##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
   o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  Commission file number 000-50348
 NATIONSHEALTH, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    06-1688360(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)13630 N.W. 8th Street, Suite 210, Sunrise, Florida
    
    33325(Address of principal executive offices)
    
    (Zip Code)
 (954) 903-5000  (Registrants
telephone number, including area code)
 N/A  Former name, former address, and former fiscal year, if changed since last report)
 x  ̈
  Large accelerated filer  ̈
    
    Accelerated filer  ̈
    
    Non-accelerated filer x
  ̈ x




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##### Table of Contents



NATIONSHEALTH, INC.
 FORM 10-Q
 FOR THE QUARTER ENDED MARCH 31, 2006
 INDEX
 PART I.Item 1.
    
    Financial StatementsCondensed Consolidated Balance Sheets (unaudited)  as of March 31, 2006 and December 31, 2005
    
    
    1Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2006 and 2005
    
    
    2Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2006 and 2005
    
    
    3Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4.
    
    Controls and Procedures
    
    
    26PART II.Item 1A.
    
    Risk Factors
    
    
    27Item 6.
    
    Exhibits
    
    
    27Signatures
    
    
    
    
    28Amendment No. 2 to Strategic AgreementSection 302 Certification of CEOSection 302 Certification of CFOSection 906 Certification of CEO and CFO




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PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 NATIONSHEALTH, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)
(In thousands)
 March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    3,435
    
    
    $
    13,971Short-term investments
    
    
    2,419
    
    
    
    923Accounts receivable, net of allowances of $16,311 and $17,525,
respectively
    
    
    9,015
    
    
    
    7,908Inventory
    
    
    1,167
    
    
    
    1,285Costs related to billings in process, net
    
    
    843
    
    
    
    874Other receivables
    
    
    996
    
    
    
    1,877Prepaid expenses and other current assets
    
    
    1,003
    
    
    
    750Total current assets
    
    
    18,878
    
    
    
    27,588Property and equipment, net
    
    
    3,829
    
    
    
    3,747Investment in joint venture
    
    
    1,530
    
    
    
    1,488Deferred
CIGNA equity compensation, net
    
    
    14,540
    
    
    
    15,510Other assets, net
    
    
    1,813
    
    
    
    1,526Total assets
    
    $
    40,590
    
    
    $
    49,859LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    13,767
    
    
    $
    13,387Accrued expenses
    
    
    11,499
    
    
    
    12,030Deferred revenue, current portion
    
    
    619
    
    
    
    235Line of credit
    
    
    2,500
    
    
    
    2,500Total current liabilities
    
    
    28,385
    
    
    
    28,152Long-Term Liabilities:Deferred revenue
    
    
    1,374
    
    
    
    1,100Convertible notes, related party, net
    
    
    5,440
    
    
    
    5,176Other long-term liabilities
    
    
    1,950
    
    
    
    1,414Total long-term liabilities
    
    
    8,764
    
    
    
    7,690Commitments and contingenciesStockholders Equity:Common stock
    
    
    3
    
    
    
    3Additional paid-in capital
    
    
    69,142
    
    
    
    68,949Unearned compensation
    
    
    
    
    
    
    (2,761
    )Accumulated deficit
    
    
    (65,704
    )
    
    
    (52,174
    )Total stockholders equity
    
    
    3,441
    
    
    
    14,017Total liabilities and stockholders equity
    
    $
    40,590
    
    
    $
    49,859
 The accompanying notes are an integral part of these condensed consolidated financial statements.
 1




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NATIONSHEALTH, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
(In thousands, except per share data)
 For the Three MonthsEnded March 31,2006
    
    
    2005Revenue:Net product sales
    
    $
    10,854
    
    
    $
    17,137Prescription card revenue
    
    
    1,973
    
    
    
    1,855Service revenue
    
    
    12,188
    
    
    
    25,015
    
    
    
    18,992Cost of product sales
    
    
    5,284
    
    
    
    6,926Cost of services
    
    
    19,082
    
    
    
    Gross Profit
    
    
    649
    
    
    
    12,066Operating Expenses:Patient acquisition and related costs
    
    
    1,081
    
    
    
    9,154Patient service and fulfillment
    
    
    2,444
    
    
    
    3,892General and administrative
    
    
    7,842
    
    
    
    4,304Provision for doubtful accounts
    
    
    856
    
    
    
    2,321Depreciation and amortization
    
    
    344
    
    
    
    216Amortization of equity issued to CIGNA
    
    
    969
    
    
    
    13,536
    
    
    
    19,887Loss from Operations
    
    
    (12,887
    )
    
    
    (7,821
    )Other Income (Expense):Interest income
    
    
    93
    
    
    
    Interest expense, related party
    
    
    (591
    )
    
    
    (248
    )Interest expense
    
    
    (145
    )
    
    
    (205
    )(643
    )
    
    
    (453
    )Net Loss
    
    $
    (13,530
    )
    
    $
    (8,274
    )Loss per share  basic and diluted
    
    $
    (0.49
    )
    
    $
    (0.32
    )Weighted average shares outstanding  basic
and diluted
    
    
    27,808
    
    
    
    26,175
 The accompanying notes are an integral part of these condensed consolidated financial statements.
 2




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NATIONSHEALTH, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
(In thousands)
 For the Three Months EndedMarch 31,2006
    
    
    2005Cash Flows from Operating Activities:Net Loss
    
    $
    (13,530
    )
    
    $
    (8,274
    )Adjustments to reconcile net loss to net cash and
cash equivalents used in operating activities:Provision for doubtful accounts
    
    
    856
    
    
    
    2,321Provision for sales allowances and returns
    
    
    679
    
    
    
    350Reserve for (recovery of) costs related to billings in process
    
    
    (102
    )
    
    
    868Depreciation and amortization
    
    
    458
    
    
    
    216Amortization of note discount
    
    
    264
    
    
    
    140Amortization of deferred loan costs and other non-cash interest
charges, net
    
    
    67
    
    
    
    74Amortization of equity issued to CIGNA
    
    
    969
    
    
    
    Stock-based compensation
    
    
    543
    
    
    
    Other non-cash charges
    
    
    400
    
    
    
    Changes in operating assets and liabilities:(Increase) decrease in:Accounts receivable
    
    
    (2,399
    )
    
    
    (7,033
    )Inventory
    
    
    118
    
    
    
    (343
    )Costs related to billings in process
    
    
    133
    
    
    
    (1,200
    )Prepaid expenses and other assets
    
    
    265
    
    
    
    (283
    )Increase (decrease) in:Accounts payable and accrued expenses
    
    
    137
    
    
    
    1,007Deferred revenue
    
    
    658
    
    
    
    Net cash and cash equivalents used in operating activities
    
    
    (10,484
    )
    
    
    (12,157
    )Cash Flows from Investing Activities:Maturity (purchase) of available for sale investments, net
    
    
    (1,496
    )
    
    
    100Acquisition of property and equipment.
    
    
    (540
    )
    
    
    (334
    )Net cash and cash equivalents used in investing activities
    
    
    (2,036
    )
    
    
    (234
    )Cash Flows from Financing Activities:Proceeds from issuance of convertible notes, related party
    
    
    
    
    
    
    15,000Net draws on lines of credit
    
    
    
    
    
    
    3,715Proceeds from exercise of warrants
    
    
    1,999
    
    
    
    Payment of note issuance costs
    
    
    
    
    
    
    (907
    )Exercise of stock options
    
    
    17
    
    
    
    Principal payments under capital lease obligations
    
    
    (32
    )
    
    
    (29
    )Net cash and cash equivalents provided by financing activities
    
    
    1,984
    
    
    
    17,779Net (Decrease) Increase in Cash and Cash Equivalents
    
    
    (10,536
    )
    
    
    5,388Cash and Cash Equivalents, Beginning of Period
    
    
    13,971
    
    
    
    2,904Cash and Cash Equivalents, End of Period
    
    $
    3,435
    
    
    $
    8,292Non-cash Investing and Financing Activities:Equipment acquired under capital leases
    
    $
    
    
    
    $
    201
 The accompanying notes are an integral part of these condensed consolidated financial statements.
 3




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NATIONSHEALTH, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 1. BASIS OF PRESENTATION
   2. LIQUIDITY AND PROFITABILITY CONSIDERATIONS
   CIGNA Funding Arrangement
  Revolving Line of Credit
  4




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Cost Reductions
  Potential Sale of Intangible Assets
  Summary
  3. CIGNA AGREEMENT
     5




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4. US BIO JOINT VENTURE
    5. REVENUE RECOGNITION
    6




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6. STOCK-BASED COMPENSATION
    Accounting for Stock Issued to Employees
 Accounting for Stock-Based Compensation Accounting for Stock-Based Compensation  Transition and Disclosure,
 Net loss, as reported
    
    $
    (8,274
    )Add: Stock-based employee compensation expense included in net
loss
    
    
    Deduct: Total stock-based compensation expense determined under
fair value based method for all awards
    
    
    (252
    )Pro forma
    
    $
    (8,526
    )Basic and diluted loss per share:As reported
    
    $
    (0.32
    )Pro forma
    
    $
    (0.33
    )
 7




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Share-Based Payment
  Quarter Ended March 31,2006 Grants
    
    
    2005 GrantsExpected volatility
    
    
    50
    %
    
    
    50
    %Approximate risk free interest rate
    
    
    4.71
    %
    
    
    4.11
    %Expected term
    
    5.0 years
    
    5.0 yearsExpected forfeitures
    
    
    25
    %
    
    
    0
    %
  WeightedAverageExerciseShares
    
    
    PriceBeginning of period
    
    
    1,834,673
    
    
    $
    6.87Granted at Exercise Price = Market Price
    
    
    66,500
    
    
    
    5.29Granted at Exercise Price > Market Price
    
    
    200,000
    
    
    
    6.65Exercised
    
    
    (2,500
    )
    
    
    6.87Forfeited
    
    
    (73,000
    )
    
    
    7.08Expired
    
    
    (136,000
    )
    
    
    6.87Outstanding at end of period
    
    
    1,889,673
    
    
    
    6.78Options exercisable at end of period
    
    
    336,717
    
    
    
    6.75Weighted-average grant date fair value
    
    $
    1.76
 8




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Options Outstanding
    
    
    Options ExercisableWeighted
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    WeightedAverage
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    AverageRange of
    
    Options
    
    
    Remaining
    
    
    Exercise
    
    
    Options
    
    
    Remaining
    
    
    ExerciseExercise Prices
    
    Outstanding
    
    
    Contractual Life
    
    
    Price
    
    
    Exercisable
    
    
    Contractual Life
    
    
    Price$4.01 to $6.65
    
    
    497,000
    
    
    
    5.48
    
    
    $
    6.06
    
    
    
    33,000
    
    
    
    4.94
    
    
    $
    5.44$6.80 to $6.80
    
    
    251,750
    
    
    
    5.45
    
    
    
    6.80
    
    
    
    20,000
    
    
    
    5.45
    
    
    
    6.80$6.87 to $6.87
    
    
    905,375
    
    
    
    4.56
    
    
    
    6.87
    
    
    
    276,217
    
    
    
    4.56
    
    
    
    6.87$6.97 to $8.20
    
    
    235,548
    
    
    
    5.59
    
    
    
    7.96
    
    
    
    7,500
    
    
    
    5.56
    
    
    
    7.931,889,673
    
    
    
    5.05
    
    
    
    6.78
    
    
    
    336,717
    
    
    
    4.67
    
    
    
    6.75
    7. LINE OF CREDIT
   9




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Balance Sheet Classifications of Borrowings Outstanding under
Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box
Arrangement.
  8. CONVERTIBLE NOTES
    10




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11




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9. STOCKHOLDERS EQUITY
 Warrants
    12




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Common Stock Reserved
  10. EARNINGS (LOSS) PER SHARE
  11. CONTINGENCIES
 Employment
Arrangements
   13




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Equity Participation Fee
  12. SEGMENT INFORMATION
   14




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Revenue:Medical Products (1)
    
    $
    12,827Medicare Part D (2)
    
    
    12,188Consolidated revenue
    
    $
    25,015Segment profit (loss):Medical Products
    
    $
    2,255Medicare Part D
    
    
    (7,969
    )Unallocated amounts:Amortization of equity issued to CIGNA
    
    
    (969
    )Other corporate expenses
    
    
    (6,204
    )Consolidated loss from operations
    
    $
    (12,887
    )
 
   Medical Products
    
    $
    10,183Medicare Part D
    
    
    4,009Unallocated assets
    
    
    26,398Consolidated assets
    
    $
    40,590
 15




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 Important Factors That May Affect Future Operations and Results
   
    
    Expected future operations, revenue, gross margins and expenses;
    
    Credit facilities and projected cash needs;
    
    Sales opportunities, strategic relationships and marketing plans; and
    
    Estimates of potential markets for our products and services, including
the anticipated drivers for future growth.
   
    
    Our ability to successfully maintain a Medicare Part D segment;
    
    Declining reimbursement levels for, or increases in the costs of, products
dispensed;
    
    Our history of operating losses and our expectation that we will incur significant
additional operating losses;
    
    An inability to raise the capital that we will need to sustain our operations;
    
    Our ability to attract new customers and retain existing customers;
    
    Identification of, and competition for, growth and expansion opportunities;
    
    Compliance with, or changes in, government regulation and legislation, or
interpretations thereof, including, but not limited to, pharmacy licensing
requirements and healthcare reform legislation, including HIPAA;
    
    An inability to establish and maintain successful collaborative relationships could
adversely affect our ability to generate revenue;
 16




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
    
    Adverse developments in any investigation related to the pharmaceutical industry;
    
    Competition and technological change that may make our products and technologies
less attractive or obsolete;
    
    An inability to obtain and maintain intellectual property protection for our
technologies;
    
    Adverse resolution of future lawsuits or investigations;
    
    Significant fluctuations in our revenue and operating results, which have occurred
in the past and which we expect to continue to fluctuate in the future;
    
    Any loss or inability to hire and retain qualified personnel;
    
    Our exposure to product liability in excess of our insurance coverage;
    
    Any failure to maintain an effective system of internal controls in the future
could adversely affect our ability to accurately report financial results or prevent
fraud;
    
    Compliance with changing regulation of corporate governance and public disclosure
may result in additional expenses;
    
    Our common stock may continue to have a volatile public trading price and low
trading volume; and
    
    Anti-takeover provisions in our governing documents and under Delaware law may make
an acquisition of us more difficult.
  Business
   17




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Medicare Part D Segment
   Medical Products Segment
 Home Delivery of Medical Products
   18




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Retail Program
  Sale of Respiratory Division
  Prescription Discount Drug Card Services
  Critical Accounting Policies
  19




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Results of Operations
  2006
    
    
    2005$
    
    
    
    
    %
    
    
    $
    
    
    
    
    %Revenue:Net product sales
    
    $
    10,854
    
    
    
    43.4
    %
    
    $
    17,137
    
    
    
    90.2
    %Prescription card revenue
    
    
    1,973
    
    
    
    7.9
    
    
    
    1,855
    
    
    
    9.8Service revenue
    
    
    12,188
    
    
    
    48.7
    
    
    
    
    
    
    
    25,015
    
    
    
    100.0
    
    
    
    18,992
    
    
    
    100.0Cost of product sales
    
    
    5,284
    
    
    
    21.1
    
    
    
    6,926
    
    
    
    36.5Cost of services
    
    
    19,082
    
    
    
    76.3
    
    
    
    
    
    
    
    Gross Profit
    
    
    649
    
    
    
    2.6
    
    
    
    12,066
    
    
    
    63.5Operating Expenses:Patient acquisition and related costs
    
    
    1,081
    
    
    
    4.3
    
    
    
    9,154
    
    
    
    48.2Patient service and fulfillment
    
    
    2,444
    
    
    
    9.8
    
    
    
    3,892
    
    
    
    20.5General and administrative
    
    
    7,842
    
    
    
    31.3
    
    
    
    4,304
    
    
    
    22.7Provision for doubtful accounts
    
    
    856
    
    
    
    3.4
    
    
    
    2,321
    
    
    
    12.2Depreciation and amortization
    
    
    344
    
    
    
    1.4
    
    
    
    216
    
    
    
    1.1Amortization of equity issued to CIGNA
    
    
    969
    
    
    
    3.9
    
    
    
    
    
    
    
    13,536
    
    
    
    54.1
    
    
    
    19,887
    
    
    
    104.7Loss from Operations
    
    
    (12,887
    )
    
    
    (51.5
    )
    
    
    (7,821
    )
    
    
    (41.2
    )Other expense, net
    
    
    (643
    )
    
    
    (2.6
    )
    
    
    (453
    )
    
    
    (2.4
    )Net Loss
    
    $
    (13,530
    )
    
    
    (54.1
    %)
    
    $
    (8,274
    )
    
    
    (43.6
    %)
 Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005
 Revenue.
 Cost of Product Sales .
 20




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Cost of Services.
  Patient Acquisition and Related Costs.
 Patient Service and Fulfillment Expenses .
 21




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General and Administrative Expenses .
 Provision
for Doubtful Accounts.
 Depreciation and Amortization .
 Amortization of Equity Issued to CIGNA .
 Other Expense.
 Net Loss.
 22




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LIQUIDITY AND CAPITAL RESOURCES
          23




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24




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Off-Balance-Sheet Arrangements
  Recently Adopted Accounting Standards
 , Share-Based Payment, Stock-Based
Compensation Stock-Based Compensation
 25




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
    26




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PART IIOTHER INFORMATION
 
 Item 1A. Risk Factors
 Any failure to comply with certain conditions required for our common stock to be listed on
The Nasdaq National Market could result in the delisting of our common stock from The Nasdaq
National Market.
    
 Item 6. Exhibits
   27




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SIGNATURES
  NATIONSHEALTH, INCDate: May 15, 2006
    By:
    /s/ Glenn M. ParkerName:
    Glenn M. ParkerTitle:
    Chief Executive Officer(Principal Executive Officer)Date: May 15, 2006
    By:
    /s/ Timothy FairbanksName:
    Timothy FairbanksTitle:
    Chief Financial Officer(Principal Financial Officer)Date: May 15, 2006
    By:
    /s/ Bryan HappName:
    Bryan HappTitle:
    Chief Accounting Officer(Principal Accounting
Officer) 28




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NATIONSHEALTH, INC.
 EXHIBIT INDEX
 Exhibit No.
    
    Description10.1*
    
    Amendment Number 2 to Strategic Agreement by and among
Connecticut General Life Insurance Company, United States
Pharmaceutical Group, L.L.C. and NationsHealth, Inc.,
dated as of March 31, 2006.10.2
    
    Second Amended and Restated Revolving Credit and Security
Agreement among United States Pharmaceutical Group, LLC,
NationsHealth Holdings, L.L.C., NationsHealth, Inc, and
CapitalSource Finance LLC, dated March 21, 2006
originally filed on March 27, 2006 and incorporated
herein by reference.10.3
    
    Employment Agreement made as of February 3, 2006, by and
between NationsHealth, Inc. and Robert E. Tremain. Filed
as Exhibit 10.1 to the Companys Form 8-K (File No.
000-50348) filed February 9, 2006 and incorporated herein
by reference.31.1
    
    Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 29