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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 December 31, 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of February 14, 2003, there were 12,371,693 shares of the registrant's
Common Stock outstanding and an additional 943,289 shares held in treasury.
POLYMEDICA CORPORATION
TABLE OF CONTENTS
Page
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements (unaudited)
Consolidated Balance Sheets as of
December 31 and March 31, 2002 3
Consolidated Statements of Operations
for the three and nine months ended
December 31, 2002 and 2001 5
Consolidated Statements of Cash Flows
for the nine months ended December 31, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 41
Item 4 - Controls and Procedures 42
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 43
Item 6 - Exhibits and Reports on Form 8-K 44
Signatures 45
Certifications 46
Exhibit Index 49
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYMEDICA CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share and per share amounts)
DECEMBER 31, MARCH 31,
2002 2002
----------- ----
ASSETS
Current assets:
Cash and cash equivalents $ 31,916 $ 27,884
Accounts receivable (net of allowances of
$20,957 and $15,539 as of December 31
and March 31, 2002, respectively) 47,896 44,059
Inventories 20,799 21,663
Deferred tax asset 10,622 10,622
Prepaid expenses and other
current assets 4,068 1,727
-------- --------
Total current assets 115,301 105,955
Property, plant and equipment, net 46,744 34,603
Goodwill 5,946 29,748
Intangible assets, net 173 698
Direct response advertising, net 59,541 52,112
Other assets 1,553 1,276
-------- --------
Total assets $229,258 $224,392
======== ========
The accompanying notes are an integral part of these unaudited
consolidated financial statements.
3
POLYMEDICA CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share and per share amounts)
DECEMBER 31, MARCH 31,
2002 2002
----------- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,237 $ 10,270
Certain amounts due to Medicare and others (Note 8) 2,476 4,798
Accrued expenses 15,018 12,990
Current portion, capital lease obligations 561 742
--------- ---------
Total current liabilities 26,292 28,800
Long-term note payable, capital lease and other obligations 1,898 1,485
Deferred income taxes 11,336 20,524
--------- ---------
Total liabilities 39,526 50,809
Commitments and contingencies (Note 10) -- --
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 December 31 and March 31, 2002, respectively 133 133
Treasury stock, at cost (962,488 and 1,143,158 shares
as of December 31 and March 31, 2002, respectively) (18,822) (22,185)
Deferred compensation (57) --
Additional paid-in capital 117,979 119,891
Retained earnings 90,499 75,744
--------- ---------
Total shareholders' equity 189,732 173,583
--------- ---------
Total liabilities and shareholders' equity $ 229,258 $ 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 NINE MONTHS ENDED
DEC. 31, DEC. 31, DEC. 31, DEC. 31,
2002 2001 2002 2001
--------- --------- --------- ---------
Net revenues $ 89,917 $ 72,696 $ 259,530 $ 204,568
Cost of sales 31,695 25,507 91,760 70,327
--------- --------- --------- ---------
Gross margin 58,222 47,189 167,770 134,241
Selling, general and administrative expenses 41,000 33,259 120,005 99,223
--------- --------- --------- ---------
Income from operations 17,222 13,930 47,765 35,018
Other income and expense:
Investment income 160 221 191 995
Interest expense (41) (40) (111) (127)
Minority interest -- (272) -- (412)
Other income and expense (1) 1 (12) --
--------- --------- --------- ---------
118 (90) 68 456
Income before income taxes 17,340 13,840 47,833 35,474
Income tax provision 6,937 5,315 18,463 13,622
--------- --------- --------- ---------
Income before cumulative effect of
change in accounting principle 10,403 8,525 29,370 21,852
Cumulative effect of change in accounting
principle, net of taxes of $9,187 (Note 4) -- -- (14,615) --
--------- --------- --------- ---------
Net income $ 10,403 $ 8,525 $ 14,755 $ 21,852
========= ========= ========= =========
Income before cumulative effect of change
in accounting principle per weighted
average share:
Basic $ .85 $ .69 $ 2.41 $ 1.73
Diluted $ .83 $ .68 $ 2.34 $ 1.69
Cumulative effect of change in accounting
principle per weighted average share:
Basic $ -- $ -- $ (1.20) $ --
Diluted $ -- $ -- $ (1.16) $ --
Net income per weighted average share:
Basic $ .85 $ .69 $ 1.21 $ 1.73
Diluted $ .83 $ .68 $ 1.18 $ 1.69
Weighted average shares, basic 12,298 12,269 12,212 12,635
Weighted average shares, diluted 12,580 12,492 12,532 12,908
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
5
POLYMEDICA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
NINE MONTHS ENDED
DECEMBER 31,
2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 14,755 $ 21,852
Adjustments to reconcile net income to net cash flows:
Cumulative effect of change in accounting principle 14,615 --
Depreciation and amortization 4,497 4,156
Amortization of direct-response advertising 26,630 21,979
Direct-response advertising (34,059) (31,577)
Minority interest -- 412
Provision for bad debts 19,199 15,539
Provision for sales allowances 12,606 9,097
Provision for inventory obsolescence 673 443
Stock-based compensation 158 --
Changes in assets and liabilities:
Accounts receivable (35,642) (31,460)
Inventories 191 (238)
Prepaid expenses and other assets (2,265) (1,250)
Accounts payable (2,033) (1,599)
Certain amounts due to Medicare and others (2,322) 4,900
Accrued expenses and other liabilities 3,394 5,097
-------- --------
Total adjustments 5,642 (4,501)
-------- --------
Net cash flows from operating activities 20,397 17,351
-------- --------
Cash flows from investing activities:
Purchase of marketable securities -- (5,499)
Proceeds from sale of marketable securities -- 5,499
Proceeds from sale of certain assets -- 22
Purchase of property, plant and equipment (15,712) (9,976)
-------- --------
Net cash flows from investing activities (15,712) (9,954)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,896 515
Repurchase of common stock (659) (17,625)
Contributions to deferred compensation plans (1,319) (1,125)
Payment of obligations under capital leases and note payable (571) (480)
-------- --------
Net cash flows from financing activities (653) (18,715)
-------- --------
Net increase/(decrease) in cash and cash equivalents 4,032 (11,318)
Cash and cash equivalents at beginning of period 27,884 39,571
-------- --------
Cash and cash equivalents at end of period $ 31,916 $ 28,253
======== ========
Supplemental disclosure of cash flow information:
Assets purchased under capital lease $ 435 $ 323
Disposal of equipment 188 --
The accompanying notes are an integral part of these
unaudited consolidated financial statements.
6
POLYMEDICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Company
PolyMedica Corporation and its subsidiaries ("PolyMedica") is a leading
provider of direct-to-consumer medical products and services, conducting
business through its Liberty Diabetes, Liberty Respiratory, and Pharmaceutical
segments.
Accounting
The unaudited consolidated financial statements included herein have been
prepared by PolyMedica 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 Reports on Form 10-Q
for the periods ended June 30 and September 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,
valuation of inventory, goodwill, direct-response advertising, accrued expenses,
accruals for Medicare adjustments, uncertainties that management determines are
estimable and probable, determination of an effective tax rate, and depreciation
and amortization. Actual results could differ from those estimates.
Certain amounts in the prior period consolidated financial statements and
the January 27, 2003 press release have been reclassified to conform with the
current period Form 10-Q presentation.
2. REVENUE RECOGNITION
We recognize revenue on shipment of products to customers who have placed
orders, upon shipment, provided that risk of loss has passed to the customer and
that, as applicable, we have
-7-
received and verified the written Authorization of Benefits and Doctor's Order
required 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 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 $62.50 million and $52.74 million of net revenues for the
three months ended December 31, 2002 and 2001, respectively, were reimbursable
by Medicare for products and services provided to Medicare beneficiaries.
Approximately $179.96 million and $143.34 million of net revenues for the nine
months ended December 31, 2002 and 2001, respectively, were reimbursable by
Medicare for products and services provided to Medicare beneficiaries.
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. During the three months
ended December 31, 2002 and 2001, we provided for sales allowances at a rate of
approximately 4.7% and 4.3% of gross revenues, respectively. During the nine
months ended December 31, 2002 and 2001, we provided for sales allowances at a
rate of approximately 4.6% and 4.3% of gross revenues, respectively.
Revenue for Medicare reimbursement is calculated based on
government-distributed reimbursement prices for Medicare-covered items. We
exclude from revenue amounts billed in excess of the government-distributed
reimbursement prices. 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 government-distributed
reimbursement prices for reimbursable supplies and we bill the remaining balance
to either third-party payers or directly to customers.
3. INVENTORIES
Inventories consist of the following:
(In thousands)
Dec. 31, March 31,
2002 2002
------- -------
Raw materials $ 1,467 $ 616
Work in process 568 832
Finished goods 18,764 20,215
------- -------
$20,799 $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 December 31 and March 31, 2002, is $3.41 million and $3.77
million, respectively, of product shipped to customers for which we have
received an order but have not yet received the required written documents.
-8-
4. GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board (the "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 impairment
tests of the goodwill 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 PolyMedica 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. The second step compares the implied fair value
of a reporting unit's goodwill with the carrying amount of that goodwill. The
implied fair value of goodwill is determined by allocating the estimated fair
value of a reporting unit to the estimated fair value of the reporting unit's
assets and liabilities, including identifiable intangible assets, with the
residual amount being the implied fair value of 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.
Additionally, new criteria have been established that determine whether an
acquired intangible asset should be recognized separately from goodwill.
Upon adoption of SFAS No. 142, we were required to perform a transitional
impairment test as of April 1, 2002. We were required to complete step one of
the transitional impairment test by September 30, 2002 and complete step two of
the transitional impairment test by March 31, 2003. Any impairment as a result
of the transitional impairment test shall be recorded as a cumulative effect of
a change in accounting principle. Thereafter, at a minimum, annual tests of
impairment are required for which any impairment identified shall be recorded as
a cost of continuing operations.
The first step of the transitional impairment test was completed in the
quarter ended September 30, 2002, which resulted in the determination that the
carrying value of the net assets related to our PolyMedica Pharmaceuticals
(U.S.A.), Inc. and PolyMedica Healthcare, Inc. reporting units, included in our
Pharmaceuticals segment, exceeded their fair value. As a result, we performed
the second step of the transitional impairment test in the quarter ended
December 31, 2002, to measure the amount of the impairment loss, in which we
compared the implied fair value of the goodwill in these two reporting units
with the carrying amount of the goodwill. We determined that the carrying value
of the goodwill for these reporting units exceeded the implied fair value of
that goodwill by $23.80 million. We have recorded a $23.80 million ($14.62
million net of taxes) impairment loss related to these reporting units as a
cumulative effect of a change in accounting principle retroactive to April 1,
2002.
Goodwill included in the PolyMedica Pharmaceuticals (U.S.A.), Inc. and
PolyMedica Healthcare, Inc. reporting units is a result of PolyMedica's
acquisition of an Alcon urological product line, including over-the-counter and
prescription urology products, in December 1992. Net of the impairment loss, the
remaining goodwill related to these reporting units as of December 31, 2002 was
$1.00 million. Including the amount of goodwill recorded in our Liberty Diabetes
segment, which was not considered to be impaired under our transitional
impairment test, PolyMedica's total goodwill as of December 31, 2002 was $5.95
million.
-9-
In performing the transitional impairment test, we made certain estimates
and assumptions which included the allocation of certain assets and liabilities
to our reporting units, estimates of our reporting units' fair values and the
related fair value of certain reporting units' assets and liabilities. We
estimated the fair value of our reporting units and certain intangible assets
calculating the present value of expected future cash flows using a discount
rate of approximately 15%.
As a result of adopting SFAS No. 142 effective April 1, 2002,
approximately $385,000 and $1.16 million of goodwill amortization was not
recognized in the three and nine months ended December 31, 2002, respectively.
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 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 nine months ended December 31, 2001,
respectively (table in thousands, except per share amounts):
Three Months Nine Months
Ended Ended
Dec. 31, 2001 Dec. 31, 2001
------------- -------------
Net income $ 8,525 $ 21,852
Add back: Impact of goodwill amortization, net of tax
benefit of $148 and $444 for the three and nine
months ended December 31, 2001, respectively 237 712
---------- ----------
Adjusted net income $ 8,762 $ 22,564
========== ==========
Net income per share, basic $ 0.69 $ 1.73
Add back: Impact of goodwill amortization, net of taxes 0.02 0.06
---------- ----------
Adjusted net income per share, basic $ 0.71 $ 1.79
========== ==========
Net income per share, diluted $ 0.68 $ 1.69
Add back: Impact of goodwill amortization, net of taxes 0.02 0.06
---------- ----------
Adjusted net income per share, diluted $ 0.70 $ 1.75
========== ==========
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 December 31, 2002 and March 31, 2002, by reportable
segment, were as follows (table in thousands):
Dec. 31, March 31,
2002 2002
---- ----
LIBERTY DIABETES:
Goodwill $ 4,951 $ 4,951
======== ========
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Customer list $ 1,816 $ 1,816
Accumulated amortization (1,643) (1,448)
-------- --------
$ 173 $ 368
======== ========
PHARMACEUTICALS:
Goodwill $ 995 $ 24,797
======== ========
Covenant not to compete $ 6,800 $ 6,800
Accumulated amortization (6,800) (6,470)
-------- --------
$ -- $ 330
======== ========
TOTAL CONSOLIDATED GOODWILL $ 5,946 $ 29,748
======== ========
TOTAL AMORTIZABLE INTANGIBLE ASSETS 8,616 8,616
TOTAL ACCUMULATED AMORTIZATION (8,443) (7,918)
-------- --------
$ 173 $ 698
======== ========
Amortization expense for intangible assets was approximately $157,000 and
$184,000 for each of the three months ended December 31, 2002 and 2001,
respectively. Amortization expense for intangible assets was approximately
$525,000 and $552,000 for the nine months ended December 31, 2002 and 2001,
respectively. As of December 31, 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 $ 65
Fiscal year 2004 108
Fiscal year 2005 --
Fiscal year 2006 --
Fiscal year 2007 --
-----
Total $ 173
=====
5. DIRECT-RESPONSE ADVERTISING - STATEMENT OF POSITION 93-7 ("SOP 93-7")
In accordance with SOP 93-7, we recorded the following activity related to
our direct-response advertising asset for the periods presented (in thousands):
Three months ended Nine months ended
------------------ -----------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
2002 2001 2002 2001
---- ---- ---- ----
Capitalized direct-response advertising $10,561 $10,487 $34,059 $31,577
Direct-response advertising amortization 9,271 8,001 26,630 21,979
------- ------- ------- -------
Increase in direct-response advertising asset, net $ 1,290 $ 2,486 $ 7,429 $ 9,598
======= ======= ======= =======
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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 business and two years for our
respiratory business, could result in accelerated charges against our earnings.
6. OTHER ASSETS
Included in other assets are restricted investments of $1.22 million and
$868,000 as of December 31 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" 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 December 31, 2002, the fair value of these investments was not
materially different from cost. In the nine months ended December 31, 2002,
$854,000 was paid directly to a beneficiary of the Plans. Amounts set aside for
the Plans in the nine months ended December 31, 2002 and 2001 totaled $1.32
million and $1.13 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. NEW 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 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. We do not expect adoption of this
statement to have a material impact on our financial position or results of
operations.
-12-
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. As
provided for in SFAS No. 123, we have elected to apply Accounting Principles
Board ("APB") No. 25 "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its stock-based compensation plans. APB No. 25
does not require options to be expensed when granted with an exercise price
equal to fair market value. We will comply with the disclosure requirements of
SFAS No. 148.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of FIN No. 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements of FIN No. 45 are applicable for
financial statements of interim or annual periods ending after December 15,
2002. We adopted FIN No. 45 in the quarter ended December 31, 2002 and will
comply with the new disclosure requirements, as applicable.
-13-
8. CERTAIN AMOUNTS DUE TO MEDICARE AND OTHERS
Certain amounts due to Medicare and others of $2.48 million as of December
31, 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
resulted in $1.06 million of refunds or credits to the DMERC and others. No
administrative overpayment notices had been received since November 8, 2001.
DMERCs are private insurance companies used by Medicare to administer
reimbursement payments. 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.
In the nine months ended December 31, 2002, we recorded a benefit of $2.22
million, or $0.11 per share (diluted), related to a reduction in certain 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 was recorded as a reduction of selling,
general and administrative expenses in the quarter ended September 30, 2002. The
liability of $2.48 million as of December 31, 2002, 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 determine that refunds are due to Medicare or others for reasons
other than those described above, we include estimates of those refund
obligations in accrued expenses.
-14-
9. SEGMENT INFORMATION
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
supplies 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. Results for
the three and nine months ended December 31, 2002 do not include amortization of
goodwill in accordance with SFAS No. 142 (Note 4). 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:
-15-
Three months ended Nine months ended
------------------ -----------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
(In thousands) 2002 2001 2002 2001
-------- -------- -------- --------
NET REVENUES:
Liberty Diabetes $ 60,119 $ 53,242 $179,595 $151,701
Liberty Respiratory 19,765 13,573 54,954 37,609
Pharmaceuticals 10,033 5,881 24,981 15,258
-------- -------- -------- --------
Total $ 89,917 $ 72,696 $259,530 $204,568
======== ======== ======== ========
DEPRECIATION AND AMORTIZATION:
Liberty Diabetes $ 6,296 $ 4,951 $ 17,722 $ 13,891
Liberty Respiratory 4,457 4,006 12,620 10,745
Pharmaceuticals 225 500 785 1,499
-------- -------- -------- --------
Total $ 10,978 $ 9,457 $ 31,127 $ 26,135
======== ======== ======== ========
INCOME BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE:
Liberty Diabetes $ 8,050 $ 9,142 $ 24,722 $ 26,446
Liberty Respiratory (see Note 8) 6,490 2,574 18,549 3,269
Pharmaceuticals 2,800 2,124 4,562 5,759
-------- -------- -------- --------
Total $ 17,340 $ 13,840 $ 47,833 $ 35,474
======== ======== ======== ========
Dec. 31, March 31,
2002 2002
-------- --------
SEGMENT ASSETS:
Liberty Diabetes $136,585 $133,009
Liberty Respiratory 42,438 31,242
Pharmaceuticals 14,987 33,205
Corporate Headquarters 35,248 26,936
-------- --------
Total $229,258 $224,392
======== ========
10. COMMITMENTS AND CONTINGENCIES
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 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.
PolyMedica 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
-16-
who are or were officers in Massachusetts state court alleging certain breaches
of fiduciary duty. We, the named individuals, and our Board of Directors (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 was served with 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. Liberty completed its response to the subpoena in November 2002.
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.
11. STOCKHOLDERS' EQUITY
Common Stock Repurchase Program
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 nine months
ended December 31, 2002, 25,000 shares of common stock were repurchased for
$659,000 at an average repurchase price of $26.37 per share. As of December 31,
2002, 1,271,000 shares had been repurchased for $25.30 million at an average
repurchase price of $19.91 per share and 729,000 shares remained authorized for
repurchase.
Shareholder Rights Plan
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 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 10. The Plan
is intended to protect and maximize the value of shareholders' interests in the
event of an unsolicited offer.
-17-
12. INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
PER SHARE
Calculations of income before cumulative effect of change in accounting
principle per weighted average share are as follows:
(In thousands, except per share data) Three Months Ended Nine Months Ended
------------------ -----------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
2002 2001 2002 2001
------- ------- ------- -------
Income before cumulative effect of change in
accounting principle $10,403 $ 8,525 $29,370 $21,852
BASIC:
Weighted average common stock outstanding, net of
treasury stock, end of period 12,298 12,269 12,212 12,635
Income before cumulative effect of change in accounting
principle per weighted average share, basic $ .85 $ .69 $ 2.41 $ 1.73
======= ======= ======= =======
DILUTED:
Weighted average common stock outstanding, net of
treasury stock, end of period 12,298 12,269 12,212 12,635
Weighted average dilutive common stock equivalents 282 223 320 273
------- ------- ------- -------
Weighted average common stock and dilutive common
stock equivalents outstanding, net of treasury stock 12,580 12,492 12,532 12,908
Income before cumulative effect of change in
accounting principle per weighted average share, diluted $ .83 $ .68 $ 2.34 $ 1.69
======= ======= ======= =======
Potentially Dilutive Stock Options
Options to purchase 657,245 and 1,380,714 shares of common stock were
outstanding during the three months ended December 31, 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 nine months ended December 31, 2002 and
2001, options to purchase 657,245 and 1,031,706 shares of common stock,
respectively, were outstanding, but were not included in the computation of
diluted earnings per share, because the
-18-
options' exercise prices were greater than the average market price of the
common shares.
13. COMPREHENSIVE INCOME
Our total net income and comprehensive income was $10.40 million and $8.53
million for the three months ended December 31, 2002 and 2001, respectively. For
the nine months ended December 31, 2002 and 2001, total net income and
comprehensive income was $14.76 million and $21.85 million, respectively.
14. SUBSEQUENT EVENTS
In January 2003 our Board declared a cash dividend of $0.25 per share of
PolyMedica's common stock to shareholders of record as of the close of business
on February 3, 2003, payable on February 13, 2003. We intend to pay this
dividend on a quarterly basis.
On January 28, 2003, we purchased a 120,000 square foot building located
in Port St. Lucie, Florida for a purchase price, excluding legal fees and
associated acquisition costs, of $3.26 million, for the purpose of supporting
the growth in our Florida businesses. We commenced renovation of the facility in
February 2003.
-19-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
BUSINESS
PolyMedica is a leading provider of direct-to-consumer medical products
and services, conducting business through our Liberty Diabetes, Liberty
Respiratory and Pharmaceuticals segments. Through our Liberty Diabetes segment
we sell diabetes testing supplies and related products and provide services
primarily to 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 primarily to 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.
Liberty Diabetes
As of December 31, 2002, we had approximately 522,000 active diabetes
customers, many of whom suffer from other chronic diseases. 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 for
those supplies that are reimbursable;
- providing 24-hour telephone support to customers; and
- using sophisticated software and advanced order fulfillment systems
to provide products and support.
-20-
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
are diagnosed, with the remaining six million 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 similarly 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 December 31, 2002, we had approximately 59,000 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, 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 522,000. In addition, we now have approximately 59,000
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.
-21-
As a result of the expansion of our customer base, and emerging ability to
leverage the value of our customer base by marketing a range of products to our
customers, including those that are newly acquired, we are considering a number
of new marketing initiatives. These initiatives may include the use of
broad-based advertising that may not qualify as direct-response advertising and,
therefore, would be expensed as incurred.
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 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 and offering therapeutic
footwear for diabetics deemed at risk for developing lower extremity
complications. 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 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 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 several well-qualified candidates who are in the final stages
of the search process.
Samuel L. Shanaman, Lead Director, is performing 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 pay Mr.
Shanaman minimum wage in cash in addition to his vesting in 80 shares of
restricted common stock for every day Mr. Shanaman works. The fair value of the
shares (approximately $25 per share on the restricted stock date of grant) and
the cash, is recorded as a selling, general and administrative expense in
PolyMedica's consolidated statements of operations, as the income is earned by
Mr. Shanaman.
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, which generally occurs in November and December. As a result, our
acquisition of new customers during this period is generally reduced and our net
revenues may fluctuate accordingly.
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.
-22-
- 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 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 Reports on Form 10-Q for the periods ended June 30 and September 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,
inventories, goodwill, advertising, accruals for Medicare adjustments, 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 is 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
-23-
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.
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.
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. See Note 4 to the consolidated financial statements. In
performing impairment tests, we are required to make certain estimates and
assumptions relating to the allocation of certain assets and liabilities to our
reporting units, estimates of the fair values of our reporting units, and the
related fair value of certain of their assets and liabilities. Changes in the
estimates and assumptions used could affect the determination of whether an
impairment exists as well as the quantification of the impairment value, should
one exist.
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.
-24-
Non-direct - response advertising, promotional, and marketing costs are
charged to earnings in the period in which they are incurred.
Accruals for Medicare Adjustments
The government's Medicare regulations are complex and sometimes subjective
and therefore may require management's interpretation. Accruals for Medicare
adjustments are recorded when, based upon our assessment of the facts and
circumstances, we believe that the amounts due are probable and estimable.
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 $9.0 million on legal and accounting fees primarily
preparing for 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
comprised of three outside directors which was established to oversee our
response to the investigations and the related litigation.
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 was served with 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. Liberty completed its response to the subpoena in November 2002.
-25-
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.
COMPLIANCE AND REGULATORY AFFAIRS
We have a Compliance and Regulatory Affairs Department that is comprised
of five groups: monitoring, investigations and special projects, internal
reviews, contracts and licensing and external communications. 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
our businesses. We have continued to expand the size and capabilities of our
compliance and regulatory affairs department.
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 investigations and special projects and internal reviews groups are
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.
The 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.
-26-
CORPORATE GOVERNANCE
In August 2001, our Board established an Oversight Committee, a special
Board committee of three non-employee directors, to oversee our response to the
investigations and the related litigation described in Item 1 of Part II, Legal
Proceedings of this Form 10-Q. 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 and that Department's compliance program to ensure compliance with
Medicare and internal Company policies.
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 non-employee directors.
Samuel Shanaman, Interim Chief Executive Officer, currently holds that position.
The role of the Lead Director is to chair regular meetings of the non-employee
directors, providing a strong focal point for both the Board and our
shareholders.
During the past several months, the Corporate Governance Committee has
drafted a set of documents intended to codify our corporate governance
principles and practices and to aid in our compliance with the Sarbanes-Oxley
Act of 2002 (the "Act") and regulations promulgated by the Commission pursuant
to the Act. In November 2002, the Corporate Governance Committee presented
drafts of these documents to the full Board for review. In January 2003, the
Board approved the following documents:
- Board Guidelines on Significant Corporate Governance Issues;
- Charters for the Compensation, Corporate Governance and Executive
Committees;
- a revised Charter for the Audit Committee;
- an Insider Trading Policy applicable to all employees, officers and
directors of PolyMedica; and
- a Code of Conduct and Ethics, applicable to all employees, officers
and directors of PolyMedica.
-27-
RESULTS OF OPERATIONS
Three Months Ended December 31, 2002 Compared to Three Months Ended December 31,
2001
The following table presents consolidated statements of operations
expressed as a percentage of net revenues:
Three months ended
Dec. 31, Dec. 31,
2002 2001
----- ----
Net revenues:
Liberty Diabetes 66.9 % 73.2 %
Liberty Respiratory 22.0 18.7
Pharmaceuticals 11.1 8.1
---- ----
Total Net Revenues 100.0 100.0
Cost of sales 35.2 35.1
---- ----
Gross margin 64.8 64.9
Selling, general and
administrative expenses
45.6 45.7
---- ----
Income from operations 19.2 % 19.2 %
==== ====
Total net revenues increased 23.7% to $89.92 million in the three
months ended December 31, 2002, as compared with $72.70 million in the three
months ended December 31, 2001. This increase was the result of the growth in
sales in each of our Liberty Diabetes, Liberty Respiratory and Pharmaceuticals
segments.
Net revenues in the Liberty Diabetes segment increased 12.9% to
$60.12 million in the three months ended December 31, 2002, as compared with
$53.24 million in the three months ended December 31, 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. The rate of revenue growth during the
quarter slowed as a result of reduced advertising spending, reductions in net
revenues for estimated refund obligations to Medicare and others, and the 3.28%
incremental cost of living adjustment that existed in the third quarter of
fiscal year 2002, but not the third quarter of fiscal year 2003. The incremental
cost of living adjustment effective January 1, 2001, 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,
went into effect late on 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 December 31, 2001 that was not
present in the quarter ended December 31, 2002.
Net revenues in the Liberty Respiratory segment increased 45.6% to
$19.77 million in the three months ended December 31, 2002, as compared with
$13.57 million in the three months ended December 31, 2001. This increase was
due primarily to the growth in our customer base as a result
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of our direct-response advertising spending. As with our Liberty Diabetes
segment, we currently expect our advertising spending to continue in order to
further the expansion of our Liberty Respiratory segment.
Net revenues in the Pharmaceuticals segment increased 70.6% to
$10.03 million in the three months ended December 31, 2002, as compared with
$5.88 million in the three months ended December 31, 2001, due to the growth in
sales of Liberty's prescription oral medications, not covered by Medicare. Sales
of these products represented 55.8% and 29.9% of total Pharmaceutical segment
net revenues in the three months ended December 31, 2002 and 2001, respectively.
We expect this trend of increasing sales from Liberty's prescription oral
medications business to continue. The current customer base for these products
consists primarily of existing Liberty Diabetes customers.
As a percentage of total net revenues, overall gross margins were
consistent at 64.8% in the three months ended December 31, 2002, as compared
with 64.9% in the three months ended December 31, 2001. This minor decrease was
due to the late implementation of the January 1, 2001 cost of living adjustment
described above and adjustments to net revenues relating to previously billed
amounts offset by increased sales in Liberty Respiratory, which has gross
margins that are higher than our corporate average.
As a percentage of total net revenues, selling, general and
administrative expenses were 45.6% in the three months ended December 31, 2002,
as compared with 45.7% in the three months ended December 31, 2001. Selling,
general and administrative expenses increased 23.3% in the three months ended
December 31, 2002 to $41.00 million, as compared with $33.26 million in the
three months ended December 31, 2001. This increase of 23.3% is the result of
additional costs required to support our 23.7% increase in net revenues for the
quarter ended December 31, 2002, as compared with the quarter ended December 31,
2001.
Investment income decreased 27.7% to $160,000 in the three months
ended December 31, 2002, as compared with $221,000 in the three months ended
December 31, 2001, due primarily to lower interest rates in the quarter ended
December 31, 2002, as compared with the quarter ended December 31, 2001.
Interest expense increased 3.5% to $41,000 in the three months ended December
31, 2002, as compared with $40,000 in the three months ended December 31, 2001.
Net income increased 22.0% to $10.40 million for the quarter ended
December 31, 2002, as compared with $8.53 million for the quarter ended December
31, 2001. The increase in our net income was primarily attributable to a 23.7%
increase in net revenues offset by a higher quarterly tax rate in the three
months ended December 31, 2002, as compared with the three months ended December
31, 2001, which was 40.0% and 38.4%, respectively, in addition to the factors
discussed above regarding gross margin and selling, general and administrative
expenses. As a result of the tax rate adjustment made in the quarter ended
December 31, 2002, the effective tax rate for the nine months ended December 31,
2002 was 38.6%, as compared with 38.4% for the nine months ended December 31,
2001.
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Nine Months Ended December 31, 2002 Compared to Nine Months Ended December 31,
2001
The following table presents consolidated statements of operations
expressed as a percentage of net revenues:
Nine months ended
Dec. 31, Dec. 31,
2002 2001
----- ----
Net revenues:
Liberty Diabetes 69.2 % 74.1 %
Liberty Respiratory 21.2 18.4
Pharmaceuticals 9.6 7.5
----- -----
Total Net Revenues 100.0 100.0
Cost of sales 35.4 34.4
----- -----
Gross margin 64.6 65.6
Selling, general and administrative expenses
46.2 48.5
----- -----
Income from operations 18.4 % 17.1 %
===== =====
Total net revenues increased 26.9% to $259.53 million in the nine
months ended December 31, 2002, as compared with $204.57 million in the nine
months ended December 31, 2001. This increase was primarily the result of the
growth in sales in each of our Liberty Diabetes, Liberty Respiratory and
Pharmaceuticals segments.
Net revenues in the Liberty Diabetes segment increased 18.4% to
$179.60 million in the nine months ended December 31, 2002, as compared with
$151.70 million in the nine months ended December 31, 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. Net revenues in the fiscal 2002
second and third quarters benefited from an incremental 3.28% cost of living
adjustment that did not exist in the fiscal 2003 second and third quarters. The
incremental cost of living adjustment effective January 1, 2001, 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, went into effect late on 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 quarters ended September 30 and December 31,
2001 that was not present in the quarters ended September 30 and December 31,
2002.
Net revenues in the Liberty Respiratory segment increased 46.1% to
$54.95 million in the nine months ended December 31, 2002, as compared with
$37.61 million in the nine months ended December 31, 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 advertising spending to continue in order to further the expansion of our
Liberty Respiratory segment.
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Net revenues in the Pharmaceuticals segment increased 63.7% to
$24.98 million in the nine months ended December 31, 2002, as compared with
$15.26 million in the nine months ended December 31, 2001, due to the growth in
sales of our prescription oral medications, not covered by Medicare. Sales of
these products represented 52.8% and 22.6% of total Pharmaceutical segment net
revenues in the nine months ended December 31, 2002 and 2001, respectively. We
expect this trend of increasing sales from Liberty's prescription oral
medications business to continue. The current customer base for these products
consists primarily of existing Liberty Diabetes customers.
As a percentage of total net revenues, overall gross margins were
64.6% in the nine months ended December 31, 2002, and 65.6% in the nine months
ended December 31, 2001. This decrease was due primarily to the late
implementation of the January 1, 2001 cost of living adjustment described above.
Increasing sales from new business initiatives that have lower margins than our
corporate average 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 nine months ended December 31, 2002, as compared with only
six months of the nine months ended December 31, 2001.
As a percentage of total net revenues, selling, general and
administrative expenses were 46.2% in the nine months ended December 31, 2002,
as compared with 48.5% in the nine months ended December 31, 2001. Selling,
general and administrative expenses increased 20.9% in the nine months ended
December 31, 2002 to $120.00 million, as compared with $99.22 million in the
nine months ended December 31, 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 nine months ended December 31, 2001 in the
Liberty Respiratory segment related to the establishment of the certain amounts
due to Medicare and others liability, coupled with a $2.22 million decrease in
selling, general and administrative expenses in the nine months ended December
31, 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 nine months
ended December 31, 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.
Investment income decreased 80.7% to $191,000 in the nine months
ended December 31, 2002, as compared with $995,000 in the nine months ended
December 31, 2001, due primarily to a lower average cash balance and lower
interest rates in the nine months ended December 31, 2002, as compared with the
nine months ended December 31, 2001. Interest expense decreased 12.3% to
$111,000 in the nine months ended December 31, 2002, as compared with $127,000
in the nine months ended December 31, 2001.
Pretax income before the cumulative effect of a change in accounting
principle related to the adoption of SFAS No. 142, was $47.83 million in the
nine months ended December 31, 2002, a 34.8% increase as compared with $35.47
million in the nine months ended December 31, 2001.
Income before the cumulative effect of a change in accounting
principle increased 34.4% to $29.37 million for the nine months ended December
31, 2002, as compared with $21.85 million for the nine months ended December 31,
2001. Our increase in income before the cumulative effect of a change in
accounting principle was primarily attributable to additional earnings as a
result of
-31-
increased net revenues, a $3.60 million charge (net of taxes) included in the
nine months ended December 31, 2001 related to the establishment of the certain
amounts due to Medicare and others liability and a $1.36 million benefit (net of
taxes) included in the nine months ended December 31, 2002. The reduction in
this liability was 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.
Net income decreased 32.5% to $14.76 million for the nine months
ended December 31, 2002, as compared with $21.85 million for the nine months
ended December 31, 2001. This decrease was primarily attributable to the $14.62
million cumulative effect of a change in accounting principle, net of taxes, in
addition to the reasons discussed earlier for the changes in income before the
cumulative effect of a change in accounting principle. The cumulative effect of
a change in accounting principle represents a $23.80 million goodwill impairment
loss, net of taxes of $9.19 million, recorded retroactive to April 1, 2002 in
accordance with SFAS No. 142.
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 four 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
increased $4.03 million to $31.92 million as of December 31, 2002, as compared
with $27.88 million as of March 31, 2002, due primarily to cash flows generated
from operations. Cash flows from operations of $20.40 million for the nine
months ended December 31, 2002 were generated by income before the cumulative
effect of a change in accounting principle of $29.37 million, offset by cash
used to fund certain areas of our operations, such as an increase in spending
for direct-response advertising of $2.48 million to $34.06 million in the nine
months ended December 31, 2002, as compared with $31.58 million in the nine
months ended December 31, 2001, to further expand our customer base.
Our contractual obligations for future annual minimum lease and
rental commitments as of December 31, 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 nine months ended December 31, 2002 and 2001, we used $15.71
million and $9.95 million of cash for investing activities, respectively. The
$5.76 million increase in total cash used for investing activities was due to an
increase in capital expenditures of $5.74 million in the nine months ended
December 31, 2002, as compared with the nine months ended December 31, 2001.
Property, plant and equipment purchases totaled $15.71 million and $9.98 million
for the nine months ended December 31, 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.
In the nine months ended December 31, 2002, we used $653,000 of cash
for financing activities, which consisted of $1.32 million set aside for
executive deferred compensation plans, $659,000 used to repurchase 25,000 shares
of our common stock at an average repurchase price of $26.37 per share, and
$571,000 used to repay capital lease and note payable obligations, offset by
$1.90 million of proceeds recognized from the issuance of PolyMedica common
stock. From June
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2000 to February 14, 2003, 1,271,000 shares of the 2,000,000 shares originally
authorized by the Board, had been repurchased for $25.30 million at an average
repurchase price of $19.91 per share.
On January 28, 2003, we purchased a 120,000 square foot building
located in Port St. Lucie, Florida for a purchase price, excluding legal fees
and associated acquisition costs, of $3.26 million, for the purpose of
supporting the growth in our Florida businesses. We commenced renovation of the
facility in February 2003.
In January 2003 our Board declared a cash dividend of $0.25 per
share of PolyMedica's common stock to shareholders of record at the close of
business on February 3, 2003, payable on February 13, 2003. We intend to pay
this dividend on a quarterly basis. We expect the quarterly cash dividend
payment to average $3.0 million.
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 February 14, 2003.
We believe that our cash and cash equivalents balance as of December
31, 2002 of $31.92 million and cash flows generated from operations, will be
sufficient to meet working capital, capital expenditure and financing needs,
including the payment of dividends to shareholders, 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 the payment of dividends to
shareholders, 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, "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 December 31, 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.
-33-
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. We do not expect adoption
of this statement to have a material impact on our financial position or results
of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. As
provided for in SFAS No. 123, we have elected to apply Accounting Principles
Board ("APB") No. 25 "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its stock-based compensation plans. APB No. 25
does not require options to be expensed when granted with an exercise price
equal to fair market value. We will comply with the disclosure requirements of
SFAS No. 148.
In November 2002, the FASB issued FASB Interpretation ("FIN") No.
45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of FIN No. 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements of FIN No. 45 are applicable for
financial statements of interim or annual periods ending after December 15,
2002. We adopted FIN No. 45 in the quarter ended December 31, 2002 and will
comply with the new disclosure requirements, as applicable.
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FACTORS AFFECTING FUTURE OPERATING RESULTS
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. 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
In the 2002 legislative session, the United States House of
Representatives (the "House") passed a bill (HR4954) (the "Bill") that would
have required certain 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
Bill required multiple winners in each area of the country and would have
required that the plan be implemented over a three-year period beginning in
2004. Because the United States Senate (the "Senate") did not act on its version
of the Bill, the Bill did not become law during the 2002 legislative session. We
believe that it is likely that legislation similar to the Bill will be
re-introduced to the House and Senate during the 2003 legislative session.
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 would increase reimbursement
for certain providers and authorize certain regulatory relief in the
administrative processes of the Medicare claims and payment rules. It is
uncertain at this time whether such legislation will be enacted and become law.
Inherent reasonableness
Final regulations have been implemented by the Centers for Medicare
and Medicaid Services
-35-
("CMS") that develop a process for identifying whether a payment may be reduced
or increased for a category of items or services if it is determined that such
payment is grossly deficient or excessive. The process set forth in these
regulations could affect the payment for 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 effect on our financial position and results of
operations.
In June 2002, Liberty was served with 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. Liberty completed its response to the subpoena in November
2002.
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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
supplies, 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 invasive 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.
-37-
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 discomfort products and prescription urology and
suppository products. Future sales of these
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products 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
business and two years for our respiratory business, could result in accelerated
charges against our earnings. In addition, new or different marketing
initiatives that may not qualify for direct-response advertising, 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;
- the timing of the introduction or acceptance of new products and
services offered by us or our competitors; and
- 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.
A reduction in working capital or another business change could prevent us from
paying dividends to shareholders
A significant decline in our cash balances or another business
change could cause us to reduce, suspend, or eliminate the quarterly payment of
dividends to shareholders.
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;
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- 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.
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 any further 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.
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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 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.
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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 (a) 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 (b) 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.
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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.
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On December 17, 2001, plaintiffs filed a consolidated derivative
complaint. The consolidated 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. After briefing and a hearing on the
motion, the court 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. 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. On January 23, 2003, the Appeals court docketed the case under the
caption Roberta Casden v. Daniel S. Bernstein and others; No. 2003-P-01070. 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 was served with 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. Liberty completed its response to the subpoena in November
2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index immediately following this report, which is incorporated
herein by reference.
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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/ Stephen C. Farrell
-------------------------
Stephen C. Farrell
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: February 14, 2003
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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.
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/s/ Samuel L. Shanaman
----------------------
Dated: February 14, 2003
Samuel L. Shanaman
Lead Director and Interim Chief Executive Officer
(Principal Executive Officer)
I, Stephen C. Farrell, 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
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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/ Stephen C. Farrell
-----------------------
Dated: February 14, 2003
Stephen C. Farrell
Chief Financial Officer
(Principal Financial Officer)
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Exhibit Index
Exhibit Description
- ------- -----------
10.61 - Letter Agreement amendment to Employment Agreement by and between the
Registrant and Stephen C. Farrell dated February 5, 2003.
99.1 - Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
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