulatory requirements for Medicare reimbursement or adjustments to
previously reimbursed amounts.
Federal governmental authorities are continually considering changes to
laws and regulations applicable to us as they relate to billing requirements and
reimbursement levels of our products. Legislation and regulations are pending
relating to:
Competitive Bidding
There is pending legislation that requires certain Medicare Part B items
and services to be competitively bid in certain areas of the country. The United
States House of Representatives (the "House") has passed a bill (HR4954) that
requires durable medical equipment and inhalation drugs to be competitively bid
unless such bidding would not be competitive because of low population in a
particular geographic region or because it would not result in significant
savings when compared to the current fee schedule reimbursement. The House bill
requires multiple winners in each area of the country. It further requires that
the plan be implemented over a three-year period beginning in 2004.
The United States Senate may consider legislation (S 3018) that mandates
similar competitive bidding except in areas where there are fewer than 500,000
individuals. The proposed Senate bill would begin in 2003 and be phased-in over
a four-year period.
32
If enacted, these proposals could apply to us; if so, we would begin the
process of understanding the bidding requirements and working with appropriate
officials in preparing bids for products that are covered. These proposals are
part of a larger Medicare bill that increases reimbursement for certain
providers and authorizes certain regulatory relief in the administrative
processes of the Medicare claims and payment rules. It is uncertain at this time
whether this legislation will be enacted and become law.
Inherent reasonableness
Final regulations may be implemented by the Centers for Medicare and
Medicaid Services ("CMS") that reduce the payment for certain Medicare Part B
items and services by as much as fifteen percent (CMS-1908F Application of
Inherent Reasonableness to All Medicare Part B Services (Other than Physician
Services)). CMS has the authority to determine whether the reimbursement for
certain fee schedule items and services is reasonable when compared to other
payers' prices for similar services and to make reductions or increases up to 15
percent. This proposal could apply to the items and services that we provide.
Litigation may materially adversely affect us
We and three individuals who are or were officers of PolyMedica are
defendants in a lawsuit alleging violations of certain sections and rules of the
Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a
derivative action against the directors and two individuals who are or were
officers in Massachusetts state court alleging certain breaches of fiduciary
duty. We, the named individuals, and the Board believe that we have meritorious
defenses to the claims made against us in the actions in which we are defendants
and intend to contest the claims vigorously. Although we do not consider an
unfavorable outcome to the various claims probable, we cannot accurately predict
their ultimate disposition, and have therefore not recorded any charges related
to their outcome. An unfavorable outcome could have a material effect on our
financial position and results of operations. Please see Item 1 of Part II,
Legal Proceedings, for a more complete description of these claims.
We could experience significantly reduced profits as the result of an
unfavorable outcome to current governmental investigations
The regulations that govern Medicare reimbursement are complex and our
compliance with those regulations may be reviewed by federal agencies, including
the Department of Health and Human Services, the DOJ, and the FDA. The U.S.
Attorney's Office for the Southern District of Florida, with the assistance of
the FBI and OIG, is investigating allegations of healthcare fraud, improper
revenue recognition and obstruction of justice by Liberty and Liberty Home
Pharmacy. Both civil and criminal investigations are being conducted. We are
cooperating with the investigations. We cannot accurately predict the outcome of
these proceedings at this time, and have therefore not recorded any charges
relating to their outcome.
If any of these investigations results in a determination that we have
failed to comply with the regulations governing Medicare reimbursement or
financial reporting or have otherwise committed healthcare fraud or securities
law violations, we could be subject to delays or loss of reimbursement,
substantial fines or penalties, and other sanctions. An adverse determination
could have a material
33
effect on our financial position and results of operations.
In June 2002, Liberty received an administrative subpoena from the U.S.
Attorney's Office for the Southern District of Illinois seeking documents
relevant to an ongoing investigation of Medicare reimbursement of "depth shoes
and inserts." Liberty has been informed that it is not a target of that
investigation.
Our stock price could be volatile
The trading price of our common stock has been volatile and is likely to
continue to be volatile. The stock market in general, and the market for
healthcare-related companies in particular, has experienced extreme volatility.
This volatility has often been unrelated to the operating performance of
particular companies. Investors may not be able to sell their common stock at or
above the price at which they purchased the stock. Prices for the common stock
will be determined in the marketplace and may be influenced by many factors,
including variations in our financial results, changes in earnings estimates by
industry research analysts, investors' perceptions of us and general economic,
industry and market conditions.
We plan to continue our rapid expansion; if we do not manage our growth
successfully, our growth and profitability may slow or stop
We have expanded our operations rapidly and plan to continue to expand.
This expansion has created significant demand on our administrative, operational
and financial personnel and other resources. Additional expansion in existing or
new markets could strain these resources and increase our need for capital. Our
personnel, systems, procedures, controls and existing space may not be adequate
to support further expansion.
The profitability of our Liberty Diabetes and Liberty Respiratory segments will
decrease if we do not receive recurring orders from customers
We generally incur losses and negative cash flow with respect to the first
order from a new customer for Liberty Diabetes and Liberty Respiratory products,
due primarily to the marketing and regulatory compliance costs associated with
initial customer qualification. Accordingly, the profitability of these segments
depends in large part, on recurring and sustained reorders. Reorder rates are
inherently uncertain due to several factors, many of which are outside our
control, including changing customer preferences, competitive price pressures,
customer transition to extended care facilities, customer mortality and general
economic conditions.
We could experience significantly reduced profits from our Liberty Diabetes
segment if improved technologies that eliminate the need for consumable testing
supplies are developed for glucose monitoring
The majority of our Liberty Diabetes net revenues are from consumable
testing supplies, used to draw and test small quantities of blood for the
purpose of measuring and monitoring glucose levels. Numerous research efforts
are underway to develop more convenient and less intrusive glucose measurement
techniques. The commercialization and widespread acceptance of new technologies
that eliminate or reduce the need for consumable testing supplies could
negatively affect our Liberty Diabetes segment.
34
We could experience a charge to earnings as a result of an impairment of our
goodwill
We are required to perform impairment tests under SFAS No. 142 annually
and whenever events or changes in circumstance suggest that the carrying value
of an asset may not be recoverable. The valuation of our goodwill is based upon
the results of these impairment tests. Changes in assumptions used and
forecasted results of operations of the reporting units carrying goodwill, could
affect the quantification of an impairment value, should one exist.
We could be liable for harm caused by products that we sell
The sale of medical products entails the risk that users will make product
liability claims. A product liability claim could be expensive. While management
believes that our insurance provides adequate coverage, no assurance can be made
that adequate coverage will exist for these claims.
We could lose customers and revenues to new or existing competitors who have
greater financial or operating resources
Competition from other sellers of products offered through our Liberty
Diabetes, Liberty Respiratory, and Pharmaceuticals segments, manufacturers of
healthcare products, pharmaceutical companies and other competitors is intense
and expected to increase. Many of our competitors and potential competitors are
large companies with well-known names and substantial resources. These companies
may develop products and services that are more effective or less expensive than
any that we are developing or selling. They may also promote and market these
products more successfully than we promote and market our products.
Loss of use of manufacturing or data storage facilities would significantly
reduce revenues and profits from our businesses
We manufacture substantially all of our prescription urology and
suppository products and many of our AZO brand name products at our facility in
Woburn, Massachusetts. In addition, we process and store most of our customer
data in our facility in Port St. Lucie, Florida. If we cannot use any of these
facilities as a result of the FDA, Occupational Safety and Health Administration
or other regulatory action, fire, natural disaster or other event, our revenues
and profits would decrease significantly. We might also incur significant
expense in remedying the problem or securing alternative manufacturing or data
storage sources.
If we or our suppliers do not comply with applicable government regulations, we
may be prohibited from selling our products
The majority of the products that we sell are regulated by the FDA and
other regulatory agencies. If any of these agencies mandate a suspension of
production or sales of our products or mandate a recall, we may lose sales and
incur expenses until we are in compliance with the regulations or change to
another acceptable supplier.
We could have difficulty selling our pharmaceutical products if we cannot
maintain and expand our sales to distributors
We rely on third party distributors to market and sell our
over-the-counter female urinary
35
discomfort products and prescription urology and suppository products. Our sales
of these products will therefore depend in part on our maintaining and expanding
marketing and distribution relationships with pharmaceutical, medical device,
personal care and other distributors and on the success of those distributors in
marketing and selling our products.
Shortening or eliminating the amortization period of our direct-response
advertising costs could adversely affect our operating results
Any change in existing accounting rules or a business change that impacts
expected net cash flows or that shortens the period over which such net cash
flows are estimated to be realized, currently four years for our diabetes
products and two years for our prescription respiratory medications and
supplies, could result in accelerated charges against our earnings.
Our quarterly revenues or operating results could vary, which may cause the
market price of our securities to decline
We have experienced fluctuations in our quarterly operating results and
anticipate that such fluctuations could continue. Results may vary significantly
depending on a number of factors, including:
- changes in reimbursement guidelines and amounts;
- changes in regulations affecting the healthcare industry;
- the timing of customer orders;
- the timing and cost of our advertising campaigns; and
- the timing of the introduction or acceptance of new products and
services offered by us or our competitors.
- changes in the mix and costs of our products. Product mix and costs
are significantly influenced by the product brand chosen by the
customers of our mail-order diabetes supply business. We provide a
wide range of product brand choices to our customers, purchased at
varying costs from suppliers. Our ability to sustain current gross
margin levels is dependent both on our ability to continue securing
favorable pricing from suppliers and on the brand choices of our
customers.
We may make acquisitions that will strain our financial and operational
resources
We regularly review potential acquisitions of businesses and products.
Acquisitions involve a number of risks that might adversely affect our financial
and operational resources, including:
- diversion of the attention of senior management from important
business matters;
- amortization of substantial intangible assets;
- difficulty in retaining key personnel of an acquired business;
- failure to assimilate operations of an acquired business;
- failure to retain the customers of an acquired business;
- possible operating losses and expenses of an acquired business;
- exposure to legal claims for activities of an acquired business
prior to acquisition; and
- incurrence of debt and related interest expense.
36
We may issue preferred stock with rights senior to the common stock
Our articles of organization authorize the issuance of up to 2,000,000
shares of preferred stock without stockholder approval. The shares may have
dividend, voting, liquidation and other rights and preferences that are senior
to the rights of the common stock. The rights and preferences of any such class
or series of preferred stock would be established by our Board in its sole
discretion.
37
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We own certain money market funds and mutual funds that are sensitive to
market risks as part of our investment portfolio. The investment portfolio is
used to preserve our capital until it is required to fund operations. None of
the market-risk sensitive instruments held in our investment portfolio are held
for trading purposes. We do, however, hold some market-risk sensitive
instruments in our executive deferred compensation plans, for trading purposes.
These investments are accounted for under SFAS No. 115, "Accounting for certain
investments in Debt and Equity Securities." The investments are recorded at fair
value, and changes in fair value are recorded as compensation expense and
investment income/(loss) for the period. We do not own derivative financial
instruments in our investment portfolio. We do not believe that the exposure to
market risks in our investment portfolio is material.
38
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of PolyMedica's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a
date within 90 days of the filing date of this Quarterly Report on Form 10-Q,
PolyMedica's Principal Executive Officer and Principal Financial Officer have
concluded that PolyMedica's disclosure controls and procedures are designed to
ensure that information required to be disclosed by PolyMedica in the reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms and are operating in an effective manner.
(b) Changes in internal controls. There were no significant changes in
PolyMedica's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their most recent evaluation.
39
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The U.S. Attorney's Office for the Southern District of Florida, with the
assistance of the FBI and Department of Health & Human Services' OIG, is
investigating allegations of health care fraud, improper revenue recognition and
obstruction of justice by Liberty Medical Supply, Inc. ("Liberty") and Liberty
Home Pharmacy Corporation ("Liberty Home Pharmacy"). Both civil and criminal
investigations are being conducted. We are cooperating with the investigations.
We cannot accurately predict the outcome of these proceedings at this time, and
have therefore not recorded any charges relating to their outcome.
On November 27, 2000, Richard Bowe SEP-IRA filed a purported class action
lawsuit in the United States District Court for the District of Massachusetts
(the "Bowe Complaint") against us and one of our then officers. The Bowe
Complaint claims violations of Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 promulgated thereunder
and seeks unspecified damages, attorneys' fees and costs. On December 19, 2000,
Trust Advisors Equity Plus LLC filed a purported class action lawsuit in the
United States District Court for the District of Massachusetts (the "Trust
Advisors Complaint") against us and one of our then officers. The Trust Advisors
Complaint asserts the same claims, makes the same allegations and seeks the same
relief as the Bowe Complaint. On January 26, 2001, the plaintiffs in the Bowe
and Trust Advisors Complaints moved to consolidate the Bowe and Trust Advisors
Complaints and to be appointed as lead plaintiffs in the consolidated action
pursuant to Section 21D(a)(3)(B) of the Exchange Act. On July 30, 2001 the Court
granted these motions and consolidated the Bowe and Trust Advisor Complaints
under the caption In re: PolyMedica Corp. Securities Litigation, Civ. Act. No.
00-12426-REK.
Plaintiffs filed a consolidated amended complaint on October 9, 2001. The
consolidated amended complaint extended the class period (the amended class
period is October 26, 1998 through August 21, 2001), and named an additional two
officers and Liberty as defendants. We and the named defendants moved to dismiss
the consolidated amended complaint on December 10, 2001. The plaintiffs filed
their opposition to this motion on February 11, 2002 and defendants filed a
reply memorandum on March 11, 2002. The Court denied the motion without a
hearing on May 10, 2002. We and the named defendants filed answers to the
consolidated amended complaint on June 20, 2002. We and the named defendants
believe that we have meritorious defenses to the claims made in the consolidated
amended complaint and intend to contest the claims vigorously. We are unable to
express an opinion as to the likely outcome of this litigation.
Between August 9, 2001 to August 24, 2001, four derivative actions were
filed in Massachusetts Superior Court for Middlesex County against our Board of
Directors: Casden v. Bernstein et al., Civ. Act. No. 01-3446; Vezmar v. LoGerfo
et al., Civ. Act. No. 01-3612; Sullivan v. Bernstein et al., Civ. Act. No.
01-3656; and Messner v. Lee et al., Civ. Act. No. 01-3697. On August 31, 2001,
plaintiffs filed a motion to consolidate the first three actions and to file an
amended consolidated complaint within 60 days. The fourth derivative action was
added to the motion to consolidate on October 3, 2001. On October 11, 2001, the
Court granted plaintiffs' motion to consolidate all four derivative actions
under the caption In re: PolyMedica Corp. Shareholder Derivative Litigation,
Civ. Act. No. 01-3446.
On December 17, 2001, plaintiffs filed a consolidated derivative
complaint. The consolidated
40
complaint named two additional officer defendants. The Complaint alleges that
the directors and officers breached their fiduciary duties by, among other
things, failing to exercise reasonable care in the oversight of corporate
affairs and management with respect to the operations of Liberty and by
acquiescing in alleged misconduct by Liberty . The Complaint seeks unspecified
damages, the return of compensation, and other relief, including injunctive
relief. The defendants filed a motion to dismiss the consolidated complaint on
January 31, 2002. Plaintiffs filed an opposition to the motion on March 22, 2002
and defendants filed a reply memorandum on April 19, 2002. The Court heard
arguments on the motion to dismiss on April 30, 2002 and entered an order
denying the motion to dismiss on July 16, 2002. On August 8, 2002, defendants
filed a motion for reconsideration of the order denying defendants' motion to
dismiss, or, in the alternative, to report the case to the Appeals Court and
stay the proceeding. After hearing oral argument, the Court issued an order on
September 16, 2002 in which it refused to reconsider its decision, but reported
the case to the Appeals Court and granted defendants' motion to stay the action.
The directors and defendants believe they have meritorious defenses to the
claims made in the consolidated complaint and intend to contest the claims
vigorously. We are unable to express an opinion as to the likely outcome of this
litigation.
A shareholder derivative complaint, Minasian v. Bernstein et. al., Civ.
Act. No. 01-11485REK, was filed against our Board of Directors in United States
District Court for the District of Massachusetts on August 17, 2001. The
Complaint alleged that the directors breached their fiduciary duties by, among
other things, failing to exercise reasonable care in the oversight of corporate
affairs and management with respect to the operations of Liberty and by
acquiescing in alleged misconduct by Liberty , and sought unspecified damages,
the return of director compensation, and other injunctive relief. On November
16, 2001, plaintiff filed an assented-to motion to dismiss the complaint without
prejudice, and the case was closed on November 21, 2001.
In June 2002, Liberty received an administrative subpoena from the U.S.
Attorney's Office for the Southern District of Illinois seeking documents
relevant to an ongoing investigation of Medicare reimbursement of "depth shoes
and inserts." Liberty has been informed that it is not a target of that
investigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on September 12, 2002, the
following proposals were submitted to a vote of our stockholders:
For Against Abstain
--- ------- -------
Election of Directors:
Steven J. Lee 10,657,496 443,440(1)
Samuel L. Shanaman 10,695,065 405,871(1)
Thomas S. Soltys 10,694,102 406,834(1)
John K. P. Stone, III 10,692,631 408,305(1)
41
For Against Abstain
--- ------- -------
To approve an amendment to
PolyMedica's 2000 Stock Incentive
Plan ("the Plan") increasing from
1,800,000 to 2,300,000 the
number of authorized shares of
common stock available for
issuance under the Plan 9,065,535 2,013,769 21,632
To ratify the selection by the Board
of PricewaterhouseCoopers LLP
as PolyMedica's independent
public accountants for the fiscal
year ending March 31, 2003 10,149,394 937,200 14,342
- ----------
(1) Represents votes "withheld" from each respective director.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index immediately following this report, which is incorporated
herein by reference.
(b) Current Report on Form 8-K, dated September 12, 2002, reporting the
declaration of a dividend of one Right for each outstanding share of
PolyMedica's common stock.
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PolyMedica Corporation
(registrant)
/s/ Samuel L. Shanaman
----------------------
Samuel L. Shanaman
Lead Director and Interim Chief Executive Officer
(Principal Executive Officer)
/s/ Eric G. Walters
-------------------
Eric G. Walters
Executive Vice President and Clerk
(Principal Financial Officer)
/s/ Stephen C. Farrell
----------------------
Stephen C. Farrell
Chief Financial Officer
(Principal Accounting Officer)
Dated: November 14, 2002
43
CERTIFICATIONS
I, Samuel L. Shanaman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PolyMedica
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
44
/s/ Samuel L. Shanaman
----------------------
Dated: November 14, 2002
Samuel L. Shanaman
Lead Director and Interim Chief Executive Officer
(Principal Executive Officer)
I, Eric G. Walters, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PolyMedica
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that
45
could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ Eric G. Walters
-------------------
Dated: November 14, 2002
Eric G. Walters
Executive Vice President and Clerk
(Principal Financial Officer)
46
Exhibit Index
Exhibit Description
- ------- -----------
10.59 - Employment Agreement by and between the Registrant and Samuel L.
Shanaman dated October 7, 2002.
10.60 - Restricted Stock Agreement by and between the Registrant and Samuel
L. Shanaman dated October 7, 2002.
99.1 - Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
47