SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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(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, 2002
OR
Transition report pursuant to Section 13 or 15 (d) of the Securities
----------- Exchange Act of 1934
Commission File Number: 000-19370
Curative Health Services, Inc.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1503914
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
150 Motor Parkway
Hauppauge, New York 11788
(631) 232-7000
(Address of principal executive offices)
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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 ______
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As of May 1, 2002 there were 11,563,209 shares of the Registrant's Common Stock,
$.01 par value, outstanding.
INDEX
Part I Financial Information Page No.
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Item 1 Financial Statements:
Condensed Consolidated Statements of Operations
Three Months ended March 31, 2002 and 2001 3
Condensed Consolidated Balance Sheets
March 31, 2002 and December 31, 2001 4
Condensed Consolidated Statements of Cash Flows
Three Months ended March 31, 2002 and 2001 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3 Quantitative and Qualitative Disclosures About Market Risk 13
Part II Other Information Page No.
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Item 1 Legal Proceedings 14
Item 2 Changes in Securities and Use of Proceeds 14
Item 5 Other Information 15
Item 6 Exhibits and Reports on Form 8-K 15
Signatures 16
Part I. Financial Information
------------------------------
Item 1. Financial Statements
Curative Health Services, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended March 31,
2002 2001
-----------------------------
Revenues:
Services $8,895 $12,807
Products 13,869 710
------ ---
Total revenues 22,764 13,517
Costs and operating expenses:
Cost of services 3,917 7,017
Cost of product sales 10,339 1,080
Selling, general and administrative 4,924 5,129
----- -----
Total costs and operating 19,180 13,226
------ ------
expenses
Income from operations 3,584 291
Interest expense 137 -
Interest income 36 557
-- ---
Income before taxes 3,483 848
Income taxes 1,433 356
----- ---
Net income $ 2,050 $ 492
======= =====
Net income per common share, basic $.21 $.07
==== ====
Net income per common share, diluted $.19 $.07
==== ====
Weighted average common shares, basic 9,653 7,121
===== =====
Weighted average common shares, diluted 10,962 7,355
====== =====
See accompanying notes
3
Curative Health Services, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, December 31,
2002 2001
---- ----
(unaudited)
ASSETS
Cash and cash equivalents $ 5,518 $12,264
Accounts receivable, net 25,073 13,139
Deferred tax assets 6,846 6,265
Inventory 11,398 4,547
Prepaid and other current assets 783 745
--- ---
Total current assets 49,618 36,960
Property and equipment, net 3,650 3,795
Goodwill and intangibles 84,671 34,787
Other assets 5,884 1,385
----- -----
Total assets $143,823 $76,927
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $15,323 $ 9,249
Accrued expenses 17,580 25,186
-------- ------
Total current liabilities 32,903 34,435
Long term liabilities 10,557 6,000
Stockholders' equity
Common stock 115 75
Additional paid in capital 95,800 34,019
Retained earnings 4,448 2,398
----- -----
Total stockholders' equity 100,363 36,492
Total liabilities and stockholders' equity $143,823 $76,927
======== =======
See accompanying notes
4
Curative Health Services, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31,
2002 2001
----------------------------
OPERATING ACTIVITIES
Net income $ 2,050 $ 492
Adjustments to reconcile net income to net cash
used in operating activities
Equity in operations of investee (8) 111
Depreciation and amortization 527 579
Changes in operating assets and liabilities (9,148) (3,146)
------- -------
NET CASH USED IN OPERATING ACTIVITIES (6,579) (1,964)
INVESTING ACTIVITIES
Notes receivable - 2,200
Acquisition of eBiocare - (38,535)
Acquisition of Hemophilia Access, Inc. (297) -
Acquisition of Apex Therapeutics, Inc. (20,121) -
Purchase of property and equipment and other (33) (171)
Sales of marketable securities - 26,978
-------- -------
NET CASH USED IN INVESTING ACTIVITIES (20,451) (9,528)
FINANCING ACTIVITIES
Proceeds from secondary offering 16,923 -
Stock repurchases - (1,118)
Proceeds from exercise of stock options 3,361 264
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 20,284 (854)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (6,746) (12,346)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,264 19,016
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,518 $ 6,670
========== ==========
SUPPLEMENTAL INFORMATION
Interest paid $ 7 $ -
= =
See accompanying notes
5
Curative Health Services, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The condensed consolidated financial statements are unaudited and reflect all
adjustments (consisting only of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of the financial
position and operating results for the interim periods. The condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements for the year ended December 31, 2001 and notes
thereto contained in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission. The results of operations for the three
months ended March 31, 2002 are not necessarily indicative of the results to be
expected for the entire fiscal year ending December 31, 2002.
Note 2. Net Income per Common Share
Net income per common share, basic, is computed by dividing the net income by
the weighted average number of common shares outstanding. Net income per common
share, diluted, is computed by dividing net income by the weighted average
number of shares outstanding plus dilutive common share equivalents. The
following table sets forth the computation of weighted average shares, basic and
diluted, used in determining basic and diluted earnings per share (in
thousands):
Three Months Ended
March 31,
2002 2001
------------------
Weighted average shares, basic 9,653 7,121
Effect of dilutive stock options 1,309 234
----- ---
Weighted average shares, diluted 10,962 7,355
====== =====
Note 3. Purchase of Apex Therapeutic Care, Inc.
On January 27, 2002, the Company entered into an agreement to acquire Apex
Therapeutic Care, Inc. ("Apex"), a leading provider of biopharmaceutical
products, therapeutic supplies and services to people with hemophilia and
related bleeding disorders. Apex is based near Los Angeles, California. The
aggregate purchase price for Apex was $60 million. Approximately $40 million of
the purchase price was paid in shares of the Company's common stock with the
remainder payable in cash and a promissory note. Payment of the promissory note
is contingent upon certain business performance criteria, therefore the actual
payment amount may be subject to a reduction. The closing of the Apex purchase
occurred on February 28, 2002. The acquisition was accounted for as a stock
purchase and, therefore, operating results of Apex have been included in the
accompanying financial statements from the date of acquisition.
6
Curative Health Services, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 3. Purchase of Apex Therapeutic Care, Inc. (continued)
Purchase price allocations have been completed on a preliminary basis, subject
to adjustment. Estimated identifiable intangibles resulting from the acquisition
are being amortized over various periods from 3 to 15 years. Unaudited pro forma
results of operations for the three months ended March 31, 2001 and 2000,
assuming the Apex acquisition had occurred on January 1, 2001 are as follows (in
thousands, except per share data):
Three Months Ended March 31,
2002 2001
---- -----
Revenues $30,914 $35,878
====== ======
Net income $ 2,615 $ 1,835
====== ======
Net income per share, diluted $ .21 $ .18
====== ======
The pro forma operating results shown above are not necessarily indicative of
operations in the periods following acquisition. The unaudited pro forma
operating results include the results of eBiocare.com as if the eBiocare.com,
Inc. acquisition had occurred on January 1, 2001.
Note 4. Segment Information
The Company adheres to the provisions of Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information". The Company has two reportable segments: Specialty Healthcare
Services and Specialty Pharmacy Services. In its Specialty Healthcare Services
business unit, the Company contracts with hospitals to manage outpatient Wound
Care Center programs. In its Specialty Pharmacy Services business unit, the
Company contracts with insurance companies, government and other payors to
provide direct to patient distribution of biopharmaceutical drugs. The Company
evaluates segment performance based on income from operations. Management
estimates that corporate general and administrative expenses allocated to the
reportable segments are 60% for Specialty Healthcare Services and 40% for
Specialty Pharmacy Services. Intercompany transactions are eliminated to
arrive at consolidated totals.
The following table presents the results of operations and total assets of the
reportable segments of the Company for the three months ended March 31, 2002 (in
thousands):
Specialty Specialty Eliminating
Health Pharmacy Entries Total
Revenues $ 8,895 $ 13,869 $ - $ 22,764
===== ====== ====== ======
Income from operations $ 2,204 $ 1,380 $ - $ 3,584
===== ====== ====== ======
Total assets $129,350 $ 16,183 $ (1,710) $143,823
======== ======= ======= =======
7
Curative Health Services, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 5. Goodwill and other intangible assets.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. The following
table sets forth the pro forma net income and earnings per share for the current
and prior period as if SFAS No. 142 had been adopted in the prior period (in
thousands, except per share data):
2002 2001
---- ----
Net income $ 2,050 $ 492
Add:
Goodwill & other
Non-recurring amortization - 42
----- -----
Adjusted net income $ 2,050 $ 534
===== ===
Net income per common share, diluted $ .19 $.07
Add:
Goodwill & other
Non-recurring amortization - -
------ -----
Adjusted net income per common
Share, diluted $ .19 $.07
====== =====
The impact of the adoption of SFAS No. 142 resulted in an increase of $42,000 of
net income for the first quarter of 2001. The increase in net income for the
prior period had no effect on net income per common share, diluted. As required
under SFAS No. 142, the Company will test its goodwill for impairment. Although
the Company has not yet completed the impairment test, the Company does not
expect to record an impairment charge in 2002. During the first quarter of 2002,
the Company recorded $47 million in goodwill and intangibles related to the
acquisition of Apex Therapeutic Care Inc. completed on February 28, 2002.
8
Curative Health Services, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Changes in Capital Structure.
During the quarter ended March 31, 2002, the Company had the following
significant changes is capital structure.
Acquisition of Hemophilia Access, Inc. On January 8, 2002, Curative acquired all
of the outstanding shares of Hemophilia Access, Inc. in exchange for 175,824
shares of its common stock.
Private Placement. On February 8, 2002, Curative completed a private placement
of 1,059,000 shares of common stock to accredited investors for net proceeds of
$16.9 million.
Acquisition of Apex. On February 28, 2002, Curative acquired all of the
outstanding shares of Apex Therapeutic Care, Inc. for $60 million. Approximately
$40 million of the purchase price was paid in shares of the Company's common
stock with the remainder payable in cash and a promissory note. Payment of the
promissory note is contingent upon certain business performance criteria,
therefore the actual payment amount may be subject to a reduction.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Curative Health Services, Inc. is a leading disease management company
that operates in two business segments: Specialty Pharmacy Services and
Specialty Healthcare Services. In its Specialty Pharmacy operations, the Company
purchases biopharmaceutical drugs from manufacturers and then contracts with
insurance companies, government and other payors to provide direct to patient
distribution of and education about, and other support services relating to
these biopharmaceutical drugs. The Company's Specialty Pharmacy revenues are
derived primarily from fees paid by the payors under these contracts for the
purchase and distribution of these biopharmaceuticals. In addition, as part of
its Specialty Pharmacy operations the Company provides biopharmaceutical product
distribution and support services under contract with retail pharmacies for
which it receives service fees. The biopharmaceutical drugs distributed by the
Company are used by patients with chronic conditions such as hemophilia,
hepatitis C, rheumatoid arthritis and multiple sclerosis. The Company contracts
with approximately 171 payors and 14 retail pharmacies.
The Specialty Healthcare Services business unit contracts with hospitals
to manage outpatient Wound Care Center programs. These Wound Care Center
programs offer a comprehensive range of services that enable the Specialty
Healthcare Services business unit to provide patient specific wound care
diagnosis and treatments on a cost-effective basis. Specialty Healthcare
Services also offers an expanded disease management offering that addresses the
diabetic disease state. Specialty Healthcare Services currently operates two
types of Wound Care Center contracts with hospitals: a management model and an
"under arrangement" model.
In the management model, Specialty Healthcare Services provides management
and support services for a chronic wound care facility owned or leased by the
hospital and staffed by employees of the hospital, and generally receives a
fixed monthly management fee and a variable case management fee. In the "under
arrangement" model, Specialty Healthcare Services provides management and
support services, as well as the clinical and administrative staff, for a
chronic wound care facility owned or leased by the hospital, and generally
receives fees based on the services provided to each patient. In both models,
physicians remain independent, and Specialty Healthcare Services recruits and
trains the physicians and staff associated with the Wound Care Center program.
10
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and 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. On an on-going basis, management evaluates its
estimates and judgments, including those related to bad debts, inventories,
intangibles, income taxes and revenue recognition. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed 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. Actual results may
differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
Trade receivables: Considerable judgment is required in assessing the
ultimate realization of receivables including the current financial condition of
the customer, age of the receivable, and the relationship with the customer. The
Company estimates its allowances for doubtful accounts using these factors. If
the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. In circumstances where the Company is aware of a
specific customer's inability to meet its financial obligations (e.g.,
bankruptcy filings), a specific reserve for bad debts is recorded against
amounts due, to reduce the receivable to the amount the Company reasonably
believes will be collected. For all other customers, the Company has reserves
for bad debt based upon the total accounts receivable balance. As of March 31,
2002 the Company's reserves for accounts receivable was approximately 18% of
total receivables.
Inventory: Inventories are carried at the lower of cost or market on a
first in, first out basis. Inventory consists of high cost biopharmaceuticals
that in many cases require refrigeration or other special handling. As a result
inventories are subject to spoilage or shrinkage. On a quarterly basis the
Company performs a physical inventory, and determines whether any shrinkage or
spoilage adjustments are needed. Although the Company believes its inventory
balances at March 31, 2002 are correct, there can be no assurances that spoilage
or shrinkage reserves will not be needed in the future. The recording of any
such reserve may have a negative impact on the Company's operating results.
Deferred tax assets: The Company has approximately $6.8 million in
deferred tax assets as of March 31, 2002 to record against future income. The
Company does not have a valuation allowance against this asset as it believes it
is more likely than not that the tax assets will be realized. The Company has
considered future income expectations and prudent tax strategies in assessing
the need for a valuation allowance. In the event that the Company determines in
the future that it needs to record a valuation allowance, an adjustment to
deferred tax assets would be charged against income in the period of
determination.
Goodwill and intangibles: Goodwill and intangibles consist of the excess
of purchase price over the fair value of net tangible and intangible assets
acquired, and separately identifiable intangibles such as pharmacy and customer
relationships, workforce in place, covenants not to compete, and trademarks.
Effective January 1, 2002, the Company adopted Statement of Financial Standards
No. 142, "Goodwill and Other Intangible Assets" and is required to analyze its
goodwill for impairment on an annual basis. In assessing the recoverability of
the Company's goodwill and intangibles the Company must make assumptions
regarding estimated future cash flows and other factors to determine the fair
value of the respective assets. If these estimates or assumptions change in the
future, the Company may need to record an impairment charge for these assets. An
impairment charge would reduce operating income in the period it was determined
that the charge was needed.
11
Results of Operations
Revenues. The Company's revenues for the first quarter of 2002 increased 68
percent to $22.7 million compared to $13.5 million for the first quarter of the
prior fiscal year. Service revenues, attributed entirely to the Specialty
Healthcare Services business unit, decreased from $12.8 million in the first
quarter of 2001 to $8.9 million in the first quarter of 2002, a decrease of $3.9
million. The revenue decrease is attributable to the operation of 96 wound care
centers at the end of the first quarter of 2002 as compared to 119 at the end of
the first quarter of the prior fiscal year, as the result of contract
terminations and renegotiations. The Company expects to continue contract
renegotiations in 2002. Historically, some hospital contracts have expired
without renewal and others have been terminated by the Company or the client
hospital for various reasons prior to their scheduled expiration. Hospitals are
currently facing financial challenges associated with lower occupancy rates and
reduced revenue streams due to pricing pressures from third party payors.
Program terminations by client hospitals have been effected for such reasons as
reduced reimbursement, financial restructuring, layoffs, bankruptcies or even
hospital closings. Further, the Medicare program implemented a new reimbursement
system during 2000 for hospital outpatient services which has reduced
reimbursement rates to hospitals. The termination, non-renewal or renegotiations
of a material number of management contracts could result in a continued decline
in the Company's Specialty Healthcare Services business unit revenue. Product
revenues increased from $.7 million in the first quarter of 2001 to $13.9
million in the first quarter of 2002. The $13.2 million increase is attributable
to the inclusion of $13.9 million of Specialty Pharmacy Services revenues in
2002 as the result of the acquisitions of eBiocare.com, Inc., Hemophilia Access,
Inc. and Apex Therapeutic Care, Inc., offset by a reduction in Specialty Health
Services revenues of $.7 million as the result of the elimination of Procuren
product sales. For the first quarter of 2002, Product revenues included $11.5
million of hemophilia related products and $2.4 million of other injectable
products.
Costs of Services. Costs of services, attributed entirely to the Specialty
Healthcare Services business unit, decreased from $7.0 million in the first
quarter of 2001 to $3.9 million for the same period in 2002, a decrease of $3.1
million or 44 percent. The decrease is attributable to reduced staffing and
operating expenses of approximately $1.3 million related to the operation of 96
programs at the end of the first quarter of 2002 as compared with 119 programs
operating at the end of the first quarter 2001, and reduced expenditures of
approximately $1.1 million related to Procuren production. Additionally there
were 13 fewer under-arrangement programs in operation at the end of the first
quarter of 2002 as compared to the same period for 2001 at which the services
component of costs is higher than at the Company's other centers due to the
additional clinical staffing and expenses that these models require. For the
first quarter of 2002 this reduction in the number of under-arrangement programs
accounted for approximately $1.1 million of the decrease in costs of services.
As a percentage of service revenues, costs of services for the first quarter of
2002 was 44 percent compared to 55 percent for the same period in 2001. This
improvement is primarily attributable to the reorganization done by the Company
in the fourth quarter of 2001.
Cost of product sales. Cost of product sales increased from $1.1 million in the
first quarter of 2001 to $10.3 million for the same period in 2002, an increase
of $9.2 million. The increase is attributable to the inclusion of Specialty
Pharmacy Services cost of sales of $10.3 million in 2002 as the result of the
acquisition of eBiocare.com, Inc., Hemophilia Access Inc., and Apex Therapeutic
Care, Inc offset by the reduction in Procuren related costs of $1.1 million as
the result of the elimination of Procuren sales. As a percentage of product
sales, cost of product sales for the first quarter of 2002 was 75 percent
compared to 152 percent for the same period in 2001. This improvement is
attributable to the inclusion of the Specialty Pharmacy Services cost of product
sales and the elimination of Procuren sales.
12
Selling, General and Administrative. Selling, general and administrative
expenses for the first quarter decreased from $5.1 million in the first quarter
of 2001 to $4.9 million in 2002, a decrease of $.2 million or 4 percent. The
reduction is due to a decrease in expenditures related to Specialty Health
Services business unit of $1.3 million, the elimination of $.7 million of
unusual legal costs associated with the Company's now resolved Department of
Justice litigation and the Shareholder lawsuit, which is subject to notice to
the class and court approval, offset by the addition of $1.1 million in selling,
general and administrative expenses related to the Specialty Pharmacy Services
business unit as the result of the acquisitions of eBiocare.com Inc., Hemophilia
Access Inc, and Apex Therapeutic Care, Inc. as well as increased costs for
corporate staff as a result of the acquisitions. The decrease in Specialty
Healthcare Services related expense is primarily attributable to the positions
eliminated at the Company during 2001. As a percentage of revenues, selling,
general and administrative expenses were 22 percent in the first quarter of
2002, compared to 38 percent for 2001. The improvement is due to the increased
revenue base and lower expenses in 2001.
Net Income. Net income was $2.1 million or $0.19 per diluted share in the first
quarter of 2002 compared to $.5 million or $0.07 per diluted share in the first
quarter of 2001. The increase in earnings of $1.5 million for the first quarter
of 2002 is primarily attributable to the inclusion of the Specialty Pharmacy
Services business unit results in 2002, the elimination of unusual legal costs
as a result of settling the Department of Justice litigation and the Shareholder
lawsuit, which is subject to notice to the class and court approval, the
elimination of Procuren product sales and the reduction of selling general and
administrative costs.
Liquidity and Capital Resources.
Working capital was $16.7 million at March 31, 2002 compared to $2.5 million at
December 31, 2001. Total cash and cash equivalents as of March 31, 2002 was $5.5
million and was invested primarily in highly liquid money market funds. The
ratio of current assets to current liabilities was 1.1:1 at December 31, 2001
and 1.5:1 at March 31, 2002. The improvement in the Company's working capital
and current ratio is primarily attributable to the acquisition of Apex
Therapeutic Care, Inc.
Cash flows used in operating activities for the first quarter of 2002 totaled
$6.6 million primarily attributable to an increase in accounts receivable, a
reduction in accounts payable and accrued expenses, including a $9.0 million
payment made during the quarter related to the settlement of the Department of
Justice lawsuit. Cash flows used in investing activities totaled $20.5 million
primarily attributable to the purchase of Apex Therapeutic Care, Inc. Cash flows
provided by financing activities totaled $20.3 million, attributable to proceeds
of $16.9 million from the Company's sale of shares in a private placement
transaction, and $3.4 million in proceeds from the exercise of stock options.
For the first quarter of 2002, the Company experienced a net increase in
accounts receivable of $11.9 million primarily attributable to the purchase of
Apex Therapeutic Care, Inc. Accounts receivable days outstanding were 71 days as
of March 31, 2002 as compared to 58 days at December 31, 2001. Days outstanding
for the Specialty Healthcare Services business was 70 days and for the Specialty
Pharmacy Services business 72 days at March 31, 2002.
The Company's longer term cash requirements include working capital for the
expansion of its Specialty Pharmacy Services business and Specialty Healthcare
Services business, and for acquisitions. Other cash requirements are anticipated
for capital expenditures in the normal course of business, the acquisition of
software, computers and equipment related to the Company's management
13
information systems. Additionally the Company has a $7.5 million obligation,
payable over four years, to the Department of Justice related to the settlement
of its litigation and a $6.5 million obligation related to the settlement of its
Shareholder lawsuit. (See Legal Proceedings, Part II Item 1). In January of 2002
the Company entered into $25 million line of credit with Healthcare Business
Credit Corporation and in February 2002 the Company sold 1,059,000 shares of
common stock in a private placement transaction raising a total of $16.9
million. These transactions were to provide liquidity for both working capital
and acquisitions. In January 2002, the Company paid $9 million to the Department
of Justice as part of the Company's settlement agreement and in February 2002
used approximately $21 million in cash related to the purchase of Apex. The
Company expects that based on its current business plan, its existing cash and
cash equivalents and available credit will be sufficient to satisfy its working
capital needs at least through June 30, 2003. The effect of inflation risk is
considered immaterial.
Health Insurance Portability and Accountability Act
During 2000 final regulations regarding the protection of the privacy of
personal health information, promulgated by the Department of Health and Human
Services, were published in the Federal Register. These regulations set the
standards for securing patient records and generally prohibit covered entities
from using or disclosing protected health information. As a result of these
regulations, the Company anticipates expenditures in ensuring patient data kept
on computer networks maintained at the Specialty Healthcare Services Wound Care
Center programs, Specialty Pharmacy Services operations and corporate offices
are in compliance with these regulations. While the Company believes that it
will be in compliance by the February 2003 deadline, there can be no assurances
that the cost of reaching compliance will not have a material impact on the
financial condition of the Company.
Cautionary Statement
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These statements include statements
regarding intent, belief or current expectations of the Company and its
management. These forward-looking statements are not guarantees of future
performance and involve a number of risks and uncertainties that may cause the
Company's actual results to differ materially from the results discussed in
these statements. Factors that might cause such differences include, but are not
limited to, those described under the heading "Critical Accounting Policies and
Estimates" herein, or those described in Exhibit 99 to this Form 10-Q, and other
factors described in the Company's future filings with the SEC.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company does not have operations subject to risks of material foreign
currency fluctuations, nor does it use derivative financial instruments in its
operations or investment portfolios. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines. The Company does not expect any material
loss with respect to its investment portfolio or exposure to market risks
associated with interest rates.
14
Curative Health Services, Inc. and Subsidiaries
Part II. Other Information
Item 1. Legal Proceedings
With respect to the Company's legal proceedings previously disclosed, except as
described in the next sentence there have been no material developments since
the disclosure provided in Item 3 - "Legal Proceedings" in the Company's Annual
Report on Form 10-K filed with the SEC for the year ended December 31, 2001.
With respect to the eBioCare indemnification litigation, on or about May 2,
2002 the court stayed the litigation with respect to substantially all such
claims, pending arbitration of such matters.
Item 2. Changes in Securities and Use of Proceeds
(c)
Acquisition of Hemophilia Access, Inc. On January 8, 2002, Curative
acquired all of the outstanding shares of Hemophilia Access, Inc. in exchange
for 175,824 shares of its common stock.
Private Placement. On February 8, 2002, Curative completed a private
placement of 1,059,000 shares of common stock to accredited investors for net
proceeds of $16.9 million. U.S. Bancorp Piper Jaffray acted as placement agent
for the shares and received a placement fee of approximately $.3 million.
Acquisition of Apex. On February 28, 2002, Curative acquired all of the
outstanding shares of Apex Therapeutic Care, Inc. for $60 million. Approximately
$40 million of the purchase price was paid in shares of the Company's common
stock with the remainder payable in cash and a promissory note. Payment of the
promissory note is contingent upon certain business performance criteria,
therefore the actual payment amount may be subject to a reduction.
Each of the issuances and sales of shares of common stock described above were
deemed to be exempt from registration under the Securities Act of 1933 in
reliance on Section 4(2) of the Act or Regulation D promulgated thereunder as
transactions by the issuer not involving a public offering, where the purchasers
represented their intention to acquire securities for investment purposes only
and not with a view to or for sale in connection with any distribution thereof,
and received or had access to adequate information about Curative Health
Services, Inc.
Item 5. Other Information
The Company has amended its securities trading policy to allow its directors,
officers and other "access employees" to implement stock trading plans under
Rule 10b5-1 of the Securities Exchange Act of 1934. Rule 10b5-1 allows persons
who adopt plans to purchase or sell a company's securities, at a time when they
are unaware of material, nonpublic information about the company, to purchase or
sell those securities according to that plan even if they subsequently come into
possession of "inside" information. The Company is aware that its Chairman,
Joseph Feshbach, has adopted a Rule10b5-1 plan and anticipates that other
Curative directors, officers and access employees may implement trading plans in
the future in compliance with the Company's amended trading policy.
15
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 99 Cautionary Statements
(b) Form 8-K
Form 8-K dated March 11, 2002, reporting under Item 2 on the acquisition
of Apex Therapeutic Care, Inc. on February 28, 2002.
16
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.
Dated: May 15, 2002
Curative Health Services, Inc.
(Registrant)
/s/ Joseph Feshbach
-------------------------------------------
Joseph Feshbach
Chief Executive Officer and Chairman
/s/ Thomas Axmacher
-------------------------------------------
Thomas Axmacher
Chief Financial Officer
(Principal Financial and Accounting Officer)
Exhibit 99
CAUTIONARY STATEMENTS
RISK RELATED TO OUR BUSINESS
If we fail to comply with the terms of our settlement agreement with the
government, we could be subject to additional litigation or other governmental
actions which would be harmful to our business
On December 28, 2001, we entered into a settlement with the Department of
Justice, the United States Attorney for the Southern District of New York, the
United States Attorney for the Middle District of Florida and the U.S.
Department of Health and Human Services, Office of the Inspector General, in
connection with all federal investigations and legal proceedings related to the
whistleblower lawsuits previously pending against us in the United States
District Court for the Southern District of New York and the United States
District Court for the District of Columbia. The focus of the government
investigation and resolution was the allegation that we improperly caused our
hospital customers to seek reimbursement for a portion of our management fees
that included costs related to advertising and marketing activities by our
personnel. Under the terms of the settlement, we were released from claims
associated with services we provided to hospitals and we agreed to pay the
United States a $9 million initial payment, with an additional $7.5 million to
be paid over the next four years. Pursuant to the settlement, we will be
required to fulfill certain additional obligations, including abiding by a
five-year Corporate Integrity Agreement (which incorporates much of our existing
compliance program), avoiding violations of law and providing certain
information to the Department of Justice from time to time. If we fail or if we
are accused of failing to comply with the terms of the settlement we may be
subject to additional litigation or other governmental actions. In addition, as
part of the settlement, we consented to the entry of a judgment for $28,000,000
against us if we fail to comply with the terms of the settlement.
If the court does not approve the settlement agreement relating to our
shareholder litigation the resumption of litigation could be harmful to our
business
Subsequent to the disclosure of the Department of Justice action, we and, in
some cases, certain of our officers were named in four shareholder lawsuits. All
suits were filed in the United States District Court for the Eastern District of
New York. The four shareholder lawsuits have been consolidated into one
class-action lawsuit. On April 12, 2002, the parties executed a stipulation of
settlement which has been submitted to the court for its approval. Under the
terms of the proposed settlement, even though we maintained that there was no
basis for the imposition of liability, in order to avoid the delay and expense
of protracted litigation, we agreed to pay $10.5 million to the class, of which
$6.5 million will be paid in common stock, cash or a combination thereof, as
determined in Curative's sole discretion within three business days of final
approval of settlement by the court. The remaining $4 million will be paid from
insurance proceeds. This settlement is subject to notice to the class and court
approval.
We are involved in litigation which may harm the value of our business
In addition to the securities litigation described above, we are currently in
dispute with some of the former shareholders of eBioCare.com, Inc. over claims
by us for indemnification in connection with our acquisition of eBioCare.com,
Inc. These claims are for indemnification in an aggregate amount in excess of
$3,000,000, which is currently held in escrow, for a breach of certain
representations and warranties made by such former shareholders. In response to
our indemnification claims, the former shareholders have filed a lawsuit in
Superior Court of California, County of Santa Clara, on or about February 1,
2002 against us seeking a declaratory judgment in their favor with respect to
certain of our claims, and other remedies including the rescission of our
acquisition of eBioCare.com, Inc. Although we believe this lawsuit is groundless
and we intend to defend these claims vigorously, an adverse result in this
dispute could harm our business.
In addition, in the ordinary course of our business, we are the subject of or
party to various lawsuits, including those arising out of services or products
provided by or to its operations, personal injury and employment disputes, the
outcome of which, in the opinion of management, will not have a material adverse
effect on our financial position or results of operations.
If we are unable to manage our growth effectively, our business will be harmed
Our growth strategy will likely place a strain on our resources, and if we
cannot effectively manage our growth, our business will be harmed. In connection
with our growth strategy, we will likely experience 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.
As part of our growth strategy, we continue to evaluate acquisition
opportunities. Acquisitions involve many risks, including:
o the specialty pharmacy industry is undergoing consolidation, therefore, we
may experience difficulty in identifying suitable candidates and
negotiating and consummating acquisitions on attractive terms;
o in the industry in which our Specialty Pharmacy Services division
operates, customers have a strong affiliation with their community-based
representatives; it is sometimes difficult to retain and assimilate the
community-based representatives of companies we acquire;
o because of the relationships between community-based representatives and
customers, the loss of a single community-based representative may entail
the loss of a significant number of customers and we are therefore subject
to a significant potential for loss of customers, especially during the
periods in which we attempt to integrate newly-acquired businesses;
o a growth strategy that involves significant acquisitions results in a
diversion of our management's attention from existing operations;
o intangible assets typically represent a significant portion of the value
of specialty pharmacy businesses, therefore any future acquisition may
involve increased amortization expense related to such assets and any such
increase 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 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 present 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. Due
to uncertainties inherent in the capital markets (e.g., availability of capital,
fluctuation of interest rates, etc.), 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 securities that would
reduce the percentage ownership of our then current shareholders.
We could be adversely affected by an impairment of the significant amount of
goodwill on our financial statements
Our acquisitions of the specialty pharmacy companies, eBioCare.com, Inc.,
Hemophilia Access, Inc. and Apex Therapeutic Care, Inc. resulted in the
recording of a significant amount of goodwill on our financial statements. The
goodwill was recorded because the fair value of the net assets acquired was less
than the purchase price. We may not realize the full value of this goodwill: we
evaluate on at least an annual 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 as a charge to our
earnings.
Since our growth strategy will likely 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 any intangible assets that meet the criteria specified in the
Financial Accounting Standards Board Statement No. 141 such as marketing,
customer or contract-based intangibles. The amount allocated to these intangible
assets could be amortized over a fairly short period. As a result, our earnings
and the market price of our common stock could be negatively affected.
We are highly dependent on our relationships with a limited number of
biopharmaceutical and other suppliers and the loss of any of these relationships
could significantly affect our ability to sustain or grow our revenues
The biopharmaceutical industry is susceptible to product shortages. Some of the
products that we distribute, such as intra-venous immuno globulin and blood- or
blood plasma-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. An industry wide
recombinant factor VIII product shortage has existed for some time, for various
reasons including manufacturers being unable to increase production to meet
rising global demand. In 2001, approximately 42%, or $15,000,000, of our
revenues derived from our sale of factor VIII. In 2001, we purchased our
supplies of blood and blood plasma-related products from five manufacturers,
including Baxter Healthcare Corp. and Novo Nordisk Pharmaceuticals, Inc. The
Company believes that these five manufacturers represent substantially all of
the production capacity for recombinant factor VIII. In the event that one of
these suppliers is unable to continue to supply us with product, it is uncertain
whether the remaining suppliers would be able to make up any shortfall resulting
from such inability. Our ability to take on additional customers or to acquire
other specialty pharmacy businesses with significant hemophilia customer bases
could be affected negatively in the event we are unable to secure adequate
supplies of our products from these manufacturers. Future availability of
product is unclear and we are not certain when the manufacturers will return to
normal product allocations. If these products, or any of the other drugs or
products that we distribute, are in short supply for long periods of time, our
business could be harmed.
If additional providers obtain access to favorably priced products we handle,
our business could be harmed
Because we do not receive federal grants under the Public Health Service Act, we
are not eligible to participate directly in a federal pricing program
administered by the Federal Health Resources and Services Administration's
Public Health Service, which allows certain entities with such grants, such as
certain hospitals and hemophilia treatment centers, to obtain discounts on
drugs, including certain biopharmaceutical products (e.g., hemophilia clotting
factor) which products represented 23% of our revenues in 2001. To the best of
our information, these entities benefit by being able to acquire, pursuant to
this federal program, products competitive with ours at prices lower than our
cost for the same products. Our customers, where eligible, may elect to obtain
hemophilia clotting factor, or other products, from such lower-cost entities and
this would result in a loss of revenue. The Federal Health Resources and
Services Administration issued a notice that we expect will broaden the number
of eligible Public Health Service entities purchasing Public Health
Service-priced hemophilia factor. If the number of hospitals and hemophilia
treatment centers eligible to participate in this program increases, the
increased competition, especially where such competitors are able to acquire
competing products at prices lower than our cost, may harm our business.
Recent investigations into reporting of average wholesale prices could reduce
our pricing and margins
Many government payors, including Medicare and Medicaid, as well as some private
payors, pay us directly or indirectly based upon the drug's average wholesale
price. If a drug's average wholesale price declines, and if we are unable to
recoup the full amount of such decline from our customers, we will lose
revenues. Biopharmaceutical products, including hemophilia factor, are included
as part of this drug reimbursement methodology. In 2001, 43% of our revenue
resulted from reimbursements based on the average wholesale price of our
products. Average wholesale price for most drugs is compiled and published by
private companies such as First DataBank, Inc. Various federal and state
government agencies have been investigating whether the reported average
wholesale price of many drugs, including some that we sell, is an appropriate or
accurate measure of the market price of the drugs. As reported in the Wall
Street Journal, there are also several whistleblower lawsuits pending against
various drug manufacturers in connection with the appropriateness of the
manufacturer's average wholesale price for a particular drug. These government
investigations and lawsuits involve allegations that manufacturers reported
artificially inflated average wholesale prices of various drugs to First
DataBank, which in turn reported these prices to its subscribers including many
state Medicaid agencies who then included these average wholesale prices in the
state's reimbursement policies. In 2001, Bayer Corporation, an occasional
supplier of hemophilia factor to us, agreed to pay $14 million in a settlement
with the federal government and 45 states in order to close an investigation
regarding these charges. Bayer also entered into a five-year corporate integrity
agreement with the government, in which Bayer agreed to provide information on
the average sale price of its drugs to the government. In February 2000, First
DataBank published a Market Price Survey of 437 drugs, which was significantly
lower than the historic average wholesale price for a number of the clotting
factor and intra-venous immuno globulin products that we sell. Consequently, a
number of state Medicaid agencies have revised their payment methodology as a
result of the Market Price Survey. Although the Centers for Medicare and
Medicaid Services had also announced that Medicare fiscal agents should
calculate the amount that they pay for Medicare claims for certain drugs by
using the lower prices on the First DataBank Market Price Survey, the proposal
to include clotting factor in the lower Medicare pricing was withdrawn. The
Centers for Medicare and Medicaid Services has announced that it will seek
legislation that would establish payments to cover the administrative costs of
suppliers of clotting factor as a supplement to a lower average wholesale price
pricing for hemophilia factor.
On September 21, 2001, the United States House Subcommittees on Health and
Oversight & Investigations held hearings to examine how Medicare reimburses
providers for the cost of drugs. In conjunction with that hearing, the United
States General Accounting Office issued its Draft Report recommending that
Medicare establish payment levels for part-B prescription drugs and their
delivery and administration that are more closely related to their costs, and
that payments for drugs be set at levels that reflect actual market transaction
prices and the likely acquisition costs to providers. More recently, on March
14, 2002, the Senate Finance Committee's Subcommittee on Health conducted a
hearing on Medicare drug reimbursement issues, including average wholesale
price. This hearing reflects Congress' interest in possibly changing the manner
in which the government reimburses providers for drugs.
The government investigations and the changes occurring in the reporting of
average wholesale price and its effects on Medicare and Medicaid prices could
have a negative effect on our business. For example, if the reduced average
wholesale prices published by First DataBank for the drugs that we sell are
ultimately adopted as the standard by which we are paid by government payors or
private payors, this could have an adverse effect on our business, including
reducing the pricing and margins on certain of our products.
Our business would be harmed if demand for our products and services is reduced
Reduced demand for our products and services, in either our Specialty Pharmacy
Services or Specialty Healthcare Services businesses, could be caused by a
number of circumstances, including:
o customer shifts to treatment regimens other than those we offer;
o new treatments or methods of delivery of existing drugs that do not
require our specialty products and services;
o the recall of a drug;
o adverse reactions caused by a drug;
o the expiration or challenge of a drug patent;
o competing treatment from a new drug, a new use of an existing drug
or genetic therapy;
o drug companies cease to develop, supply and generate demand for
drugs that are compatible with the services we provide;
o drug companies stop outsourcing the services we provide or fail to support
existing drugs or develop new drugs;
o governmental or private initiatives that would alter how drug
manufacturers, health care providers or pharmacies promote or sell
products and services;
o the loss of a managed care or other payor relationship covering a number
of high revenue customers;
o the cure of a disease we service; or
o the death of a high-revenue customer.
Our business involves risks of professional, product and hazardous substance
liability and any inability to obtain adequate insurance may adversely affect
our business
The provision of health services entails an inherent risk of professional
malpractice, regulatory violations and other similar claims. Claims, suits or
complaints relating to health services and products provided by physicians,
pharmacists or nurses in connection with our Specialty Healthcare Services and
Specialty Pharmacy Services programs may be asserted against us in the future.
Our operations involve the handling of bio-hazardous materials. Our employees,
like those of all companies that provide services dealing with human blood
specimens, may be exposed to risks of infection from AIDS, hepatitis and other
blood-borne diseases if appropriate laboratory practices are not followed.
Although we believe that our safety procedures for handling and disposing of
such materials comply with the standards prescribed by state and federal
regulations, the risk of accidental infection or injury from these materials
cannot be completely eliminated. In the event of such an accident, we could be
held liable for any damages that result, and such liability could harm our
business.
Our operations expose us to product and professional liability risks that are
inherent in managing the delivery of wound care services, and the provision and
marketing of biopharmaceutical products. We currently maintain professional and
product liability insurance coverage of $25 million in the aggregate. Because we
cannot predict the nature of future claims that may be made, we can not assure
you that the coverage limits of our insurance would be adequate to protect us
against any potential claims, including claims based upon the transmission of
infectious disease, contaminated product or otherwise. In addition, we may not
be able to obtain or maintain professional and product liability insurance in
the future on acceptable terms or with adequate coverage against potential
liabilities.
We rely on key community-based representatives whose absence or loss could harm
our business
The success of our Special Pharmacy Services division depends upon our ability
to retain key employees known as community-based representatives, and the loss
of their services could adversely affect our business and prospects. Our
community-based representatives are our chief contact and maintain the primary
relationship with our customers and the loss of a single community-based
representative could result in the loss of a significant number of customers. We
do not have key man insurance on any of our community-based representatives. In
addition, our success will depend, among other things, upon the successful
recruitment and retention of qualified personnel, and we may not be able to
retain all of our key management personnel or be successful in recruiting
additional replacements should that become necessary.
Our inability to maintain a number of important contractual relationships could
adversely affect our operations
Substantially all of the revenues of our Specialty Healthcare Services
operations are derived from management contracts with acute care hospitals. At
present, we have approximately 100 management contracts. The contracts generally
have initial terms of three to five years and many have automatic renewal terms
unless specifically terminated. During the year ending December 31, 2002, the
contract terms of 32 of our management contracts will expire, including 14
contracts which provide for automatic one-year renewals. The contracts often
provide for early termination either by the client hospital if specified
performance criteria are not satisfied, or by us under various other
circumstances. Historically, some contracts have expired without renewal and
others have been terminated by us or the client hospital for various reasons
prior to their scheduled expiration. During 2001, nine contracts expired without
renewal and an additional 31 contracts were terminated prior to their scheduled
expiration. Generally, these contracts were terminated by hospitals because of
the Specialty Healthcare Services legal action, hospital financial difficulties
and Medicare reimbursement changes which reduced hospital revenues. Our
continued success is subject to our ability to renew or extend existing
management contracts and obtain new management contracts. Any hospital may
decide not to continue to do business with us following expiration of its
management contract, or earlier if such management contract is terminable prior
to expiration. In addition, any changes in the Medicare program or third-party
reimbursement levels which generally have the effect of limiting or reducing
reimbursement levels for health services provided by programs managed by us
could result in the early termination of existing management contracts and could
adversely affect our ability to renew or extend existing management contracts
and to obtain new management contracts. The termination or non-renewal of a
material number of management contracts could harm our business.
In addition, a portion of the revenues of our Specialty Pharmacy Services
operations is derived from contractual relationships with retail pharmacies. Our
success is subject to the continuation of these relationships and termination of
one or more of these relationships could harm our business.
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 December 31, 1999, 2000 and 2001 we derived approximately
100%, 100% and 74%, respectively, of our gross patient service revenue from
non-governmental payors, none of which individually accounted for more than 10%
of our total revenues. Many payors seek to limit the number of providers that
supply drugs to their enrollees. From time to time, payors with whom we have
relationships require that we and our competitors bid to keep their business,
and therefore, due to the uncertainties involved in any bidding process, we may
either not be retained or our margins may be adversely affected. The loss of a
significant number of payor relationships, or an adverse change in the financial
condition of a significant number of payors could result in the loss of a
significant number of patients and harm our business.
Changes in reimbursement rates may cause reductions in the revenues of our
operations
As a result of the Balanced Budget Act of 1997, the Centers for Medicare and
Medicaid Services implemented the Outpatient Prospective Payment System for all
hospital outpatient department services furnished to Medicare patients beginning
August 2000. Under the system, a predetermined rate is paid to hospitals for
clinic services rendered, regardless of the hospital's cost. The new payment
system does not provide comparable reimbursement for previously reimbursed
services and the payment rates for many services are insufficient for many of
our hospital customers, resulting in revenue and income shortfalls for the wound
care center operations managed by us on behalf of the hospitals. As a result,
during 2000 and 2001, we renegotiated and modified many of our management
contracts, which has resulted in reduced revenue and income to us from the
modified contracts and in numerous cases contract termination. These
renegotiations resulted in reduced revenues of approximately $8.5 million. In
addition, we lost approximately $28 million in revenues as the result of
contract terminations. At any time during any given year, 10% to 20% of hospital
contracts are being renegotiated. We expect that contract renegotiation and
modification with many of our hospital customers will continue and this could
result in further reduced revenues and income to us from those contracts and
even contract terminations. These results could harm our business.
The Wound Care Center programs managed by Specialty Healthcare Services on
behalf of acute care hospitals are generally treated as "provider based
entities" for Medicare reimbursement purposes. This designation is required for
the hospital based program to be covered under the Medicare outpatient
reimbursement system. With the Outpatient Prospective Payment System, Medicare
published criteria for determining when programs may be designated "provider
based entities." Although the implementation date for Provider Based Designation
Regulations for our managed outpatient programs is October 2002, the regulations
continue to be subject to change and further clarification. Specialty Healthcare
Services' 11 managed "under arrangement" models, where we employ the clinical
and administrative staff that work in the center, are potentially at risk for
not meeting the criteria for a "provider based entity." Specialty Healthcare
Services has been in discussions with its "under arrangement" hospital customers
to convert the programs to a management model. The interpretation and
application of these criteria are not entirely clear and there is a risk that
some of the programs, in particular the 11 under arrangement models, managed by
Specialty Healthcare Services could be found not to be "provider based
entities." Although we believe that the programs it manages substantially meet
the current criteria to be designated "provider based entities," a widespread
denial of such designation would harm our business.
The profitability of our Specialty Pharmacy Services operations depends in large
part on the reimbursement we receive from third-party payors. In recent years,
competition for patients, efforts by traditional third-party payors to contain
or reduce healthcare costs, and the increasing influence of managed care payors,
such as health maintenance organizations, have resulted in reduced rates of
reimbursement. If these trends continue, they could harm our business. The
profitability of our specialty pharmacy operations also depends, indirectly, on
reimbursement from third-party payors because our customers seek reimbursement
from third-party payors for the cost of drugs and related medical supplies that
we distribute. Changes in reimbursement policies of private and governmental
third-party payors, including policies relating to the Medicare, Medicaid and
other federally funded programs, could reduce the amounts reimbursed to these
customers for our products and in turn, the amount these customers would be
willing to pay for our products and services. In addition, where we have direct
relationships with payors, changes in their reimbursement policies may reduce
amounts payable directly to us by such payors. Changes in those reimbursement
policies could affect our customers, which in turn could harm our business.
We are subject to pricing pressures and other risks involved with commercial
payors
Commercial payors, such as managed care organizations and traditional indemnity
insurers increasingly are requesting fee structures and other arrangements
providing for health care providers to assume all or a portion of the financial
risk of providing care. The lowering of reimbursement rates, increasing medical
review of bills for services and negotiating for reduced contract rates could
harm our business. Pricing pressures by commercial payors may continue and our
business may be adversely affected by these trends.
Also, continued growth in managed care and capitated plans have pressured health
care providers to find ways of becoming more cost competitive. Managed care
organizations have grown substantially in terms of the percentage of the
population they cover and in terms of the portion of the health care economy
they control. Managed care organizations have continued to consolidate to
enhance their ability to influence the delivery of health care services and to
exert pressure to control health care costs. A rapid increase in the percentage
of revenue derived from managed care payors or under capitated arrangements
without a corresponding decrease in our operating costs could harm our business.
There is substantial competition in our industry and we may not be able to
compete successfully
The principal competition with our Specialty Healthcare Services business
consists of specialty clinics that have been established by some hospitals or
physicians. Additionally, there are some private companies which provide wound
care services through a hyperbaric oxygen therapy program format. In addition,
recently developed technologies, or technologies that may be developed in the
future, are or may be the basis for products which compete with our chronic
wound care services. We may not be able to enter into co-marketing arrangements
with respect to these products, and we may not be able to compete effectively
against such companies in the future. Our Specialty Pharmacy Services business
faces competition from other disease management entities, general health care
facilities and service providers, pharmaceutical companies, biopharmaceutical
companies as well as other competitors. Many of these companies have
substantially greater capital resources and marketing staffs and greater
experience in commercializing products and services than we have.
If we are unable to effectively adapt to changes in the healthcare industry,
our business will be harmed
Political, economic and regulatory influences are subjecting the health care
industry in the United States to fundamental change. Although Congress has
failed to pass comprehensive health care reform legislation thus far, we
anticipate that Congress and state legislatures will continue to review and
assess alternative health care delivery and payment systems and may in the
future propose and adopt legislation effecting fundamental changes in the health
care delivery system as well as changes to the Medicare Program's coverage and
payments of the drugs and services we provide. It is possible that future
legislation enacted by Congress or state legislatures will contain provisions
that may harm our business, or may change the operating environment for our
targeted customers (including hospitals and managed care organizations). Health
care industry participants may react to such legislation or the uncertainty
surrounding related proposals by curtailing or deferring expenditures and
initiatives, including those relating to our programs and services. It is also
possible that future legislation either could result in modifications to the
nation's public and private health care insurance systems, or coverage for
biopharmaceutical products, which could affect reimbursement policies in a
manner adverse to us, or could encourage integration or reorganization of the
health care delivery system in a manner that could materially and adversely
affect our ability to compete or to continue our operations without substantial
changes. Other legislation relating to our business or to the health care
industry may be enacted, including legislation relating to third-party
reimbursement, and such legislation may have a negative effect on our business.
Our industry is subject to extensive government regulation and noncompliance by
us or our suppliers, our customers or our referral sources could harm our
business
The marketing, labeling, dispensing, storage, provision and purchase of drugs,
health supplies and health services including the biopharmaceutical products we
provide, are extensively regulated by federal and state governments, and if we
fail or are accused of failing to comply with laws and regulations, our business
could be harmed. Our business could also be harmed if the suppliers, customers
or referral sources 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 federal government, or states in
which we operate, could, in the future, enact more restrictive legislation or
interpret existing laws and regulations in a manner that could limit the manner
in which we can operate our business and have a negative impact on our business.
There are a number of state and federal laws and regulations that apply to our
operations including, but not limited to:
o The federal "anti-kickback law" prohibits the offer or solicitation of
remuneration 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 of 1996, or 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 include significant fines, exclusion from participation in the
Medicare and Medicaid programs and 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 further analysis of whether the parties violated the
anti-kickback law. In addition to the anti-kickback law, many states have
adopted similar kickback and/or fee-splitting laws, which can affect the
financial relationships we may have with physicians, vendors, other retail
pharmacies and patients. The finding of a violation of the federal or one
of these state laws could harm our business.
o In 2000, the Department of Health and Human Services issued final
regulations implementing the Administrative Simplification provision of
HIPAA concerning the maintenance, transmission and security of electronic
health information, particularly individually identifiable information. The
regulations, when effective, will require the development and
implementation of security and transaction standards for all electronic
health information and impose significant use and disclosure obligations on
entities that send or receive individually identifiable electronic health
information. As a result of these regulations, we anticipate new
expenditures in ensuring that patient data kept on our computer networks
are in compliance with these regulations. While we believe that we will be
in compliance by the current February 2003 deadline, the cost of reaching
compliance may harm our business. Also, 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 harm our
business.
o 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.
o 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. In addition, in some states,
coordination of nursing services for patients could necessitate licensure
as a home health agency and/or could necessitate the need to use licensed
nurses to provide certain patient directed services. 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.
o Pharmacies (retail, mail-order and wholesale) as well as pharmacists often
must obtain state licenses to operate and dispense drugs. Pharmacies must
also obtain licenses in some states in order to operate and provide goods
and services to residents of those states. If we are unable to maintain
our licenses or if states place burdensome restrictions or limitations on
non-resident pharmacies, this could limit or affect our ability to operate
in some states which could harm our business.
o 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 or referral sources.
o The federal 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.
There is a delay between our performance of services and our reimbursement
The health care industry is characterized by delays that typically range from
three to nine months between when services are provided and when the
reimbursement or payment for these services is received. This makes working
capital management, including prompt and diligent billing and collection, an
important factor in our results of operations and liquidity. Trends in the
industry may further extend the collection period and impact our working
capital.
We rely heavily on a limited number of shipping providers, and our business
would be harmed if our rates are increased or our providers are unavailable
A significant portion of our revenues result from the sale of drugs we deliver
to our patients and a significant amount of our products are shipped by mail,
overnight courier or in person through our community based representatives. The
costs incurred in shipping are not passed on to our customers and, therefore,
changes in these costs directly impact our margins. We depend heavily on these
outsourced shipping services for efficient, cost effective delivery of our
product. The risks associated with this dependence include:
o any significant increase in shipping rates;
o strikes or other service interruptions by these carriers; and
o spoilage of high cost drugs during shipment, since our drugs often
require special handling, such as refrigeration.
RISK RELATED TO OUR COMMON STOCK
Possible volatility of stock price in the public market
The market price of our common stock has experienced and may continue to
experience substantial volatility. Over the past eight quarters, the market
price of our common stock has ranged from a low of $5.06 per share in second
quarter of 2000 to a high of $22.40 per share in the first quarter of 2002. Many
factors have influenced the common stock price in the past, including
fluctuations in our earnings and changes in our financial position, management
changes, low trading volume, and negative publicity and uncertainty resulting
from the legal actions brought against us. In addition, the securities markets
have from time to time experienced significant broad price and volume
fluctuations that may be unrelated to the operating performance of particular
companies. All of these factors could adversely affect the market price of our
common stock.
Provisions of our articles of incorporation and Minnesota law may make it more
difficult for you to receive a change-in-control premium Our board's ability to
designate and issue up to 10,000,000 shares of preferred stock and issue up to
50,000,000 shares of common stock could adversely affect the voting power of the
holders of common stock, and could have the effect of making it more difficult
for a person to acquire, or could discourage a person from seeking to acquire,
control of our company. If this occurred you could lose the opportunity to
receive a premium on the sale of your shares in a change of control transaction.
In addition, the Minnesota Business Corporation Act contains provisions that
would have the effect of restricting, delaying or preventing altogether certain
business combinations with any person who, after this offering becomes an
interested stockholder. Interested stockholders include, among others, any
person who, together with affiliates and associates, acquires 10% or more of a
corporation's voting stock in a transaction which is not approved by a duly
constituted committee of the board of the corporation. These provisions could
also limit your ability to receive a premium in a change of control transaction.