SECURITIES AND EXCHANGE COMMISSION

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 March 31, 2004

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 number 000-25769

ACCREDO HEALTH, INCORPORATED

(Exact name of registrant as specified in its charter)

1640 CENTURY CENTER PKWY, SUITE 101, MEMPHIS, TN 38134

(901) 385-3688

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year,
if changed since last report)

     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 [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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ACCREDO HEALTH, INCORPORATED
INDEX

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2004

1.

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the condensed consolidated financial position, results of operations and cash flows of Accredo Health, Incorporated (the “Company” or “Accredo”) have been included. Operating results for the three and nine-month periods ended March 31, 2004, are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2004.

Certain amounts for the three and nine-month periods ended March 31, 2003 have been reclassified to conform to the presentation for the three and nine-month periods ended March 31, 2004. These reclassifications had no effect on net income or total revenues.

The balance sheet at June 30, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

2.

RESTATEMENT

Subsequent to the issuance of the Company’s fiscal year 2003 quarterly financial statements, the Company’s management determined that previously issued interim financial statements should be restated due to a change in the timing and recognition of revenue. For revenue recognition purposes, prior to April 1, 2003, the Company considered the delivery criteria to have been met when product was shipped to its patients, and the Company had no further obligation related to such product. The Company has now determined that the delivery criteria are met when the product has been delivered to the patient (which typically occurs one day after shipment), and the Company has no further obligation related to such product. The restatement (in thousands, except per share data) resulted in a decrease in net patient revenue of $8,456 for the three months and nine months ended March 31, 2003. The previously reported net loss for the three months ended March 31, 2003 increased from $17,769 to $18,723 and the previously reported net income for the nine months ended March 31, 2003 decreased from $13,250 to $12,296. The previously reported basic and diluted loss per common share was increased by $.02 for the three months ended March 31, 2003 and the previously reported basic and diluted earnings per common share was decreased by $.02 for the nine months ended March 31, 2003.

A summary of the significant effects of the restatement is as follows (in thousands, except per share data):

     Condensed Consolidated Statement of Operations Data:

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3.

STOCKHOLDERS’ EQUITY

     During the quarter and nine months ended March 31, 2004, employees and directors exercised stock options to acquire 311,924 and 601,460 shares of Accredo common stock, respectively. The weighted average option exercise price was $13.27 per share for the quarter and $8.88 per share for the nine-month period.

4.

PRO FORMA NET INCOME EFFECT OF COMPANY STOCK OPTION PLANS

The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Pro forma information regarding net income is required by Statement of Financial Accounting Standards No. 123 (“Statement 123”) and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. Significant assumptions used by the Company in the Black-Scholes option-pricing model computations are as follows for the three-month and nine-month periods ended March 31:

The Black-Scholes option model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the three-month and nine-month periods ended March 31 is as follows (in thousands, except share data):

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5.

COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) includes changes in the fair value of certain derivative financial instruments that qualify for hedge accounting. Comprehensive income (loss) for all periods presented is as follows:

The adjustments made in computing comprehensive income (loss) are reflected as a component of stockholders’ equity under the heading “accumulated other comprehensive loss”.

6.

CONTINGENCIES

Commencing April 8, 2003, the Company and certain officers and directors were named as defendants in several substantially similar putative class action lawsuits filed in the United States District Court for the Western District of Tennessee, Memphis Division. The various complaints have been consolidated into a single action, but the Court has not appointed a Lead Plaintiff. Once the Lead Plaintiff is appointed, a Consolidated Complaint will be filed to which the Defendants will respond. The lawsuits filed to date name the Company, David D. Stevens, Joel Kimbrough, John R. Grow and Thomas W. Bell, Jr. as Defendants. One of the lawsuits also named the Company’s former independent auditor, Ernst & Young LLP, as a defendant. The lawsuits allege violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)(5) promulgated thereunder, and Section 20 of the Securities Exchange Act of 1934. The putative class representatives seek to represent a class of individuals and entities that purchased Company stock during the period June 16, 2002 through April 7, 2003 and who supposedly suffered damages from the alleged violations of the securities laws. The Company believes that the claims asserted in the putative class action lawsuits are without merit.

In addition, two purported derivative lawsuits were filed in the Circuit Court of Shelby County, Tennessee for the Thirtieth Judicial District at Memphis. These actions were consolidated and a Consolidated Derivative Complaint was filed on July 28, 2003. The derivative action names Company officers, directors and a former director; David D. Stevens, John R. Grow, Kyle J. Callahan, Kevin L. Roberg, Kenneth R. Masterson, Kenneth J. Melkus, Dick R. Gourley, Nancy Ann DeParle, Joel R. Kimbrough, Thomas W. Bell, Jr., and Patrick J. Welsh; as defendants. The derivative lawsuit alleges that the defendants breached fiduciary duties owed to the Company by engaging in the same alleged conduct that is the basis of the putative class action lawsuits. On behalf of the Company, the derivative complaint seeks compensatory damages from the defendants and the disgorgement of profits, benefits and other compensation received by the defendants. The Company believes that the claims asserted in the derivative lawsuit are without merit and has filed a Motion to Dismiss the Consolidated Derivative Complaint.

Also, from time to time, the Company is involved in lawsuits, claims, audits and investigations arising in the normal course of its business. In the Company’s opinion, in the aggregate these lawsuits, claims, audits and investigations should not have a material adverse effect on the Company’s business, financial condition, or results of operations. In addition, the business that the Company acquired from Gentiva Health Services, Inc. has several lawsuits and claims related to its historic operation by Gentiva, which are being controlled by Gentiva and for which the Company is entitled to indemnification from liability by Gentiva.

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7.

ACQUISITION

On October 17, 2003, the Company acquired certain assets, including inventory and accounts receivable, of Alpha Therapeutic Services, Inc. (“ATS”) from Baxter Healthcare Corporation. ATS, located in the City of Industry, California, provides pharmaceutical care for certain chronic, long-term patient populations including those requiring IVIG and blood related disorders such as hemophilia. As a result of the acquisition, we have increased our market share in these products. The aggregate purchase price paid was $35.7 million. Total assets acquired were $4.2 million. The excess of the total purchase price over the fair value of the assets acquired was allocated as follows: $30.8 million to goodwill and $0.7 million to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The results of the ATS operations have been included in the consolidated financial statements since October 18, 2003.

8.

EARNINGS PER SHARE

The Company presents earnings per share in accordance with SFAS No. 128, Earnings Per Share. All per share amounts have been calculated using the weighted average number of shares outstanding during each period. Diluted earnings per share are adjusted for the impact of common stock equivalents using the treasury stock method when the effect is dilutive. Options to purchase approximately 26,000 and 2.5 million shares of common stock were outstanding at March 31, 2004 and March 31, 2003, 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 common shares and, therefore, the effect would be antidilutive. A reconciliation of the basic and diluted weighted average shares outstanding is as follows at March 31:

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

Some of the information in this quarterly report contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “intend,” “estimate” and “continue” or similar words. You should read statements that contain these words carefully for the following reasons:

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the statements discuss our future expectations;

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the statements contain projections of our future earnings or of our financial condition; and

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the statements state other “forward-looking” information.

     Specifically, this report contains, among others, forward-looking statements about:

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our expectations regarding our product mix for periods following March 31, 2004;

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our expectations regarding our payor mix for periods following March 31, 2004;

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our expectations regarding the transfer of patients pursuant to our strategic alliance with Medco Health Solutions, Inc. following March 31, 2004;

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our expectations regarding the scope and cost of our capital expenditures following March 31, 2004;

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our sources and availability of funds to satisfy our working capital needs;

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our critical accounting policies; and

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our expectations regarding the percentage of our revenues attributable to federal and state programs.

The forward-looking statements contained in this report reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties. Many important factors could cause our actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict. Important factors that could cause actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements include, among other things, the factors discussed in Part I, Item 2 of this report under the sub-heading “Risk Factors.”

You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we currently expect or anticipate. You should be aware that the occurrence of any of the events described in the risk factors discussed elsewhere in this quarterly report and other events that we have not predicted or assessed could have a material adverse effect on our earnings, financial condition and business. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.

We qualify all of our forward-looking statements by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

OVERVIEW

For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this report. This management’s discussion and analysis should also be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Form 10-K for the fiscal year ended June 30, 2003.

We provide specialty retail pharmacy services for the treatment of patients with costly, chronic diseases. We derive revenues primarily from the retail sale of drugs to patients. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The following table presents the percentage of our total revenues generated from sales with respect to the diseases that we primarily serve:

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In the June 2004 quarter, we anticipate that revenues for the treatment of RSV will represent a much smaller percentage of our overall revenues with an offsetting increase in the percentage of our revenues from the other diseases listed above. Synagis®, for the treatment of RSV, is primarily dispensed in the December and March quarters.

Reimbursement for the products we sell comes from governmental payors, Medicare and Medicaid, and from non-governmental payors. The following table presents the percentage of our total revenues reimbursed by these payors:

The increase in Medicare reimbursement and the related decrease in non-governmental reimbursement from fiscal year 2002 to fiscal year 2003 is due to the increase in revenues from hemophilia factor and the PAH products, Flolan® and Remodulin®, as a result of the acquisition of the SPS division. These are the only products we distributed in fiscal years 2002 and 2003 for which we are reimbursed directly by Medicare. We anticipate that our payor mix for the remainder of our fiscal year 2004 will be similar to the payor mix achieved in fiscal 2003 and the nine months ended March 31, 2004.

STRATEGIC ALLIANCE

On February 9, 2004, we signed a long-term agreement with Medco Health Solutions, Inc. (“Medco”) to become the preferred retail and home delivery pharmacy provider to Medco members for our specialty product lines that we currently dispense to treat patients with long-term, chronic diseases. The agreement includes drugs to treat hemophilia, pulmonary arterial hypertension, RSV, multiple sclerosis, growth hormone deficiency and Gaucher’s disease. We have historically provided our drugs to some Medco members, however, we expect an increase in the number of prescriptions for Medco members resulting from the agreement.

ACQUISITION

On October 17, 2003, we acquired certain assets, including inventory and accounts receivable, of Alpha Therapeutic Services, Inc. (“ATS”) from Baxter Healthcare Corporation. ATS provides pharmaceutical care for certain chronic, long-term patient populations including those requiring IVIG and blood related disorders such as hemophilia. As a result of the acquisition, we have increased our market share in these products. The aggregate purchase price paid was $35.7 million. The results of the ATS operations have been included in the consolidated financial statements since October 18, 2003. During the March 2004 quarter, we completed the transition of the ATS patients into our existing IVIG and hemophilia operations eliminating the facility and related costs previously associated with ATS.

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RESULTS OF OPERATIONS

As discussed in Note 2 to the condensed consolidated financial statements included under Item 1, we have restated our condensed consolidated financial statements for the three and nine-month periods ended March 31, 2003. The following management’s discussion and analysis gives effect to the restatement.

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Revenues. Total revenues increased 14% from $358.1 million to $409.3 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. Net patient revenue increased 14% from $349.4 million to $398.9 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. During fiscal 2003, we began distributing certain wholesale products on a consignment basis for the manufacturer and sold our infertility business thus eliminating revenues from the sale of these products from our business. Revenues from these products amounted to approximately $23.0 million for the three months ended March 2003. Excluding the $23.0 million from the three months ended March 31, 2003 results, our revenues increased 22% from the March 2003 quarter to the March 2004 quarter. The increase is primarily due to volume growth in our products for the treatments of RSV, PAH, growth hormone disorders, hemophilia, autoimmune disorders and PID as a result of the addition of new patients and additional sales of product to existing patients. While we benefited from prior payor agreements with Medco in the March quarter, we did not experience a transfer of new patients pursuant to the new strategic alliance discussed above. However, we do expect the transfer of patients to begin by the end of our fourth quarter. We also benefited from the addition of new and expanded contracts with managed care organizations.

Cost of Sales. Cost of sales increased 15% from $283.5 million to $325.5 million from the three months ended March 31, 2003 to the three months ended March 31, 2004, which is commensurate with the increase in our revenues discussed above. As a percentage of revenues, cost of sales increased from 79.2% to 79.5% from the three months ended March 31, 2003 to the three months ended March 31, 2004, resulting in gross margins of 20.8% and 20.5% for the three months ended March 31, 2003 and 2004, respectively. Gross margins for the individual products have remained relatively stable. However, a change in product mix resulted in a decrease in the composite gross margin in the three months ended March 31, 2004. The primary change in product mix was an increase in the percentage of total revenues of Synagis® for the treatment of RSV from 11% in the three months ended March 31, 2003 to 14% in the three months ended March 31, 2004. Synagis® has a lower gross margin than the composite gross margin.

General and Administrative. General and administrative expense increased from $33.8 million to $34.2 million, or 1%, from the three months ended March 31, 2003 to the three months ended March 31, 2004. As a percentage of revenues, general and administrative expense decreased from 9.4% to 8.4% from the three months ended March 31, 2003 to the three months ended March 31, 2004. Although there has been a slight increase in general and administrative expense, the expense as a percentage of revenues has decreased one percent due to the 14% increase in total revenues from the three months ended March 31, 2003 to the three months ended March 31, 2004, which has resulted in a leveraging of some of our general and administrative expenses.

Bad Debts. Bad debts decreased from $66.1 million to $9.3 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. As a percentage of revenues, bad debt expense was 2.3% for the three months ended March 31, 2004, which is in line with our historical trends. During the March 2003 quarter, we analyzed historical collection rates and other data used in estimating the allowance for doubtful accounts. Our calculations indicated that the accounts receivable reserve needed to be increased. As a result of the new information obtained through the analysis, we recorded a charge to bad debt expense and increased the allowance for doubtful accounts resulting in total bad debt expense of $66.1 million for the three months ended March 31, 2003.

Depreciation and Amortization. Depreciation expense increased from $1.6 million to $2.1 million from the three months ended March 31, 2003 to the three months ended March 31, 2004, as a result of purchases of property and equipment associated with our revenue growth including additional computer hardware and enhancements to our fully integrated pharmacy and reimbursement software system. Amortization expense increased from $1.1 million to $1.2 million from the three months ended March 31, 2003 to the three months ended March 31, 2004 due to additional amortization related to the purchase of the ATS assets.

Interest Income/Expense, Net. Interest expense, net decreased from $2.4 million to $2.0 million from the three months ended March 31, 2003 to the three months ended March 31, 2004 due to a decrease in the amount of debt outstanding and lower interest rates.

Income Tax Expense. Our effective tax rate decreased from 39.3% to 38.6% from the three months ended March 31, 2003 to the three months ended March 31, 2004. The decrease in the effective tax rate for the period is primarily due to a larger

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percentage of our profits being derived from locations that are not taxable in certain states. The difference between the recognized effective tax rate and the statutory rate is primarily attributed to state income taxes.

Nine Months Ended March 31, 2004 Compared to Nine Months Ended March 31, 2003

Revenues. Total revenues increased 9% from $1.044 billion to $1.134 billion from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. Net patient revenue increased 9% from $1.016 billion to $1.103 billion from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. During fiscal 2003, we began distributing certain wholesale products on a consignment basis for the manufacturer and sold our infertility business thus eliminating revenues from the sale of these products from our business. Revenues from these products amounted to approximately $63.9 million for the nine months ended March 31, 2003. Excluding the $63.9 million from the nine months ended March 31, 2003 results, our revenues increased 16% from the March 2003 period to the March 2004 period. The increase is primarily due to volume growth in our products for the treatments of PAH, RSV, growth hormone disorders, hemophilia, autoimmune disorders and PID as a result of the addition of new patients and additional sales of product to existing patients. In addition, we experienced growth in revenues from Avonex® due to product pricing increases. We also benefited from the addition of new and expanded contracts with managed care organizations.

Cost of Sales. Cost of sales increased 8% from $830.2 million to $894.3 million from the nine months ended March 31, 2003 to the nine months ended March 31, 2004, which is commensurate with the increase in our revenues discussed above. As a percentage of revenues, cost of sales decreased from 79.5% to 78.9% from the nine months ended March 31, 2003 to the nine months ended March 31, 2004, resulting in gross margins of 20.5% and 21.1% for the nine months ended March 31, 2003 and 2004, respectively. Gross margins for the individual products have remained relatively stable. However, a change in product mix and lower acquisition costs on some of the products we distribute resulted in an increase in the composite gross margin in the nine months ended March 31, 2004. The primary change in product mix was an increase in the percentage of total revenues from products for the treatment of pulmonary arterial hypertension, which has a higher gross margin percentage than many of the other products we distribute.

General and Administrative. General and administrative expense increased from $97.2 million to $103.2 million, or 6%, from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. As a percentage of revenues, general and administrative expense decreased from 9.3% to 9.1% from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. The increase in expense is primarily due to the increase in audit fees as a result of the change to Deloitte & Touche LLP for the fiscal 2003 audit, increased salaries and benefits associated with the expansion of our support staffs to support the revenue growth and increased insurance premiums. Although there has been a slight increase in general and administrative expense, the expense as a percentage of revenues has decreased 0.2% due to the 9% increase in total revenues from the nine months ended March 31, 2003 to the nine months ended March 31, 2004, which has resulted in a leveraging of some of our general and administrative expenses.

Bad Debts. Bad debts decreased from $80.3 million to $23.7 million from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. As a percentage of revenues, bad debt expense was 2.1% for the nine months ended March 31, 2004, which is in line with our historical trends. During the March 2003 quarter, we analyzed historical collection rates and other data used in estimating the allowance for doubtful accounts. Our calculations indicated that the accounts receivable reserve needed to be increased. As a result of the new information obtained through the analysis, we recorded a charge to bad debt expense and increased the allowance for doubtful accounts resulting in total bad debt expense of $80.3 million for the nine months ended March 31, 2003.

Depreciation and Amortization. Depreciation expense increased from $4.1 million to $5.8 million from the nine months ended March 31, 2003 to the nine months ended March 31, 2004, as a result of purchases of property and equipment associated with our revenue growth including additional computer hardware and enhancements to our fully integrated pharmacy and reimbursement software system. Amortization expense increased from $3.4 million to $3.5 million from the nine months ended March 31, 2003 to the nine months ended March 31, 2004 due to additional amortization related to the purchase of the ATS assets.

Interest Income/Expense, Net. Interest expense, net decreased from $7.2 million to $6.4 million from the nine months ended March 31, 2003 to the nine months ended March 31, 2004 due to a decrease in the amount of debt outstanding and lower interest rates.

Income Tax Expense. Our effective tax rate decreased from 39.6% to 38.6% from the nine months ended March 31, 2003 to the nine months ended March 31, 2004. The decrease in the effective tax rate for the period is primarily due to a larger percentage of our profits being derived from locations that are not taxable in certain states. The difference between the recognized effective tax rate and the statutory rate is primarily attributed to state income taxes.

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LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2004, working capital was $325.6 million, cash and cash equivalents were $44.6 million and the current ratio was 2.3 to 1.0.

Net cash provided by operating activities was $49.2 million for the nine months ended March 31, 2004. During the nine months ended March 31, 2004, accounts receivable increased $41.1 million, inventories increased $48.3 million and accounts payable, accrued expenses and income taxes payable increased $52.4 million. These changes are due primarily to our revenue growth and the timing of the collection of receivables, inventory purchases and payments of accounts payable.

Net cash used in investing activities was $46.1 million for the nine months ended March 31, 2004. Cash used in investing activities consisted primarily of $35.7 million for the purchase of the ATS assets and $10.2 million for purchases of property and equipment.

Net cash used in financing activities was $6.5 million for the nine months ended March 31, 2004, which consisted of $12.5 million in debt repayments, $1.4 million of distributions to our minority interest partner less $6.1 million from the net proceeds of stock option exercises and $1.3 million from the proceeds of long-term borrowings.

Historically, we have funded our operations and continued internal growth through cash provided by operations. We anticipate that our capital expenditures for the fiscal year ending June 30, 2004 will consist primarily of additional computer hardware, enhancements to our fully integrated pharmacy and reimbursement software system and costs to build out and furnish additional space needed to meet the needs of our growth. We expect the cost of our capital expenditures in fiscal year 2004 to be approximately $14.0 million, exclusive of any acquisitions of businesses. We expect to fund the remaining expenditures through cash provided by operating activities and/or borrowings under the revolving credit facility with our bank.

During 2002, we amended our $60 million revolving credit facility with Bank of America, N.A. and other participating banks (collectively the “Lenders”) to increase the size of the credit facility to $325 million. The credit facility consists of a $125 million revolving commitment due June 2007, a $75 million term loan (Tranche A Term Loan) due in periodic principal payments through March 2007, and a $125 million term loan (Tranche B Term Loan) due in periodic principal payments through March 2009. The amount available to borrow under this credit facility is based upon certain ratios calculated as of the end of each quarter. Based upon the asset coverage ratio as of March 31, 2004, the total amount available to borrow is approximately $308 million. As of March 31, 2004, the total amount outstanding under the credit facility was $182.5 million, which included $60.0 million under the Tranche A Term Loan and $122.5 million under the Tranche B Term Loan.

Amounts outstanding under the credit agreement bear interest at varying rates based upon the London Inter-bank Offered Rate (“LIBOR”) or the prime rate of interest (as selected by us), plus a variable margin rate based upon our leverage ratio as defined by the credit agreement. Our obligations under the credit agreement are secured by a lien on substantially all of our assets, including a pledge of all of the common stock or partnership interest of each of our subsidiaries in which we own an 80% or more interest. The Lenders’ security interest in a portion of our inventory is subordinate to the liens on that inventory under the terms of a security agreement between one of our vendors and us. The same vendor has a security interest in certain accounts receivable, which is subordinate to the rights of the Lenders.

The credit agreement contains financial covenants, including requirements to maintain certain ratios with respect to leverage, fixed charge coverage, net worth and asset coverage each as defined in the credit agreement. The credit agreement also includes customary affirmative and negative covenants, including covenants relating to transactions with affiliates, uses of proceeds, restrictions on subsidiaries, limitations on indebtedness, limitations on mergers, acquisitions and asset dispositions, limitations on investments, limitations on payment of dividends and stock repurchases, and other distributions. The credit agreement also contains customary events of default, including events relating to changes in control of our company.

The credit agreement required us to enter into a one-year interest rate swap agreement within 60 days of June 13, 2002, to protect against fluctuations in interest rates. The credit agreement required the interest rate swap to provide coverage in an amount equal to at least 50% of the outstanding principal amount of the loans. On July 17, 2002, we entered into an interest rate swap agreement effectively converting for a period of one year $120 million of floating-rate borrowings to fixed-rate borrowings with a fixed rate of 2.175%, plus the applicable margin rate as determined by the credit agreement. On June 4, 2003, we entered into an interest rate swap agreement effectively converting for a period of one year beginning July 21, 2003, $120 million of floating-rate borrowings to fixed-rate borrowings with a fixed rate of 1.14%, plus the applicable margin rate as determined by the credit agreement.

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On May 5, 2003, we amended the credit agreement to exclude the charges, as defined in the amendment to the credit agreement, taken in the March 2003 quarter in connection with the additional accounts receivable reserves of the SPS division from the calculation of Consolidated EBITDA, as defined in the credit agreement, and to reduce the Consolidated Net Worth requirement, as defined in the credit agreement, to allow for a reduction in the minimum net worth requirement equal to the net loss incurred in the March 2003 quarter. The amendment also included a 25 basis point increase in interest rates per the credit agreement for a period of twelve months beginning May 15, 2003.

On November 18, 2003, we amended our credit agreement lowering the margin on the Tranche B Term Loan to 2.25% for LIBOR based loans and ..75% for prime rate based loans effectively reducing the margin by 50 basis points through May 2004 and 25 basis points for the remaining term of the loan. We paid Bank of America, N.A. $175,000 in administrative fees to obtain the amendment.

On February 6, 2003, the Securities and Exchange Commission (“SEC”) declared effective our shelf registration statement on Form S-3 providing for the offer, from time to time, of various securities, up to an aggregate of $500 million. The shelf registration statement may enable us to more efficiently raise funds from the offering of securities covered by the shelf registration statement, subject to market conditions and our capital needs.

We believe that our cash from operations, cash available under the revolving credit facility and the proceeds from any offering of debt or equity securities allowed by the shelf registration statement will be sufficient to meet our internal operating requirements and growth plans for at least the next 12 months.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and judgments on an ongoing basis. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates, and different assumptions or conditions may yield different estimates.

Information regarding our “Critical Accounting Policies and Estimates” can be found in our Annual Report on Form 10-K for our most recent fiscal year ended June 30, 2003, filed with the SEC on September 29, 2003. The four critical accounting policies that we believe are either the most judgmental, or involve the selection or application of alternative accounting policies, and are material to our financial statements are those relating to revenue recognition, allowance for doubtful accounts, allowance for contractual discounts and medical claims reserve. In addition, Note 1 to the financial statements in our Annual Report contains a summary of our significant accounting policies.

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RISK FACTORS

     You should carefully consider the risks and uncertainties we describe below before investing in Accredo. The risks and uncertainties described below are not the only risks and uncertainties that could develop. Other risks and uncertainties that we have not predicted or evaluated could also affect our company.

     If any of the following risks occur, our earnings, financial condition or business could be materially harmed, and the trading price of our common stock could decline, resulting in the loss of all or part of your investment.

We are highly dependent on our relationships with a limited number of biopharmaceutical suppliers and the loss of any of these relationships could significantly impact our ability to sustain or grow our revenues.

     Approximately 33% of our revenue in the quarter was derived from the sale of IVIG and hemophilia product. The majority of our IVIG and hemophilia product was purchased from Baxter Healthcare Corporation. We also derive a substantial percentage of our revenue and profitability from our relationships with Biogen, Genzyme, GlaxoSmithKline and MedImmune. Our revenue derived from these relationships represented approximately 42% of our revenue for the quarter.

     Our agreements with these suppliers are short-term and cancelable by either party without cause on 30 to 365 days prior notice. These agreements also generally limit our ability to handle competing drugs during and, in some cases, after the term of the agreement, but allow the supplier to distribute through channels other than us. Further, these agreements provide that pricing and other terms of these relationships be periodically adjusted for changed market conditions or required service levels. Any termination or adverse adjustment to any of these relationships could have a material adverse effect on a significant portion of our business, financial condition and results of operations.

Our ability to grow could be limited if we do not expand our existing base of drugs or if we lose patients.

     We primarily sell 20 product lines. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The drugs that we sell with respect to the following core disease markets accounted for approximately 89% of our revenues for the quarter, with the drugs for hemophilia, autoimmune disorders and PID constituting approximately 33% of our revenue for the period:

•

Hemophilia, Autoimmune Disorders, PID and Hereditary Emphysema

•

Pulmonary Arterial Hypertension

•

Multiple Sclerosis

•

Lysosomal Storage Disorders such as Gaucher Disease (also known as Enzyme Deficiencies)

•

Growth Hormone-Related Disorders

•

Respiratory Syncytial Virus

     Due to the small patient populations that use the drugs we handle, our future growth is highly dependent on expanding our base of drugs. Further, a loss of patient base or reduction in demand for any reason of the drugs we currently handle could have a material adverse effect on a significant portion of our business, financial condition and results of operations.

Our business would be harmed if demand for our products and services is reduced.

     Reduced demand for our products and services could be caused by a number of circumstances, including:

•

patient shifts to treatment regimens other than those we offer;

•

new treatments or methods of delivery of existing drugs that do not require our specialty products and services;

•

a recall of a drug;

•

adverse reactions caused by a drug;

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	•		the expiration or challenge of a drug patent;
	•		competing treatment from a new drug or a new use of an existing drug;
	•		the loss of a managed care or other payor relationship covering a number of high revenue patients;

•

the cure of a disease we service; or

•

the death of a high-revenue patient.

There is substantial competition in our industry, and we may not be able to compete successfully.

     The specialty pharmacy industry is highly competitive and is continuing to become more competitive. Most of the drugs, supplies and services that we provide are also available from our competitors. Our current and potential competitors include:

•

other specialty pharmacy distributors;

•

specialty pharmacy divisions of wholesale drug distributors;

•

pharmacy benefit management companies (“PBM”);

•

hospital-based pharmacies;

•

retail pharmacies;

•

home infusion therapy companies;

•

manufacturers that sell their products both to distributors and directly to users;

•

comprehensive hemophilia treatment centers;

•

patient support groups and payors entering the specialty pharmacy distribution business; and

•

other alternative site health care providers.

     Many of our competitors have substantially greater resources and more established operations and infrastructure than we have. We are particularly at risk from any of our suppliers deciding to pursue its own distribution and services and not outsource these needs to companies like us. A significant factor in effective competition will be our ability to maintain and expand relationships with managed care companies, pharmacy benefit managers and other payors who can effectively determine the pharmacy source for their enrollees.

Entry by PBMs into the specialty pharmacy market, our strategic alliance with Medco Health Solutions, and consolidation in the industry could affect our ability to serve patients.

     Caremark Rx, Inc. and AdvancePCS recently combined to form the nation’s second largest pharmacy benefit manager, processing drug claims for about 95 million individuals with about 600 million prescriptions filled per year. Express Scripts, Inc., which provides PBM services to over 50 million members acquired Curascripts on January 30, 2004. All of these firms are our customers and competitors. On February 9, 2004, we entered into a 10-year strategic alliance with Medco Health Solutions, Inc. where we became the preferred retail and home delivery pharmacy provider to Medco’s members for our specialty pharmacy products. We expect that there will be further consolidation among specialty pharmacy providers. As pharmacy benefits managers acquire specialty pharmacy capability, it is likely that they will attempt to cancel their relationships with entities that compete with the PBM specialty pharmacy operations, and to cause the PBM patients to obtain their drugs from the PBM’s specialty pharmacy.

Our business could be harmed by changes in Medicare or Medicaid.

     Changes in the Medicare, Medicaid or similar government programs or the amounts paid by those programs for our services may adversely affect our earnings. Such programs are highly regulated and subject to frequent and substantial changes and cost containment measures. In recent years, changes in these programs have limited and reduced reimbursement to providers. The Medicare Prescription Drug, Improvement and Modernization Act of 2003, recently enacted into law,

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provides for Medicare rate reductions that were effective January 1, 2004. Hemophilia products were excluded from the rate change of AWP less 5% to AWP less 15%. It is not clear as to the impact of the Act, if any, on hemophilia product reimbursement in fiscal 2005 and 2006. We understand that it is CMS’s intention that the ASP plus 6% reimbursement formula will affect Hemophilia products during these periods. Regulations implementing the Act have not been finalized at this time. We expect that these developments could ultimately reduce prices and margins on some of the drugs that we distribute.

     In order to deal with budget shortfalls, some states are attempting to create state administered prescription drug discount plans, limit the number of prescriptions per person that are covered, raising Medicaid co-pays and deductibles, proposing more restrictive formularies and proposing reductions in pharmacy reimbursement rates. For example, California’s Medicaid program, MediCal, recently adopted a plan that will shift away from use of the discounted AWP, instead using Average Selling Price plus 20% for hemophilia products. California has not yet determined exactly how it will calculate Average Selling Price. The State of California adopted a 5% reimbursement rate reduction paid to providers of the state’s MediCal program, which was scheduled to take effect on January 1, 2004. On December 23, 2003, the United States District Court for the Eastern District of California issued an injunction enjoining the State from implementing this reduction. The length of the injunction and the ultimate outcome of this litigation are uncertain at this time. Any reduction in the reimbursement from MediCal could adversely impact revenues and profitability from the sale of drugs by us or by our two partnerships in California to patients covered by MediCal. Any reductions in amounts reimbursable by government programs for our services or changes in regulations governing such reimbursements could materially and adversely affect our business, financial condition and results of operations.

Changes in average wholesale prices could reduce our pricing and margins.

     Many government payors, including Medicare and Medicaid, pay us directly or indirectly at a percentage off the drug’s AWP. We have also contracted with a number of private payors to sell drugs at AWP or at a percentage off AWP. AWP for most drugs is compiled and published by several private companies, including First DataBank, Inc. In February 2000, First DataBank published a Market Price Survey of 437 drugs, which was significantly lower than the historic AWP for a number of the hemophilia products and IVIG products that we sell. A number of state Medicaid agencies have revised their payment methodology as a result of the Market Price Survey.

     The recently enacted Medicare Prescription Drug, Improvement and Modernization Act of 2003, changes the way the federal government pays for certain Part B drugs. Regulations implementing the Act have not been finalized at this time. We expect that these developments could ultimately reduce prices and margins on some of the drugs that we distribute.

     Various federal and state government agencies have been investigating whether the reported AWP of many drugs, including some that we sell, is an appropriate or accurate measure of the market price of the drugs. There are also several whistleblower lawsuits pending against various drug manufacturers that have been reported in the business press. These government investigations and lawsuits involve allegations that manufacturers reported artificially inflated AWP prices of various drugs to First DataBank.

     We cannot predict the eventual results of these law changes, government proposals, investigations, lawsuits or the changes made by First DataBank. If government payors or private payors revise their pricing based on new methods of calculating the AWP for drugs we handle or implement reimbursement methodology based on some value other than AWP, this could have a material adverse effect on our business, financial condition and results of operation, including reducing the pricing and margins on certain of our products.

Our business will suffer if we lose relationships with payors.

     We are highly dependent on reimbursement from non-governmental payors. For the fiscal years ended June 30, 2001, 2002 and 2003 and the nine months ended March 31, 2004, we derived approximately 81%, 79%, 73% and 72% respectively of our gross patient revenue from non-governmental payors (including self-pay), which included 4%, 3%, 1% and 1%, respectively for those periods, from sales to private physician practices whose ultimate payor is typically Medicare.

     Many payors seek to limit the number of providers that supply drugs to their enrollees. For example, we were selected by Aetna, Inc. as one of three providers of injectable medications. We received approximately 7% of our total revenues from Aetna in the fiscal year ended June 30, 2003. From time to time, payors with whom we have relationships require that we and our competitors bid to keep their business, and there can be no assurance that we will be retained or that our margins will not be adversely affected when that happens. The loss of a payor relationship, for example, our relationship with Aetna, Inc. and affiliates (which is terminable on 90 days notice), or an adverse change in the financial condition of a payor like Aetna, could

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result in the loss of a significant number of patients and have a material adverse effect on our business, financial condition and results of operations.

We incurred additional debt to acquire the SPS business of Gentiva Health Services, Inc. which may limit our future financial flexibility.

     The current level of our debt will have several important effects on our future operations, including, among others:

•

A significant portion of our cash flow from operations will be dedicated to the payment of principal on the debt and will not be available for other purposes;

•

Our debt covenants will require us to meet financial tests, and may impose other limitations that may limit our flexibility in planning for and reacting to changes in our business, including possible acquisition opportunities;

•

Our ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate and other purposes may be limited;

•

Failure to meet our debt covenants could result in foreclosure by our lenders or an increase in the interest rate or administrative fees associated with our debt;

•

We may be at a competitive disadvantage to similar companies that have less debt; and

•

Our vulnerability to adverse economic and industry conditions may increase.

Our business could be harmed if payors decrease or delay their payments to us or seek to recoup payments already made.

     Our profitability depends on payment from governmental and non-governmental payors, and we could be materially and adversely affected by cost containment trends in the health care industry or by financial difficulties suffered by non-governmental payors. Cost containment measures affect pricing, purchasing and usage patterns in health care. Payors also influence decisions regarding the use of a particular drug treatment and focus on product cost in light of how the product may impact the overall cost of treatment. Further, some payors, including large managed care organizations and some private physician practices, have recently experienced financial trouble. The timing of payments and our ability to collect from payors also affects our revenue and profitability. Payors also have contractual rights to audit our books and records to determine if they have overpaid us. If we are unable to collect from payors or if payors fail to pay us in a timely manner, or if payors seek to recoup payments already made to us, it could have a material adverse effect on our business and financial condition.

If any of our relationships with medical centers are disrupted or cancelled, our business could be harmed.

     We have joint venture relationships with four medical centers that provide services primarily related to hemophilia, growth hormone-related disorders and RSV. For the fiscal years ended June 30, 2001, 2002 and 2003, we derived approximately 4% of our income before income taxes from equity in the net income of unconsolidated joint ventures. We derived approximately 2% of our income before income taxes from equity in the net income of unconsolidated joint ventures during the most recent quarter.

     We own 80% of one of our joint ventures with Children’s Home Care, Inc. and the financial results of this joint venture are included in our consolidated financial results. This consolidated joint venture represented approximately 10% of our income before income taxes for the fiscal years ended June 30, 2001 and 2002, 17% of our income before income taxes for the fiscal year ended June 30, 2003 and 8% of our income before income taxes in the most recent quarter.

     Recently, the OIG issued a Special Advisory Bulletin focused on complex contractual joint ventures that could potentially violate the anti-kickback statute. In this bulletin, the OIG discussed the characteristics that potentially indicate a prohibited arrangement. Some of these characteristics are present in our existing joint ventures. As a result, some of our joint ventures may be restructured.

     In addition to joint venture relationships, we also provide pharmacy management services to several medical centers. Our agreements with medical centers have terms of between one and five years, and may be cancelled by either party without cause upon notice of between one and twelve months. Adverse changes in our relationships with those medical centers could be caused, for example, by:

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	•		changes caused by consolidation within the hospital industry;
	•		changes caused by regulatory uncertainties inherent in the structure of the relationships; or restrictive changes to regulatory requirements.

     Any termination or adverse change of these relationships could have a material adverse effect on our business, financial condition and results of operations.

If additional providers obtain access to favorable PHS pricing for drugs we handle, our business could be harmed.

     The federal pricing program of the Public Health Service, commonly known as PHS, allows hospitals and hemophilia treatment centers to obtain discounts on hemophilia products. While we are able to access PHS pricing through our contracts to provide contract pharmacy services to hemophilia treatment centers, we are not eligible to participate directly in these programs. Increased competition from hospitals and hemophilia treatment centers that have such favorable pricing may reduce our profit margins.

Our acquisition and joint venture strategy may not be successful, which could cause our business and future growth prospects to suffer.

     As part of our growth strategy, we continue to evaluate acquisition and joint venture opportunities, but we cannot predict or provide assurance that we will complete any future acquisitions or joint ventures. Acquisitions and joint ventures involve many risks, including:

•

difficulty in identifying suitable candidates and negotiating and consummating acquisitions on attractive terms;

•

difficulty in assimilating the new operations;

•

increased transaction costs;

•

diversion of our management’s attention from existing operations;

•

dilutive issuances of equity securities that may negatively impact the market price of our stock;

•

increased debt; and

•

increased amortization expense related to intangible assets that would decrease our earnings.

     We could also be exposed to unknown or contingent liabilities resulting from the pre-acquisition operations of the entities we acquire, such as liability for failure to comply with health care or reimbursement laws. We also face exposure if any seller of an entity which we acquire, is not able to fulfill its indemnification obligations under the terms of the purchase agreement. We may suffer impairment of assets or have to bear a liability for which we are entitled to indemnification but are unable to collect.

Fluctuations in our quarterly financial results may cause our stock price to decline.

     Our results of operations may fluctuate on a quarterly basis, which could adversely affect the market price of our common stock. Our results may fluctuate as a result of:

•

lower prices paid by Medicare or Medicaid for the drugs that we sell, including lower prices resulting from recent state and federal legislation and revisions in the method of establishing AWP;

•

below-expected sales or delayed launch of a new drug;

•

price and term adjustments with our drug suppliers;

•

increases in our operating expenses in anticipation of the launch of a new drug;

•

product shortages;

•

inaccuracies in our estimates of the costs of ongoing programs; the timing and integration of our acquisitions;

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•

changes in our estimates used to prepare our financial statements;

•

effectiveness of our sales force;

•

changes in governmental regulations;

•

the annual renewal of deductibles and co-payment requirements that affect patient ordering patterns;

•

our provision of drugs to treat seasonal illnesses, such as RSV;

•

physician prescribing patterns;

•

general political and economic conditions;

•

interest rate fluctuations; and

•

adverse experience in collection of accounts receivable.

Our business would be harmed if the biopharmaceutical industry reduces research, development and production of the types of drugs that are compatible with the services we provide.

     Our business is highly dependent on continued research, development, manufacturing and marketing expenditures of biopharmaceutical companies, and the ability of those companies to develop, supply and generate demand for drugs that are compatible with the services we provide. Our business would be materially and adversely affected if those companies stopped outsourcing the services we provide or failed to support existing drugs or develop new drugs. Our business could also be harmed if the biopharmaceutical industry undergoes any of the following developments:

•

supply shortages;

•

adverse drug reactions;

•

drug recalls;

•

increased competition among biopharmaceutical companies;

•

an inability of drug companies to finance product development because of capital shortages;

•

a decline in product research, development or marketing;

•

a reduction in the retail price of drugs from governmental or private market initiatives;

•

changes in the FDA approval process; or

•

governmental or private initiatives that would alter how drug manufacturers, health care providers or pharmacies promote or sell products and services.

Our business could be harmed if the supply of any of the products that we distribute becomes scarce.

     The biopharmaceutical industry is susceptible to product shortages such as the shortage in products for treatment of Hereditary Emphysema. Some of the products that we distribute, such as some of our hemophilia products, IVIG and some other blood-related products, are collected and processed from human donors. Accordingly, the supply of these products is highly dependent on human donors and their availability has been constrained from time to time. There was also an industry wide recombinant factor VIII product shortage that existed for some time, as a result of the manufacturers being unable to increase production to meet rising global demand. Supply of this drug has only recently returned to normal levels. If these products, or any of the other drugs that we distribute, are in short supply for long periods of time, our business could be harmed.

If some of the drugs that we provide lose their “orphan drug” status, we could face more competition.

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     Our business could also be adversely affected by the expiration or challenge to the orphan drug status that has been granted by the FDA to some of the drugs that we handle. When the FDA grants orphan drug status, it will not approve a second drug for the same treatment for a period of seven years unless the new drug is chemically different or clinically superior. Not all of the drugs that we sell which are related to our core disease states have orphan drug status. The loss of orphan drug status, or approval of new drugs notwithstanding orphan drug status, could result in additional competitive drugs entering the market, which could harm our business.

We rely heavily on a single shipping provider, and our business would be harmed if our rates are increased or our provider is unavailable.

     Almost all of our revenues result from the sale of drugs we deliver to our patients and a single carrier, FedEx, ships principally all of our products. We depend heavily on these outsourced shipping services for efficient, cost effective delivery of our product. The risks associated with this dependence include:

•

any significant increase in shipping rates;

•

strikes or other service interruptions by our primary carrier, FedEx, or by another carrier that could affect FedEx; or

•

spoilage of high cost drugs during shipment, since our drugs often require special handling, such as refrigeration.

Disruptions in commercial activities such as those following the September 2001 terrorist attacks on the U.S. may adversely impact our results of operations, our ability to raise capital or our future growth.

     Our operations have been and could again be harmed by terrorist attacks on the U.S. For example, transportation systems and couriers that we rely upon to deliver our drugs have been and could again be disrupted, thereby causing a decrease in our revenues. In addition, we may experience a rise in operating costs, such as costs for transportation, courier services, insurance and security. We also may experience delays in payments from payors, which would harm our cash flow. The U.S. economy in general may be adversely affected by terrorist attacks or by any related outbreak of hostilities. Any such economic downturn could adversely impact our results of operations, impair our cost of or ability to raise debt or equity capital or impede our ability to continue growing our business.

If we are unable to manage our growth effectively, our business will be harmed.

     Our rapid growth over the past several years has placed a strain on our resources, and if we cannot effectively manage our growth, our business, financial condition and results of operations could be materially and adversely affected. We have experienced a large increase in the number of our employees, the size of our programs and the scope of our operations. Our ability to manage this growth and be successful in the future will depend partly on our ability to retain skilled employees, enhance our management team and improve our management information and financial control systems.

We could be adversely affected by an impairment of the significant amount of goodwill and other intangibles on our financial statements.

     Our formation and our acquisitions have resulted in the recording of a significant amount of goodwill on our financial statements. The goodwill was recorded because the fair value of the tangible net assets acquired was less than the purchase price. There can be no assurance that we will realize the full value of this goodwill. We evaluate on an on-going basis whether events and circumstances indicate that all or some of the carrying value of goodwill is no longer recoverable, in which case we would write off the unrecoverable goodwill in a charge to our earnings. As of March 31, 2004, we had goodwill, net of accumulated amortization, of approximately $383 million, or 37% of total assets and 66% of stockholders’ equity.

     Since our growth strategy may involve the acquisition of other companies, we may record additional goodwill in the future. The possible write-off of this goodwill could negatively impact our future earnings. We will also be required to allocate a portion of the purchase price of any acquisition to the value of non-competition agreements, patient base and contracts that are acquired. The amount allocated to these items could be amortized over a fairly short period. As a result, our earnings and the market price of our common stock could be negatively impacted.

We rely on a few key employees whose absence or loss could adversely affect our business.

     We depend on a few key executives, and the loss of their services could cause a material adverse effect to our company. We do not maintain “key person” life insurance policies on any of those executives. As a result, we are not insured against the

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losses resulting from the death of our key executives. Further, we must be able to attract and retain other qualified, essential employees for our technical operating and professional staff, such as pharmacists and nurses. If we are unable to attract and retain these essential employees, our business could be harmed.

We have been named in several shareholder class action lawsuits and a shareholders’ derivative lawsuit asserting claims under the securities laws.

     The uncertainty associated with these unresolved lawsuits could harm our business and financial condition. The defense of these lawsuits also could result in litigation fees and costs, as well as the diversion of resources. Negative developments with respect to the lawsuits could cause our stock price to decline significantly. The indemnification provisions contained in our Certificate of Incorporation and Bylaws require us to indemnify our current and former officers and directors who are named as defendants against the allegations contained in these suits. Even though we maintain directors and officers insurance applicable to the lawsuits, there can be no guarantee that the proceeds of such insurance will be available for defense fees and costs, or payment of any settlement or judgment in the lawsuits or, if available, will be sufficient to cover the fees and costs and any settlement or judgment imposed against us.

     The ultimate cost and effect of these lawsuits on our financial condition, results of operations, customer relations and management is unknown at this time.

     In addition to the securities litigation currently pending against us and our officers and directors, we may also in the future be the target of similar litigation. Additional securities litigation could result in substantial costs and divert our attention and resources.

We may need additional capital to finance our growth and capital requirements, which could prevent us from fully pursuing our growth strategy.

     In order to implement our growth strategy, we will need substantial capital resources and will incur, from time to time, short- and long-term indebtedness, the terms of which will depend on market and other conditions. We cannot be certain that existing or additional financing will be available to us on acceptable terms, if at all. As a result, we could be unable to fully pursue our growth strategy. Further, additional financing may involve the issuance of equity or debt securities that would reduce the percentage ownership of our then current stockholders.

Our industry is subject to extensive government regulation and noncompliance by us or our suppliers could harm our business.

     The marketing, sale and purchase of drugs and medical supplies is extensively regulated by federal and state governments, and if we fail or are accused of failing to comply with laws and regulations, we could suffer a material adverse effect on our business, financial condition and results of operations. Our business could also be materially and adversely affected if the suppliers or others we work with are accused of violating laws or regulations. The applicable regulatory framework is complex, and the laws are very broad in scope. Many of these laws remain open to interpretation, and have not been addressed by substantive court decisions.

     The health care laws and regulations that especially apply to our activities include:

•

The federal “Anti-Kickback Law” prohibits the offer or solicitation of compensation in return for the referral of patients covered by almost all governmental programs, or the arrangement or recommendation of the purchase of any item, facility or service covered by those programs. The Health Insurance Portability and Accountability Act (“HIPAA”) created new violations for fraudulent activity applicable to both public and private health care benefit programs and prohibits inducements to Medicare or Medicaid eligible patients. The potential sanctions for violations of these laws range from significant fines, to exclusion from participation in the Medicare and Medicaid programs, to criminal sanctions. Although some “safe harbor” regulations attempt to clarify when an arrangement will not violate the Anti-Kickback Law, our business arrangements and the services we provide may not fit within these safe harbors. Failure to satisfy a safe harbor requires analysis of whether the parties intended to violate the Anti-Kickback Law. The finding of a violation could have a material adverse effect on our business.

•

The Department of Health and Human Services (“DHHS”) has issued regulations implementing the Administrative Simplification provisions of HIPAA concerning the maintenance of privacy and security of individually identifiable health information. These new regulations require the development and implementation of measures to maintain the privacy and security of health information and require that certain health claims transactions be conducted in accordance with uniform standards. These regulations govern health care providers, health plans and health

24

			clearinghouses. Failure to comply with these regulations, or wrongful disclosure of confidential patient information could result in the imposition of administrative or criminal sanctions, including exclusion from the Medicare and state Medicaid programs. In addition, if we choose to distribute drugs through new distribution channels such as the Internet, we will have to comply with government regulations that apply to those distribution channels, which could have a material adverse effect on our business.
	•		The Ethics in Patient Referrals Act of 1989, as amended, commonly referred to as the “Stark Law,” prohibits physician referrals to entities with which the physician or their immediate family members have a “financial relationship.” A violation of the Stark Law is punishable by civil sanctions, including significant fines and exclusion from participation in Medicare and Medicaid.

•

State laws prohibit the practice of medicine, pharmacy and nursing without a license. To the extent that we assist patients and providers with prescribed treatment programs, a state could consider our activities to constitute the practice of medicine. If we are found to have violated those laws, we could face civil and criminal penalties and be required to reduce, restructure, or even cease our business in that state.

•

Pharmacies and pharmacists must obtain state licenses to operate and dispense drugs. Pharmacies must also obtain licenses in some states to operate and provide goods and services to residents of those states. Our entities that provide nursing for our patients and our nurses must obtain licenses in certain states to conduct our business. If we are unable to maintain our licenses or if states place burdensome restrictions or limitations on non-resident pharmacies or nurses, this could limit or affect our ability to operate in some states which could adversely impact our business and results of operations.

•

Federal and state investigations and enforcement actions continue to focus on the health care industry, scrutinizing a wide range of items such as joint venture arrangements, referral and billing practices, product discount arrangements, home health care services, dissemination of confidential patient information, clinical drug research trials and gifts for patients. Recently, the OIG issued a Special Advisory Bulletin focused on complex contractual joint ventures that could potentially violate the anti- kickback statute. In this bulletin, the OIG discussed the characteristics that potentially indicate a prohibited arrangement. Some of these characteristics are present in our existing joint ventures.

•

The False Claims Act encourages private individuals to file suits on behalf of the government against health care providers such as us. Such suits could result in significant financial sanctions or exclusion from participation in the Medicare and Medicaid programs.

The market price of our common stock may experience substantial fluctuations for reasons over which we have little control.

     Our common stock is traded on the Nasdaq National Market System. The market price of our common stock could fluctuate substantially based on a variety of factors, including the following:

•

future announcements concerning us, our competitors, the drug manufacturers with whom we have relationships or the health care market;

•

changes in government regulations;

•

overall volatility of the stock market;

•

changes in estimates by analysts; and

•

changes in operating results from quarter to quarter.

     Furthermore, stock prices for many companies fluctuate widely for reasons that may be unrelated to their operating results. These fluctuations, coupled with changes in our results of operations and general economic, political and market conditions, may adversely affect the market price of our common stock.

Some provisions of our charter documents and the Stockholder Protection Rights Plan may have anti-takeover effects that could discourage a change in control, even if an acquisition would be beneficial to our stockholders.

     Our certificate of incorporation, our bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. In addition, our Board of Directors has

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adopted a Stockholder Protection Rights Plan, sometimes referred to as a poison pill, which would substantially dilute the interest sought by an acquirer.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to the impact of financial market risk is significant. Our primary financial market risk exposure consists of interest rate risk related to interest that we are obligated to pay on our variable-rate debt.

We use derivative financial instruments to manage some of our exposure to rising interest rates on our variable-rate debt, primarily by entering into variable-to-fixed interest rate swaps. We have fixed the interest rate through July 21, 2003 on $120.0 million of our variable-rate debt through the use of a variable-to-fixed interest rate swap. As a result, we will not benefit from any decrease in interest rates nor will we be subjected to any detriment from rising interest rates on this portion of our debt during the period of the swap agreement. Accordingly, a 100 basis point decrease in interest rates along the entire yield curve would not increase pre-tax income by $300,000 for a quarter as would be expected without this financial instrument. However, a 100 basis point increase in interest rates along the entire yield curve would also not decrease pre-tax income by $300,000 for the same period as a result of using this derivative financial instrument.

For the remaining portion of our variable-rate debt, we have not hedged against our interest rate risk exposure. As a result, we will benefit from decreasing interest rates, but rising interest rates on this portion of our debt will also harm us. Accordingly, if we maintain our current level of total debt, a 100 basis point decrease in interest rates along the entire yield curve would result in an increase in pre-tax income of approximately $160,000 during a quarter. However, a 100 basis point increase in interest rates would result in a decrease in pre-tax income of approximately $160,000 for the same period.

Actual changes in rates may differ from the hypothetical assumptions used in computing the exposures in the examples cited above.

ITEM 4. CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report the Company maintains disclosure controls and procedures that provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There have been no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)

Exhibits

*

In accordance with Release No. 34-47986, this exhibit is hereby furnished to the SEC as an accompanying document and is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933.

(b)

Reports on Form 8-K

We filed a report on Form 8-K on February 2, 2004 to furnish as an exhibit, the press release reporting our financial results for the quarter ended December 31, 2003.

We filed a report on Form 8-K on February 10, 2004 to furnish as an exhibit, the press release by Medco Health Solutions, Inc. announcing a 10-year strategic alliance under which Accredo Health. Inc. will become the preferred retail and home delivery pharmacy provider to Medco Health members for the specialty product lines that Accredo currently dispenses to treat patients with long-term chronic diseases.

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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.

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Exhibit Index

*

In accordance with Release No. 34-47986, this exhibit is hereby furnished to the SEC as an accompanying document and is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933.

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