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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2004 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from     to Commission file number     000-25769 ACCREDO HEALTH, INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE
    
    62-1642871(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 1640 CENTURY CENTER PKWY, SUITE 101, MEMPHIS, TN 38134 (Address of principal executive offices)
(Zip Code) (901) 385-3688 (Registrants telephone number, including area code) NO CHANGE (Former name, former address and former fiscal year,
if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes   þ
    No  o Indicate by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).
Yes þ
    No  o APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. CLASS
    
    OUTSTANDING AT January 28, 2005COMMON STOCK, $0.01 PAR VALUE
    
    
    48,949,659TOTAL COMMON STOCK
    
    
    48,949,659




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ACCREDO HEALTH, INCORPORATED
INDEX Part I    FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Statements of Income (unaudited)For the three months and six months ended December 31,
2004 and 2003Condensed Consolidated Balance SheetsJune 30, 2004 and December 31, 2004 (unaudited)Condensed Consolidated Statements of Cash Flows (unaudited)For the six months ended December 31, 2004 and 2003Notes to Condensed Consolidated Financial Statements (unaudited)Item 2. Managements Discussion and Analysis of Financial Condition
and Results of OperationsItem 3. Quantitative and Qualitative Disclosure About Market RiskItem 4. Controls and ProceduresPart II    OTHER INFORMATIONItem 4. Submission of Matters to a Vote of Security HoldersItem 6. Exhibits and Reports on Form 8-KEX-31.1  CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A)EX-31.2  CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A)EX-32.1  CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350EX-32.2  CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
  Note: Items 1, 2, 3 and 5 of Part II are omitted because they are not applicable. 2




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PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS. ACCREDO HEALTH, INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 (000S OMITTED, EXCEPT SHARE DATA)
 (UNAUDITED)
 Six Months Ended December 31,
    
    
    Three Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net patient revenue
    
    $
    903,206
    
    
    $
    704,278
    
    
    $
    492,742
    
    
    $
    378,239Other revenue
    
    
    19,241
    
    
    
    18,937
    
    
    
    10,576
    
    
    
    10,540Equity in net income of joint ventures
    
    
    1,233
    
    
    
    1,550
    
    
    
    628
    
    
    
    1,002Total revenues
    
    
    923,680
    
    
    
    724,765
    
    
    
    503,946
    
    
    
    389,781Cost of sales
    
    
    756,849
    
    
    
    568,821
    
    
    
    414,358
    
    
    
    309,924Gross profit
    
    
    166,831
    
    
    
    155,944
    
    
    
    89,588
    
    
    
    79,857General & administrative
    
    
    78,050
    
    
    
    68,988
    
    
    
    42,067
    
    
    
    34,436Bad debts
    
    
    12,404
    
    
    
    14,428
    
    
    
    6,804
    
    
    
    7,254Depreciation and amortization
    
    
    7,833
    
    
    
    6,056
    
    
    
    3,994
    
    
    
    3,101Income from operations
    
    
    68,544
    
    
    
    66,472
    
    
    
    36,723
    
    
    
    35,066Interest expense, net
    
    
    10,862
    
    
    
    4,401
    
    
    
    3,581
    
    
    
    2,125Minority interest in consolidated joint venture
    
    
    377
    
    
    
    1,053
    
    
    
    170
    
    
    
    571Income before income taxes
    
    
    57,305
    
    
    
    61,018
    
    
    
    32,972
    
    
    
    32,370Provision for income taxes
    
    
    22,056
    
    
    
    23,601
    
    
    
    12,760
    
    
    
    12,461Net income
    
    $
    35,249
    
    
    $
    37,417
    
    
    $
    20,212
    
    
    $
    19,909Cash dividends declared on common stock
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Earnings per share:Basic
    
    $
    0.72
    
    
    $
    0.78
    
    
    $
    0.41
    
    
    $
    0.41Diluted
    
    $
    0.72
    
    
    $
    0.77
    
    
    $
    0.41
    
    
    $
    0.41Weighted average shares outstanding:Basic
    
    
    48,772,130
    
    
    
    47,921,203
    
    
    
    48,890,785
    
    
    
    47,994,280Diluted
    
    
    49,138,888
    
    
    
    48,664,877
    
    
    
    49,184,531
    
    
    
    48,775,626
 See accompanying notes to condensed consolidated financial statements. 3




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ACCREDO HEALTH, INCORPORATED 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (000S OMITTED, EXCEPT SHARE DATA)
 (Unaudited)December 31,
    
    
    June 30,2004
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    63,774
    
    
    $
    42,743Patient accounts receivable, less allowance for
doubtful accounts of $80,547 at December 31, 2004
and $81,051 at June 30, 2004
    
    
    391,881
    
    
    
    325,642Due from affiliates
    
    
    2,295
    
    
    
    4,191Other accounts receivable
    
    
    32,803
    
    
    
    28,584Inventories
    
    
    157,153
    
    
    
    128,323Prepaids and other current assets
    
    
    5,650
    
    
    
    5,084Income taxes receivable
    
    
    1,721
    
    
    
    382Deferred income taxes
    
    
    14,018
    
    
    
    14,129Total current assets
    
    
    669,295
    
    
    
    549,078Property and equipment, net
    
    
    44,050
    
    
    
    41,283Other assets:Joint venture investments
    
    
    7,996
    
    
    
    7,713Goodwill, net
    
    
    550,122

    
    
    
    382,628Other intangible assets, net
    
    
    19,840
    
    
    
    17,480Total assets
    
    $
    1,291,303
    
    
    $
    998,182LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    219,920
    
    
    $
    164,780Accrued expenses
    
    
    20,167
    
    
    
    22,625Due to affiliates
    
    
    1,225
    
    
    
    654Current portion of long-term debt
    
    
    4,753
    
    
    
    4,445Total current liabilities
    
    
    246,065
    
    
    
    192,504Long-term debt
    
    
    370,123
    
    
    
    174,866Deferred income taxes
    
    
    28,525
    
    
    
    25,112Minority interest in consolidated joint venture
    
    
    3,534
    
    
    
    3,757Commitments
    
    
    
    
    
    
    Stockholders equity:Undesignated Preferred Stock, 5,000,000 shares
authorized, no shares issued
    
    
    
    
    
    
    Common Stock, $.01 par value; 100,000,000 shares authorized;
48,938,252 and 48,603,341 shares issued and outstanding at
December 31, 2004 and June 30, 2004, respectively
    
    
    489
    
    
    
    486Additional paid-in capital
    
    
    441,890
    
    
    
    436,021Accumulated other comprehensive income
    
    
    
    
    
    
    8Retained earnings
    
    
    200,677
    
    
    
    165,428Total stockholders equity
    
    
    643,056
    
    
    
    601,943Total liabilities and stockholders equity
    
    $
    1,291,303
    
    
    $
    998,182
 See accompanying notes to condensed consolidated financial statements. 4




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ACCREDO HEALTH, INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (000S OMITTED)
 (UNAUDITED)
 Six Months EndedDecember 31,2004
    
    
    2003OPERATING ACTIVITIES:Net income
    
    $
    35,249
    
    
    $
    37,417Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    9,350
    
    
    
    7,853Provision for losses on accounts receivable
    
    
    12,404
    
    
    
    14,428Deferred income tax expense
    
    
    3,542
    
    
    
    5,715Tax benefit of exercise of stock options
    
    
    1,826
    
    
    
    1,195Undistributed earnings of joint ventures
    
    
    (283
    )
    
    
    (1,110
    )Minority interest in income of consolidated joint venture
    
    
    377
    
    
    
    1,053Write-off of unamortized debt issuance costs
    
    
    4,422
    
    
    
    Loss on sale of property and equipment
    
    
    288
    
    
    
    Changes in operating assets and liabilities:Patient receivables and other
    
    
    (67,265
    )
    
    
    (50,893
    )Due from affiliates
    
    
    2,467
    
    
    
    (26
    )Inventories
    
    
    (19,161
    )
    
    
    (47,481
    )Prepaids and other current assets
    
    
    (310
    )
    
    
    (83
    )Income taxes receivable
    
    
    696
    
    
    
    5,372Accounts payable and accrued expenses
    
    
    40,488
    
    
    
    52,182Net cash provided by operating activities
    
    
    24,090
    
    
    
    25,622INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (9,059
    )
    
    
    (5,577
    )Proceeds from sale of property and equipment
    
    
    62
    
    
    
    Additions to other assets
    
    
    (927
    )
    
    
    Business acquisitions
    
    
    (187,167
    )
    
    
    (35,823
    )Net cash used in investing activities
    
    
    (197,091
    )
    
    
    (41,400
    )FINANCING ACTIVITIES:Proceeds from issuance of long-term debt
    
    
    376,450
    
    
    
    1,381Principal payments on long-term debt
    
    
    (180,885
    )
    
    
    (8,296
    )Payment of debt issuance costs
    
    
    (4,979
    )
    
    
    Issuance of common stock
    
    
    4,046
    
    
    
    1,950Distributions to minority interest partner
    
    
    (600
    )
    
    
    (1,400
    )Net cash provided by (used in) financing activities
    
    
    194,032
    
    
    
    (6,365
    )Increase (decrease) in cash and cash equivalents
    
    
    21,031
    
    
    
    (22,143
    )Cash and cash equivalents at beginning of period
    
    
    42,743
    
    
    
    48,006Cash and cash equivalents at end of period
    
    $
    63,774
    
    
    $
    25,863
 See accompanying notes to condensed consolidated financial statements. 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 December 31, 2004
 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary to present fairly the condensed consolidated financial position, results of
operations and cash flows of Accredo Health, Incorporated ( the Company or Accredo
) have been included. Operating results for the three and six-month periods ended
December 31, 2004 are not necessarily indicative of the results that may be expected
for the fiscal year ending June 30, 2005. The balance sheet at June 30, 2004 has been derived from the audited financial
statements at that date but does not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America
for complete financial statements. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Companys Annual Report on
Form 10-K for the fiscal year ended June 30, 2004. 2. STOCKHOLDERS EQUITY During the three and six-month periods ended December 31, 2004, employees
exercised stock options to acquire 25,072 and 299,900 shares of Accredo common stock,
respectively. The weighted average exercise price was $15.38 per share for the
three-month period and $10.74 per share for the six-month period. Employees of the Company also acquired 35,011 shares of Accredo common stock
during the period pursuant to the provisions of the Companys Employee Stock Purchase
Plan at a price of approximately $23.56 per share. Shares acquired under the plan
were purchased on December 31, 2004 from employee funds accumulated via payroll
deductions from July through December 2004. 3. PRO FORMA NET INCOME EFFECT OF COMPANY STOCK OPTION PLANS The Company accounts for its stock-based employee compensation plans under
the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related Interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under those plans
had an exercise price equal to the market value of the underlying common stock on the
date of grant. Pro forma information regarding net income is required by Statement of
Financial Accounting Standards No. 123 (SFAS 123) and has been determined as if the
Company had accounted for its employee stock options under the fair value method of
SFAS 123. Significant assumptions used by the Company in the Black-Scholes
option-pricing model computations are as follows for the three-month and six-month
periods ended December 31: Six Months Ended
    
    
    Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Weighted average risk-free
interest rate
    
    
    3.24
    %
    
    
    2.77
    %
    
    
    3.29
    %
    
    
    2.79
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility factor
    
    
    .60
    
    
    
    .70
    
    
    
    .60
    
    
    
    .70Weighted-avg. expected life
    
    4.0 yrs
    4.0 yrs
    4.0 yrs
    4.0 yrsEstimated turnover
    

    
    8
    %
    
    
    8
    %
    
    
    8
    %
    
    
    8
    %
 The Black-Scholes option model was developed for use in estimating the fair value
of traded options, which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Companys employee stock
options have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the fair
value estimate, in managements opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock options. 6




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For purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options vesting period. The Companys pro forma
information for the three-month and six-month periods ended December 31 is as follows
(in thousands, except share data): Six Months Ended
    
    
    Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net income, as reported
    
    $
    35,249
    
    
    $
    37,417
    
    
    $
    20,212
    
    
    $
    19,909Less stock-based
employee compensation
cost, net of related
tax effects, applying
the fair value method
to all awards
    
    
    (6,078
    )
    
    
    (5,655
    )
    
    
    (3,239
    )
    
    
    (3,447
    )Pro forma net income
    
    $
    29,171
    
    
    $
    31,762
    
    
    $
    16,973
    
    
    $
    16,462Earnings per share:Basic  as reported
    
    $
    0.72
    
    
    $
    0.78
    
    
    $
    0.41
    
    
    $
    0.41Basic  pro forma
    
    $
    0.60
    
    
    $
    0.66
    
    
    $
    0.35
    
    
    $
    0.34Diluted  as reported
    
    $
    0.72
    
    
    $
    0.77
    
    
    $
    0.41
    
    
    $
    0.41Diluted  pro forma
    
    $
    0.60
    
    
    $
    0.66
    
    
    $
    0.35
    
    
    $
    0.34
 The Financial Accounting Standards Board issued Statement No. 123 (revised 2004),
Share-Based Payment, on December 16, 2004. SFAS 123(R) requires all entities to
recognize compensation expense in an amount equal to the fair value of share based
payments. The standard is effective for awards granted, modified, or settled after
the first reporting period beginning after June 15, 2005. The Company will adopt SFAS
123(R) using the modified prospective method in the fiscal quarter ended September 30,
2005. 4. COMPREHENSIVE INCOME Comprehensive income includes changes in the fair value of certain derivative
financial instruments that qualify for hedge accounting. Comprehensive income for all
periods presented is as follows (in thousands): Six Months Ended December 31,
    
    
    Three Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Reported net income
    
    $
    35,249
    
    
    $
    37,417
    
    
    $
    20,212
    
    
    $
    19,909Unrealized gain on interest rate
swap contracts, net of tax benefit
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    26Comprehensive income
    
    $
    35,249
    
    
    $
    37,511
    
    
    $
    20,212
    
    
    $
    19,935
 The adjustments made in computing comprehensive income are reflected as a
component of stockholders equity under the heading accumulated other comprehensive
income. 5. CONTINGENCIES The Company, David D. Stevens and Joel R. Kimbrough are named as defendants in a
putative class action lawsuit filed in the United States District Court for the
Western District of Tennessee, Memphis Division. A Consolidated Amended Complaint was
filed on September 15, 2004. Defendants filed a Motion to Dismiss the Consolidated
Amended Complaint on November 1, 2004. The lawsuit alleges violations of Section 10(b)
of the Securities Exchange Act of 1934 and Rule 10(b)(5) promulgated thereunder, and
Section 20 of the Securities Exchange Act of 1934. The putative class representatives
seek to represent a class of individuals and entities that purchased Company stock
during the period June 16, 2002 through April 7, 2003 and who supposedly suffered
damages from the alleged violations of the securities laws. The Company believes that
the claims asserted in the putative class action lawsuits are without merit. 7




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In addition, two purported derivative lawsuits were filed in the Circuit Court of
Shelby County, Tennessee for the Thirtieth Judicial District at Memphis. These actions
were consolidated and a Consolidated Derivative Complaint was filed on July 28, 2003.
The derivative action names certain current and former Company officers and directors
(David D. Stevens, John R. Grow, Kyle J. Callahan, Kevin L. Roberg, Kenneth R.
Masterson, Kenneth J. Melkus, Dick R. Gourley, Nancy-Ann DeParle, Joel R. Kimbrough,
Thomas W. Bell, Jr., and Patrick J. Welsh) as defendants. The derivative lawsuit
alleges that the defendants breached fiduciary duties owed to the Company by engaging
in the same alleged conduct that is the basis of the putative class action lawsuits.
On behalf of the Company, the derivative complaint seeks compensatory damages from the
defendants and the disgorgement of profits, benefits and other compensation received
by the defendants. The Company has filed a motion to dismiss the Consolidated
Derivative Complaint and the parties are awaiting the Courts ruling on this motion.
The Company believes that the claims asserted in the derivative lawsuit are without
merit. The Company and the Companys 80% owned joint venture in California provided
contract pharmacy and related billing services to a local California pharmacy that was
recently audited by the California Department of Health Services (Department)
concerning its MediCal billing for clotting factor supplied to the pharmacy by the
Company or the Companys joint venture. The audit is for the period January 2, 2001
to March 5, 2003 with dates of payment from March 26, 2001 to April 21, 2003.
Although the joint venture is not currently involved with the audits, the contract
pharmacy relationship is implicated and the pharmacy is seeking indemnification from
the joint venture. Since the initiation of the audit, the state agency has
temporarily withheld MediCal payments from the pharmacy and has alleged, among other
things, overbilling and false claims. In December 2004, the Department notified the
pharmacy that it had completed its audit and assessed the pharmacy approximately $13.5
million in alleged overbilling and overpayment received by the pharmacy from MediCal.
Over 80% of the assessment was for claims allegedly submitted in excess of acquisition
cost. The remaining portion of the assessment cited overpayments for lack of
documentation and false claims. The Department stated in its letter that the pharmacy
received reimbursement for services that were falsely represented as provided by the
pharmacy. The pharmacy has appealed the assessment. The Company believes the
assessment is without merit and expects the pharmacy and the joint venture to
vigorously defend against these allegations through judicial proceedings, if
necessary. Since false claim statutes are implicated, the pharmacy could also be
assessed fines and penalties. Due to the uncertainty about the issues involved in this
matter, based on the facts and circumstances known to date, the Company believes some
amount of monetary loss is reasonably possible in the range of zero to $20 million. The Company and the Companys 80% owned joint venture in California also provided
contract pharmacy and related billing services to a second local California pharmacy.
The California Department of Health Services is also auditing this pharmacy. The
Company has recently received a letter from the Department asking for information in
connection with the audit. The Company anticipates that this audit will involve issues
that are the same as or similar to those involved in the audit described in the
preceding paragraph. The Company is in the process of gathering information responsive
to the Departments letter and cannot determine at this time whether it will incur any
liability associated with this audit. Also, from time to time, the Company is involved in lawsuits, claims, audits, and
investigations arising in the normal course of business. In the Companys opinion, in
the aggregate these lawsuits, claims, audits and investigations should not have a
material adverse effect on the Companys business, financial condition, or results of
operations. In addition, the business that the Company acquired from Gentiva Health
Services, Inc. has several lawsuits and claims related to its historical operations by
Gentiva, which are being controlled by Gentiva and for which the Company is entitled
to indemnification from liability by Gentiva. 6. ACQUISITIONS On October 17, 2003, the Company acquired certain assets, including inventory and
accounts receivable, of Alpha Therapeutic Services, Inc. (ATS) from Baxter Healthcare
Corporation. ATS, located in the City of Industry, California, provides pharmaceutical
care for certain chronic, long-term patient populations including those requiring IVIG
and blood related disorders such as hemophilia. As a result of the acquisition, we
have increased our market share in these products. The aggregate purchase price paid
was $35.7 million. Total assets acquired were $4.2 million. The excess of the total
purchase price over the fair value of the assets acquired was allocated as follows:
$30.8 million to goodwill and $0.7 million to acquired patient relationships. The
acquired patient relationship intangible is being amortized over five years. The
results of the ATS operations have been included in the consolidated financial
statements since October 18, 2003. On July 21, 2004, the Company acquired all of the outstanding stock of HRA
Holding Corporation and its wholly owned subsidiary, Hemophilia Resources of America,
Inc. (HRA). HRA specializes in providing pharmaceuticals, therapeutic supplies and
disease management services for people with hemophilia and related bleeding disorders.
The acquisition of HRA increased the Companys market leading position in the
distribution of hemophilia related products. The aggregate purchase price paid for
this acquisition, inclusive of transaction costs and related expenses, was
approximately $165.8 million and was funded by the Companys increased credit
facility. This transaction was accounted for using the purchase method of 8




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accounting. Total assets acquired and liabilities assumed were $24.0 million and
$6.6 million, respectively. The excess of the purchase price, including acquisition
costs of approximately $0.3 million, over the fair value of the net assets acquired of
$17.4 million was allocated as follows: $145.1 million to goodwill and $2.5 million
related to acquired patient relationships. The acquired patient relationship
intangible is being amortized over five years. Final resolution of the working capital
adjustment, as defined in the merger agreement, may result in the payment of
additional consideration. The Company also paid $0.8 million as consideration for an
agreement with a selling shareholder not to compete with the Company for a period of
ten years. The transition and integration of HRA business activities commenced during
the September 2004 quarter and will continue throughout the remainder of fiscal 2005.
The results of HRA have been included in the consolidated financial statements since
July 21, 2004. On July 1, 2004, the Company acquired all of the outstanding stock of Home Health
Care Resources, Inc. (HHCR). HHCR specializes in providing pharmaceuticals,
therapeutic supplies and disease management services for people with autoimmune
disorders and hemophilia. The aggregate purchase price paid for this acquisition,
inclusive of transaction costs and related expenses, was approximately $26.8 million.
In addition, it appears that HHCR will be paid additional consideration amounting to
$3 million related to an earn-out payment based on the achievement of certain
financial results for the six months ended December 31, 2004. This transaction was
accounted for using the purchase method of accounting. Total assets acquired and
liabilities assumed were $4.3 million and $0.8 million, respectively. The excess of
the purchase price over the fair value of the net assets acquired of $3.5 million was
allocated as follows: $22.7 million to goodwill and $0.3 million related to acquired
patient relationships. The acquired patient relationship intangible is being amortized
over five years. The Company also paid $0.3 million as consideration for an agreement
with the selling shareholders not to compete with the Company for a period of ten
years. The results of HHCR have been included in the consolidated financial statements
since July 1, 2004. 7. EARNINGS PER SHARE The Company presents earnings per share in accordance with SFAS No. 128, Earnings
Per Share. All per share amounts have been calculated using the weighted average
number of shares outstanding during each period. Diluted earnings per share are
adjusted for the impact of common stock equivalents using the treasury stock method
when the effect is dilutive. Options to purchase approximately 4.1 million and 2.1
million shares of common stock were outstanding at December 31, 2004 and December 31,
2003, respectively, but were not included in the computation of diluted earnings per
share because the options exercise prices were greater than the average market price
of common shares and, therefore, the effect would be antidilutive. A reconciliation
of the basic and diluted weighted average shares outstanding is as follows at December
31: Six Months Ended
    
    
    Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Weighted average
number of common
shares
outstanding used
as the
denominator in
the basic
earnings per
share
calculation
    
    
    48,772,130
    
    
    
    47,921,203
    
    
    
    48,890,785
    
    
    
    47,994,280Additional
shares assuming
exercise of
dilutive stock
options
    
    
    366,758
    
    
    
    743,674
    
    
    
    293,746
    
    
    
    781,346Weighted average
number of common
and equivalent
shares used as
the denominator
in the diluted
earnings per
share
calculation
    
    
    49,138,888
    
    
    
    48,664,877
    
    
    
    49,184,531
    
    
    
    48,775,626
 9




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FORWARD LOOKING STATEMENTS Some of the information in this quarterly report contains forward-looking
statements that involve substantial risks and uncertainties. You can identify these
statements by forward-looking words such as may, will, expect, anticipate,
believe, intend, estimate and continue or similar words. You should read
statements that contain these words carefully for the following reasons:  
    the statements discuss our future expectations;
    the statements contain projections of our future earnings or of our financial condition; and
    the statements state other forward-looking information. Specifically, this report contains, among others, forward-looking statements about:  
    our expectations regarding our product mix for periods following December 31, 2004;
    our expectations regarding our payor mix for periods following December 31, 2004;
    our expectations regarding the movement of patients to us pursuant to our
strategic alliance with Medco Health Solutions, Inc. following December 31,
2004;
    our expectations regarding the scope and cost of our capital expenditures following December 31, 2004;
    our sources and availability of funds to satisfy our working capital needs;
    the implementation or interpretation of current or future regulations and
legislation relating to the industry in which we operate;
    our critical accounting policies; and
    our expectations regarding the percentage of our revenues attributable to federal and state programs. The forward-looking statements contained in this report reflect our current views
about future events, are based on assumptions and are subject to known and unknown
risks and uncertainties. Many important factors could cause our actual results or
achievements to differ materially from any future results or achievements expressed in
or implied by our forward-looking statements. Many of the factors that will determine
future events or achievements are beyond our ability to control or predict. Important
factors that could cause actual results or achievements to differ materially from the
results or achievements reflected in our forward-looking statements include, among
other things, the factors discussed in Part I, Item 2 of this report under the
sub-heading Risk Factors. You should read this report, the information incorporated by reference into this
report and the documents filed as exhibits to this report completely and with the
understanding that our actual future results or achievements may be materially
different from what we currently expect or anticipate. You should be aware that the
occurrence of any of the events described in the risk factors discussed elsewhere in
this quarterly report and other events that we have not predicted or assessed could
have a material adverse effect on our earnings, financial condition and business. In
such case, the trading price of our common stock could decline, and you may lose all
or part of your investment. The forward-looking statements contained in this report reflect our views and
assumptions only as of the date this report is signed. Except as required by law, we
assume no responsibility for updating any forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.
In addition, with respect to all of our forward-looking statements, we claim the
protection of the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. 10




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OVERVIEW For an understanding of the significant factors that influenced our results, the
following discussion should be read in conjunction with our unaudited consolidated
financial statements and related notes appearing elsewhere in this report. This
managements discussion and analysis should also be read in conjunction with the
managements discussion and analysis and consolidated financial statements included in
our Form 10-K for the fiscal year ended June 30, 2004. We provide specialty retail pharmacy services for the treatment of patients with
costly, chronic diseases. We derive revenues primarily from the retail sale of drugs
to patients. We focus almost exclusively on a limited number of complex and expensive
drugs that serve small patient populations. The following table presents the
percentage of our total revenues generated from sales with respect to the diseases
that we primarily serve: Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Hemophilia,
Autoimmune
Disorders and
Primary
Immunodeficiency
(PID)
    
    
    34
    %
    
    
    34
    %
    
    
    36
    %
    
    
    37
    %Multiple Sclerosis
    
    
    15
    %
    
    
    14
    %
    
    
    16
    %
    
    

    15
    %Pulmonary
Arterial
Hypertension
(PAH)
    
    
    15
    %
    
    
    15
    %
    
    
    15
    %
    
    
    16
    %Gaucher Disease
    
    
    6
    %
    
    
    9
    %
    
    
    6
    %
    
    
    9
    %Growth
Hormone-Related
Disorders
    
    
    9
    %
    
    
    8
    %
    
    
    9
    %
    
    
    8
    %Respiratory
Syncytial Virus
(RSV)
    
    
    11
    %
    
    
    11
    %
    
    
    6
    %
    
    
    6
    %
 We anticipate that our revenue mix for the March 2005 quarter will be similar to
the revenue mix in the December 2004 quarter as a result of revenues from the seasonal
drug Synagis® for the treatment of RSV. Most Synagis® sales occur from October
through March of the following year. In our fiscal fourth quarter (June 2005), we
anticipate that our RSV revenues will represent a much smaller percentage of our
overall revenues with an offsetting increase in the percentage of our revenues from
the other diseases listed above. Reimbursement for the products we sell comes from governmental payors, Medicare
and Medicaid, and non-governmental payors. The following table presents the percentage
of our total revenues reimbursed by these payors: Year Ended
    
    
    Year Ended
    
    
    Six Months EndedJune 30, 2003
    
    
    June 30, 2004
    
    
    December 31, 2004Non-governmental
    
    
    73
    %
    
    
    72
    %
    
    
    72
    %Governmental:Medicaid
    
    
    20
    %
    
    
    21
    %
    
    
    20
    %Medicare
    
    
    7
    %
    
    
    7
    %
    
    
    8
    %
 We anticipate that our payor mix for the remainder of our fiscal year 2005 will
be similar to the payor mix achieved in fiscal 2004 and the six months ended December
31, 2004. ACQUISITIONS On October 17, 2003, we acquired certain assets, including inventory and accounts
receivable, of Alpha Therapeutic Services, Inc. (ATS) from Baxter Healthcare
Corporation. ATS, located in the City of Industry, California, provides pharmaceutical
care for certain chronic, long-term patient populations including those requiring IVIG
and blood related disorders such as hemophilia. As a result of the acquisition, we
have increased our market share in these products. The aggregate purchase price paid
was $35.7 million. The results of the ATS operations have been included in the
consolidated financial statements since October 18, 2003. On July 21, 2004, the Company acquired all of the outstanding stock of HRA
Holding Corporation and its wholly owned subsidiary, Hemophilia Resources of America,
Inc. (HRA). HRA specializes in providing pharmaceuticals, therapeutic 11




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supplies and disease management services for people with hemophilia and related
bleeding disorders. The acquisition of HRA increased the Companys market leading
position in the distribution of hemophilia related products. The aggregate purchase
price paid for this acquisition, inclusive of transaction costs and related expenses,
was approximately $165.8 million and was funded by the Companys increased credit
facility. This transaction was accounted for using the purchase method of accounting.
Total assets acquired and liabilities assumed were $24.0 million and $6.6 million,
respectively. The excess of the purchase price, including acquisition costs of
approximately $0.3 million, over the fair value of the net assets acquired of $17.4
million was allocated as follows: $145.1 million to goodwill and $2.5 million related
to acquired patient relationships. The acquired patient relationship intangible is
being amortized over five years. Final resolution of the working capital adjustment,
as defined in the merger agreement, may result in the payment of additional
consideration. The Company also paid $0.8 million as consideration for an agreement
with a selling shareholder not to compete with the Company for a period of ten years.
The transition and integration of HRA business activities commenced during the
September 2004 quarter and will continue throughout the remainder of fiscal 2005. The
results of HRA have been included in the consolidated financial statements since July
21, 2004. On July 1, 2004, the Company acquired all of the outstanding stock of Home Health
Care Resources, Inc. (HHCR). HHCR specializes in providing pharmaceuticals,
therapeutic supplies and disease management services for people with autoimmune
disorders and hemophilia. The aggregate purchase price paid for this acquisition,
inclusive of transaction costs and related expenses, was approximately $26.8 million.
In addition, it appears that HHCR will be paid additional consideration amounting to
$3 million related to an earn-out payment based on the achievement of certain
financial results for the six months ended December 31, 2004. This transaction was
accounted for using the purchase method of accounting. Total assets acquired and
liabilities assumed were $4.3 million and $0.8 million, respectively. The excess of
the purchase price over the fair value of the net assets acquired of $3.5 million was
allocated as follows: $22.7 million to goodwill and $0.3 million related to acquired
patient relationships. The acquired patient relationship intangible is being amortized
over five years. The Company also paid $0.3 million as consideration for an agreement
with the selling shareholders not to compete with the Company for a period of ten
years. The results of HHCR have been included in the consolidated financial statements
since July 1, 2004. RESULTS OF OPERATIONS Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003 Total Revenues.Total revenues increased 29% from $389.8 million to $503.9
million from the three months ended December 31, 2003 to the three months ended
December 31, 2004. Net patient revenue increased 30% from $378.2 million to $492.7
million from the three months ended December 31, 2003 to the three months ended
December 31, 2004. The increase is primarily due to volume growth in our products for
the treatments of hemophilia, multiple sclerosis, growth hormone disorders, PAH, RSV
and autoimmune disorders as a result of the addition of new patients and additional
sales of product to existing patients. In addition, the increase is driven in part by
the acquisitions of HRA and HHCR which were purchased in July 2004. We also benefited
from the addition of new and expanded contracts with managed care organizations and
pharmacy benefit managers (PBMs), including our expanded relationship with Medco
Health Solutions, Inc. (Medco). Cost of Sales.Cost of sales increased 34% from $309.9 million to $414.4 million
from the three months ended December 31, 2003 to the three months ended December 31,
2004. The 34% growth in costs of sales exceeded the 29% revenue growth discussed
above. As a percentage of revenues, cost of services increased from 79.5% to 82.2%
from the three months ended December 31, 2003 to the three months ended December 31,
2004, resulting in gross margins of 20.5% and 17.8% for the three months ended
December 31, 2003 and 2004, respectively. The decline is primarily a result of
reductions in reimbursement levels from government and commercial payors in the three
months ended December 31, 2004 as compared to the same period last year. These
reductions principally relate to our hemophilia (specifically products reimbursed by
MediCal), PAH (specifically products reimbursed by Medicare), and IVIG product lines.
Furthermore, the decrease is a result of product mix changes. We derived a larger
percentage of our revenues from lower margin products in the 2004 period when compared
to the same period last year, including changes resulting from our expanded
relationship with Medco. The primary change in product mix was an increase in the
percentage of total revenues from products for the treatment of multiple sclerosis and
growth hormone deficiency. General and Administrative.General and administrative expense increased from
$34.4 million to $42.1 million, or 22%, from the three months ended December 31, 2003
to the three months ended December 31, 2004. As a percentage of revenues, general and
administrative expense was 8.8% for the three months ended December 31, 2003 and 8.3%
for the three months ended December 31, 2004. The decrease as a percentage of revenue
is primarily due to the significant revenue growth in the current period as compared
to the same period last year and changes in product mix, both driven in part from our
expanded relationship with Medco. The increase on an absolute dollar basis is
primarily due to increased salaries and fringe benefits associated with the expansion
of our staff to support our revenue growth, including health insurance costs. Rent
and information technology expenses also increased with the expansion of our office
space. These increases were 12




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##### Table of Contents



partially offset by reductions in directors and officers insurance costs for the
three months ended December 31, 2004 as compared to the same period last year. Bad Debts.Bad debts decreased from $7.3 million to $6.8 million from the three
months ended December 31, 2003 to the three months ended December 31, 2004. As a
percentage of revenues, bad debt expense decreased from 1.9% to 1.4% from the three
months ended December 31, 2003 to the three months ended December 31, 2004. This
decrease is primarily due to a decrease in the percentage of our revenues that were
reimbursed by major medical benefit plans versus prescription card benefits, and the
impact of changes in product mix, including the incremental Medco revenues in the
three months ended December 31, 2004, that did not exist in the same period last year.
The change in revenue mix discussed above directly impacts the percentage of revenue
reimbursed by prescription card benefits versus major medical benefit plans. The
majority of the reimbursement provided by major medical benefit plans are subject to
much higher co-payment and deductible amounts versus the typical $20 to $30 co-pay
generally required by prescription card benefit plans. The revenue stream associated
with the expanded Medco business is pre-adjudicated by Medco and has virtually no bad
debt costs associated with it. Depreciation and Amortization.Depreciation expense increased from $1.9 million
to $2.7 million from the three months ended December 31, 2003 to the three months
ended December 31, 2004, as a result of purchases of property and equipment associated
with our revenue growth including additional computer hardware, enhancements to our
fully integrated pharmacy and reimbursement software system, and build-outs of
additional space. Amortization expense increased from $1.2 million to $1.3 million
from the three months ended December 31, 2003 to the three months ended December 31,
2004. This increase resulted from the amortization of certain intangible assets
associated with the HRA and HHCR acquisitions that were completed in July 2004. Interest Expense, Net.Interest expense, net increased from $2.1 million to $3.6
million from the three months ended December 31, 2003 to the three months ended
December 31, 2004 due to increased borrowings and higher interest rates. Upon the
closing of our expanded facility in July 2004 (now at $550 million capacity), we
increased our borrowings to $375.0 million. The borrowings were primarily used to
fund the acquisition of HRA that also occurred in July 2004. Amounts borrowed under
the previous Senior Credit facility were approximately $186.6 million at December 31,
2003. Amounts borrowed under the expanded Senior Credit facility were $373.1 million
at December 31, 2004. Provision for Income Taxes.Our effective tax rate increased from 38.5% to 38.7%
from the three months ended December 31, 2003 to the three months ended December 31,
2004. The difference between the recognized effective tax rate and the statutory rate
is primarily attributed to state income taxes. Changes in the effective tax rates are
primarily due to changes in the estimated percentage of our profits being derived from
subsidiaries that are taxable in certain states. Six Months Ended December 31, 2004 Compared to Six Months Ended December 31, 2003 Total Revenues.Total revenues increased 27% from $724.8 million to $923.7
million from the six months ended December 31, 2003 to the six months ended December
31, 2004. Net patient revenue increased 28% from $704.3 million to $903.2 million from
the six months ended December 31, 2003 to the six months ended December 31, 2004. The
increase is primarily due to volume growth in our products for the treatments of
hemophilia, multiple sclerosis, growth hormone disorders, PAH, RSV and autoimmune
disorders as a result of the addition of new patients and additional sales of product
to existing patients. In addition, the increase is driven in part by the acquisitions of HRA
and HHCR which were purchased in July 2004. We also benefited from the addition of
new and expanded contracts with managed care organizations and PBMs, including our
expanded relationship with Medco. Cost of Sales.Cost of sales increased 33% from $568.8 million to $756.8 million
from the six months ended December 31, 2003 to the six months ended December 31, 2004.
The 33% growth in costs of sales exceeded the 27% revenue growth discussed above. As
a percentage of revenues, cost of services increased from 78.5% to 81.9% from the six
months ended December 31, 2003 to the six months ended December 31, 2004, resulting in
gross margins of 21.5% and 18.1% for the six months ended December 31, 2003 and 2004,
respectively. The decline is primarily a result of reductions in reimbursement levels
from government and commercial payors in the six months ended December 31, 2004, as
compared to the same period last year. These reductions principally relate to our
hemophilia (specifically products reimbursed by MediCal), PAH (specifically products
reimbursed by Medicare), and IVIG product lines. Furthermore, the decrease is a
result of product mix changes. We derived a larger percentage of our revenues from
lower margin products in the 2004 period when compared to the same period last year,
including changes resulting from our expanded relationship with Medco. The primary
change in product mix was an increase in the percentage of total revenues from
products for the treatment of multiple sclerosis and growth hormone deficiency. General and Administrative.General and administrative expense increased from
$69.0 million to $78.0 million, or 13%, from the six months ended December 31, 2003 to
the six months ended December 31, 2004. As a percentage of revenues, general and
administrative expense decreased from 9.5% to 8.5% from the six months ended December
31, 2003 to 13




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##### Table of Contents



the six months ended December 31, 2004. The decrease as a percentage of revenue
is primarily due to the significant revenue growth in the current period as compared
to the same period last year and changes in product mix, both driven in part from our
expanded relationship with Medco. The increase on an absolute dollar basis is
primarily due to increased salaries and fringe benefits associated with the expansion
of our staff to support our revenue growth. Rent and information technology expenses
also increased with the expansion of our office space. These increases were partially
offset by reductions in professional fees and directors and officers insurance costs
for the six months ended December 31, 2004, as compared to the same period last year. Bad Debts.Bad debts decreased from $14.4 million to $12.4 million from the six
months ended December 31, 2003 to the six months ended December 31, 2004. As a
percentage of revenues, bad debt expense decreased from 2.0% to 1.3% from the six
months ended December 31, 2003 to the six months ended December 31, 2004. This
decrease is primarily due to a decrease in the percentage of our revenues that were
reimbursed by major medical benefit plans versus prescription card benefits, and the
impact of changes in product mix, including the incremental Medco revenues in the six
months ended December 31, 2004, that did not exist in the same period last year. The
change in revenue mix discussed above directly impacts the percentage of revenue
reimbursed by prescription card benefits versus major medical benefit plans. The
majority of the reimbursement provided by major medical benefit plans are subject to
much higher co-payment and deductible amounts versus the typical $20 to $30 co-pay
generally required by prescription card benefit plans. The revenue stream associated
with the expanded Medco business is pre-adjudicated by Medco and has virtually no bad
debt costs associated with it. Depreciation and Amortization.Depreciation expense increased from $3.8 million
to $5.3 million from the six months ended December 31, 2003 to the six months ended
December 31, 2004, as a result of purchases of property and equipment associated with
our revenue growth including additional computer hardware, enhancements to our fully
integrated pharmacy and reimbursement software system, and build-outs of additional
space. Amortization expense increased from $2.3 million to $2.5 million from the six
months ended December 31, 2003 to the six months ended December 31, 2004. This
increase resulted from the amortization of certain intangible assets associated with
the HRA and HHCR acquisitions that were completed in July 2004. Interest Expense, Net.Interest expense, net increased from $4.4 million to $10.9
million from the six months ended December 31, 2003 to the six months ended December
31, 2004. Interest expense (net) in the current period includes the write-off of
approximately $4.4 million in unamortized debt issuance costs associated with the
replacement and expansion of our Senior Credit facility. The write-off was recorded
in the September 2004 quarter. Upon the closing of the expanded facility (now at $550
million capacity), we increased our borrowings to $375.0 million. The borrowings were
primarily used to refinance the existing facility and to fund the acquisition of HRA
that also occurred during the September 2004 quarter. Excluding the write-off of
unamortized debt issuance costs, interest expense (net) would have been $6.5 million
for the six months ended December 31, 2004, as compared to $4.4 million for the six
months ended December 31, 2003. This increase is attributable to increased borrowings
under the expanded facility and higher interest rates during the current period as
compared to the same period last year. Amounts borrowed under the previous Senior
Credit facility were approximately $186.6 million at December 31, 2003. Amounts
borrowed under the expanded Senior Credit facility were $373.1 million at December 31,
2004. Provision for Income Taxes.Our effective tax rate was 38.5% for the six months
ended December 31, 2004, as compared to 38.7% for the six months ended December 31,
2003. The difference between the recognized effective tax rate and the statutory rate
is primarily attributed to state income taxes. Changes in the effective tax rates are
primarily due to changes in the estimated percentage of our profits being derived from
subsidiaries that are taxable in certain states. 14




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2004, working capital was $423.2 million, cash and cash
equivalents were $63.8 million and the current ratio was 2.7 to 1.0. Net cash provided by operating activities was $24.1 million for the six months
ended December 31, 2004. During the six months ended December 31, 2004, accounts
receivable increased $67.3 million, inventories increased $19.2 million and accounts
payable, accrued expenses and income taxes receivable increased $41.2 million. These
changes are due primarily to our revenue growth and the timing of the collection of
receivables, inventory purchases and payments of accounts payable. The growth in
accounts receivable from June 30, 2004, to December 31, 2004, was lower than the
sequential revenue growth, as evidenced by an eight day reduction in days sales
outstanding. This is driven in part by the effect of our expanded PBM relationships,
as well as improved billing and collection processes. The rise in inventory is driven
primarily by managements intent to increase quantities on hand of certain IVIG
products in anticipation of potential product shortages. The increase is also due to
certain inventory purchasing commitments. Net cash used in investing activities was $197.1 million for the six months ended
December 31, 2004. Cash used in investing activities consisted primarily of $187.2
million for the purchase of HRA and HHCR and $9.1 million for purchase of property and
equipment. Cash used for the addition of other assets was approximately $0.9 million.
Proceeds from the sale of property and equipment were approximately $0.1 million. Net cash provided by financing activities was $194.0 million for the six months
ended December 31, 2004. This amount consisted of $376.5 million of proceeds from the
issuance of long-term debt and $4.0 million from the issuance of common stock, less
$180.9 million in debt repayments, $5.0 million for the payment of debt issuance
costs, and $0.6 million of distributions to our minority interest partner. Historically, we have funded our operations and continued internal growth through
cash provided by operations. Capital expenditures amounted to $19.7 million in fiscal
year 2004 and $16.0 million in fiscal year 2003. We anticipate that our capital
expenditures for the fiscal year ending June 30, 2005 will consist primarily of
additional computer hardware, including installation of a second data center,
enhancements to our fully integrated pharmacy and reimbursement software system and
costs to build out and furnish additional space needed to meet our anticipated growth.
We expect the cost of our capital expenditures in fiscal year 2005 to be approximately
$20.0 million, exclusive of any acquisitions of businesses. We expect to fund these
expenditures through cash provided by operating activities and/or borrowings under the
revolving credit facility with our bank. As of June 30, 2004, our $325 million revolving credit facility with Bank of
America, N.A. and other participating banks (collectively the Lenders) consisted of
a $125 million revolving commitment expiring June 2007, a $75 million term loan
(Tranche A Term Loan) due in periodic principal payments through March 2007, and a
$125 million term loan (Prior Tranche B Term Loan) due in periodic principal payments
through March 2009. On November 18, 2003, we amended our credit facility to lower the
margin on the Prior Tranche B Term Loan to 2.25% for London Inter-Bank Offered Rate
(LIBOR) based loans and 0.75% for prime rate based loans effectively reducing the
margin by 50 basis points through May 2004 and 25 basis points for the remaining term
of the loan. We paid Bank of America, N.A. $175,000 in administrative fees related to
this amendment. During the quarter ended September 30, 2004, we replaced our credit
facility to increase the size of the credit facility to $550 million, consisting of a
$175 million revolving commitment expiring July 2009 and a $375 million term loan
(Tranche B Term Loan) due in periodic principal payments through June 2011. Amounts outstanding under the credit facility bear interest at varying rates
based upon a LIBOR or prime rate of interest (as selected by us), plus a variable
margin rate based upon our leverage ratio as defined by the credit agreement. The
combination of a variable rate margin and LIBOR base rate resulted in an effective
borrowing rate of 3.39% and 4.23% at June 30, 2004, and December 31, 2004,
respectively. Our obligations under the credit facility are secured by a lien on
substantially all of our assets, including a pledge of all of the common stock or
partnership interest of each of our domestic subsidiaries. The Lenders security
interest in a portion of our inventory is subordinate to the liens on that inventory
under the terms of a security agreement between one of our vendors and us. The same
vendor has a security interest in certain accounts receivable, which is subordinate to
the rights of the Lenders. The credit facility documentation contains financial covenants, including
requirements to maintain certain ratios with respect to leverage, fixed charge
coverage, net worth and asset coverage, each as defined in the credit agreement. The
credit facility documentation also includes customary affirmative and negative
covenants, including covenants relating to transactions with affiliates, uses of
proceeds, restrictions on subsidiaries, limitations on indebtedness, limitations on
mergers, acquisitions and asset dispositions, limitations on investments, limitations
on payment of dividends and stock repurchases, and other distributions. The credit
facility documentation also contains customary events of default, including events
relating to changes in control of the Company. 15




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##### Table of Contents



On June 4, 2003, we entered into an interest rate swap agreement effectively
converting for a period of one year beginning July 21, 2003, $120 million of
floating-rate borrowings to fixed-rate borrowings with a fixed rate of 1.14%, plus the
applicable margin rate as determined by the credit agreement. The interest rate swap
agreement expired on July 21, 2004. On February 6, 2003, the Securities and Exchange Commission (SEC) declared
effective our shelf registration statement on Form S-3 providing for the offer, from
time to time, of various securities, up to an aggregate of $500 million. The shelf
registration statement may enable us to more efficiently raise funds from the offering
of securities covered by the shelf registration statement, subject to market
conditions and our capital needs. Our liquidity needs currently arise primarily from working capital requirements,
capital expenditures, commitments related to financing obtained through the issuance
of long-term debt and inventory purchase obligations. We believe that our cash from
operations, cash available under the recently increased revolving credit facility and
the proceeds from any offering of debt or equity securities allowed by the shelf
registration statement will be sufficient to meet our internal operating and working
capital requirements and growth plans for at least the next 12 months. Commitments and Contractual Obligations The following table sets forth a summary of our contractual cash obligations as
of December 31, 2004. With the exception of long-term debt, this table does not
reflect amounts already recorded on our balance sheet. Payments Due Under Contractual Obligations by Fiscal Year2005 (1)
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    Total(in thousands)Long-term debt
    
    $
    2,343
    
    
    $
    4,407
    
    
    $
    4,248
    
    
    $
    3,878
    
    
    $
    3,750
    
    
    $
    356,250
    
    
    $
    374,876Operating leases
    
    
    3,945
    
    
    
    5,864
    
    
    
    4,398
    
    
    
    2,856
    
    
    
    2,093
    
    
    
    1,093
    
    
    
    20,249Purchase obligations
    
    
    154,336
    
    
    
    166,962
    
    
    
    28,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    349,798Capital leases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other long-term
Liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    160,624
    
    
    $
    177,233
    
    
    $
    37,146
    
    
    $
    6,734
    
    
    $
    5,843
    
    
    $
    357,343
    
    
    $
    744,923
    The long-term debt obligations in the table reflect the maturities pursuant
to revised and expanded credit facility amendments that occurred during the quarter
ended September 30, 2004. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. In preparing
our financial statements, we are required to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. We evaluate our
estimates and judgments on an ongoing basis. We base our estimates and judgments on
historical experience and on various other factors that we believe to be reasonable
under the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily apparent from
other sources. Our actual results may differ from these estimates, and different
assumptions or conditions may yield different estimates. Information regarding our Critical Accounting Policies and Estimates can be
found in our Annual Report on Form 10-K for our most recent fiscal year ended June 30,
2004, filed with the SEC on September 13, 2004. The four critical accounting policies
that we believe are either the most judgmental, or involve the selection or
application of alternative accounting policies, and are material to our financial
statements are those relating to revenue recognition, allowance for doubtful accounts, allowance for contractual discounts and medical claims
reserve. In addition, Note 1 to the financial statements in our Annual Report contains
a summary of our significant accounting policies. 16




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RISK FACTORS You should carefully consider the risks and uncertainties we describe below
before investing in Accredo Health, Incorporated. The risks and uncertainties
described below arenotthe only risks and uncertainties that could develop. Other
risks and uncertainties that we have not predicted or evaluated could also affect our
company. If any of the following risks occur, our earnings, financial condition or
business could be materially harmed, and the trading price of our common stock could
decline, resulting in the loss of all or part of your investment We are highly dependent on our relationships with a limited number of
biopharmaceutical suppliers and the loss of any of these relationships could
significantly impact our ability to sustain or grow our revenues. Approximately 36% of our revenue for the six months ended December 31, 2004 was
derived from the sale of IVIG and blood clotting factor product. The majority of our
IVIG and blood clotting factor products were purchased from Baxter Healthcare
Corporation. We also derive a substantial percentage of our revenue and profitability
from our relationships with Biogen Idec, Inc., Genzyme Corporation, GlaxoSmithKline,
Inc. and MedImmune, Inc. Our revenue derived from these relationships represented
approximately 38% of our revenue during the six months ended December 31, 2004. Our agreements with these suppliers are short-term and cancelable by either party
without cause on 60 to 365 days prior notice. These agreements also generally limit
our ability to handle competing drugs during and, in some cases, after the term of the
agreement, but allow the supplier to distribute through channels other than us.
Further, these agreements provide that pricing and other terms of these relationships
be periodically adjusted for changing market conditions or required service levels.
Any termination or modification to any of these relationships could have a material
adverse effect on a significant portion of our business, financial condition and
results of operations. Our ability to grow could be limited if we do not expand our existing base of drugs or
if we lose patients. We primarily sell 21 product lines. We focus almost exclusively on a limited
number of complex and expensive drugs that serve small patient populations. The drugs
that we sell with respect to the following core disease markets accounted for
approximately 88% of our revenues for the six months ended December 31, 2004, with the
drugs for hemophilia, autoimmune disorders and PID constituting approximately 36% of
our revenue for the same period:  
    Hemophilia, Autoimmune Disorders and PID;
    Pulmonary Arterial Hypertension;
    Multiple Sclerosis;
    Gaucher Disease;
    Growth Hormone-Related Disorders; and
    Respiratory Syncytial Virus, or RSV. Due to the small patient populations that use the drugs we handle, our future
growth is highly dependent on expanding our base of drugs. Further, a loss of patient
base or reduction in demand for any reason of the drugs we currently handle could have
a material adverse effect on a significant portion of our business, financial
condition and results of operations. Our business would be harmed if demand for our products and services is reduced. Reduced demand for our products and services could be caused by a number of
circumstances, including:  
    patient shifts to treatment regimens other than those we offer;
    new treatments or methods of delivery of existing drugs that do not require our specialty products and services;
    a recall of a drug;
    adverse reactions caused by a drug;
    the expiration or challenge of a drug patent; 17




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
    competing treatment from a new drug or a new use of an existing drug;
    the loss of a managed care or other payor relationship;
    the expansion of product-only service models;
    changes in sites of service;
    the cure of a disease we service; or
    the death of a high-revenue patient. There is substantial competition in our industry, and we may not be able to compete
successfully. The specialty pharmacy industry is highly competitive and is continuing to become
more competitive. Most of the drugs, supplies and services that we provide are also
available from our competitors. Our current and potential competitors include:  
    other specialty pharmacy distributors;
    specialty pharmacy divisions of wholesale drug distributors;
    payors or pharmacy benefit management companies (PBMs);
    hospital-based pharmacies;
    retail pharmacies;
    home infusion therapy companies;
    manufacturers that sell their products both to distributors and directly to users;
    comprehensive hemophilia treatment centers;
    patient support groups and payors entering the specialty pharmacy distribution business; and
    other alternative site health care providers. Many of our competitors have substantially greater resources and more established
operations and infrastructure than we have. We are particularly at risk from any of
our suppliers or payors deciding to pursue their own distribution and services instead
of outsourcing these needs to companies like us. A significant factor in effective
competition will be our ability to maintain and expand relationships with managed care
companies, PBMs and other payors who can effectively determine the pharmacy source for
their enrollees. Entry by PBMs into the specialty pharmacy market, our strategic alliance with Medco
Health Solutions, changes in Medcos business and consolidation in the industry could
affect our ability to serve patients. Caremark Rx, Inc. and AdvancePCS combined to form the nations second largest
pharmacy benefit manager, processing drug claims for about 95 million individuals with
about 600 million prescriptions filled per year. Express Scripts, Inc., which provides
PBM services to over 50 million members, acquired Curascripts on January 30, 2004. All
of these firms are our customers and competitors. On February 9, 2004, we entered into
a 10-year strategic alliance with Medco Health Solutions, Inc. (Medco) where we became
the preferred retail and home delivery pharmacy provider to Medcos members for our
specialty pharmacy products. Because of the amount of revenue that we generate from
our relationship with Medco, we could be adversely impacted if Medco is not able to
retain the customer base that we service or is not able to attract new customers and
expand their customer base. As a result of our relationship with Medco, other PBMs may be reluctant to do
business with us. As PBMs acquire specialty pharmacy capability, it is likely that
they will attempt to cancel their relationships with entities, including us, that
compete with the PBM specialty pharmacy operations, and to cause the PBM patients to
obtain their drugs from the PBMs own specialty pharmacy. We also expect there will be
further consolidation among specialty pharmacy providers, such as the 18




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recently proposed merger of Chronimed and MIM Corporation. Such events could
materially and adversely affect our financial condition and results of operations. Our business could be harmed by changes in Medicare or Medicaid. Changes in Medicare, Medicaid or similar government health benefit programs or
the amounts paid by those programs for our services may adversely affect our earnings.
Such programs are highly regulated and subject to substantial changes and cost
containment measures. In recent years, changes in these programs have modified
payments to providers both positively and negatively. The Medicare Prescription Drug,
Improvement and Modernization Act of 2003, or MMA, is having a significant impact on
the U.S. drug delivery system and, correspondingly, on our business. The MMA expands
drug benefits for Medicare beneficiaries. The MMA changes drug pricing methodologies
resulting in both increases and decreases in drug payments. The MMA changes Medicares
payment methodology over the next three years from a system based on average wholesale
price, or AWP, to one based on average sales price, or ASP, and provided for Medicare
rate reductions that were effective January 1, 2004. In November 2004, the
reimbursement levels for Remodulin® were retroactively increased from the rates
initially established under the MMA. The amount of Medicare reimbursement that we
receive for blood clotting factor was changed effective January 1, 2005 to an ASP
methodology. We expect that the effect of the MMA will be to reduce prices and
margins on some of the drugs that we distribute. Future changes and clarifications to
MMA may also impact our business. At least one Medicaid program has adopted, and we expect other Medicaid programs,
some states and some commercial payors, to adopt those aspects of the MMA that either
result in or appear to result in price reductions for drugs covered by such programs.
Adoption of ASP as the measure for determining reimbursement by state Medicaid
programs for the drugs we sell could materially reduce our revenue and gross margins. In order to deal with budget shortfalls, some states are attempting to create
state administered prescription drug discount plans, to limit the number of
prescriptions per person that are covered, to raise Medicaid co-pays and deductibles,
and are proposing more restrictive formularies and reductions in pharmacy
reimbursement rates. For example, Californias Medicaid program, MediCal, recently
adopted a plan that shifted away from use of acquisition cost plus 1% and instead uses
ASP plus 20% for blood clotting factor products. This reduction and any further
reductions in the reimbursement from MediCal could adversely impact revenues and
profitability from the sale of drugs by us or by our two partnerships in California to
patients covered by MediCal. Any reductions in amounts reimbursable by other
government programs for our services or changes in regulations governing such
reimbursements could materially and adversely affect our business, financial condition
and results of operations. Changes in average wholesale prices could reduce our pricing and margins. Many government payors, including Medicare and Medicaid, have paid, or continue
to pay, us directly or indirectly at a percentage off a drugs AWP. We have also
contracted with a number of private payors to sell drugs at AWP or at a percentage off
AWP. AWP for most drugs is compiled and published by several private companies,
including First DataBank, Inc. Several states have filed lawsuits against
pharmaceutical manufacturers for allegedly inflating reported AWP for prescription
drugs. In addition, class action lawsuits have been brought by consumers against
pharmaceutical manufacturers alleging overstatement of AWP. We are not responsible for
such calculations, reports or payments; however, there can be no assurance that our
ability to negotiate discounts from drug manufacturers will not be materially
adversely affected by such investigations or lawsuits, in the future. The Federal Government has also entered into settlement agreements with several
drug manufacturers relating to the calculation and reporting of AWP pursuant to which
the drug manufacturers, among other things, have agreed to report new pricing
information, the average sales price, to government healthcare programs. The average
sales price is calculated differently than AWP. The recently enacted MMA changes the way the federal government pays for certain
Part B drugs. While the majority of our revenue is reimbursed by private payors, as
CMS implements the ASP methodology of reimbursement, it may affect our current AWP
based reimbursement structure with our private payors. If private payors adopt the ASP
methodology, it could have a material effect on reimbursement rates that we are able
to negotiate with these payors. While we cannot predict the eventual results of these law changes, government
proposals, investigations, or lawsuits, the effect of the MMA has been and will be to
reduce prices and margins on some of the drugs that we distribute. If government
payors or private payors revise their pricing based on new methods of calculating the
AWP for drugs we handle or implement reimbursement methodology based on some value
other than AWP, this could have a material adverse effect on our business, financial
condition and results of operation, including reducing the pricing and margins on
certain of our products. 19




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Our business will suffer if we lose relationships with payors. We are highly dependent on reimbursement from non-governmental payors. For the
fiscal years ended June 30, 2002, 2003 and 2004, and the six months ended December 31,
2004, we derived approximately 79%, 73%, 72% and 72% respectively of our gross patient
revenue from non-governmental payors (including self-pay), which included 3%, 1%, 1%
and 1%, respectively for those periods, from sales to private physician practices
whose ultimate payor is typically Medicare. Many payors seek to limit the number of providers that supply drugs to their
enrollees. For example, we were selected by Aetna, Inc. as one of three providers of
injectable medications. We received approximately 10% of our total revenues from Aetna
in the fiscal year ended June 30, 2004, and approximately 10% in the six months ended
December 31, 2004. Aetna has recently indicated that during 2005, it will be
transferring patients and therapies from us to a new joint venture between Aetna and
one of our competitors. Our relationship with Medco was responsible for approximately
15% of our total revenue in the six months ended December 31, 2004. This revenue was
generated from patients that we serviced on a retail basis prior to our expanded
relationship with Medco that commenced in February 2004 and also from patients that
were referred to us through the expanded relationship. From time to time, payors with
whom we have relationships require that we and our competitors bid to keep their
business, and there can be no assurance that we will be retained or that our margins
will not be adversely affected when that happens. Further, significant consolidation
has occurred among non-government payors, and we expect there will be further
consolidation in the future. If payors with whom we have relationships are part of
this consolidation, our relationships with those payors could be terminated. The loss
of a payor relationship, for example, the loss of our relationship with Aetna, Inc.
and affiliates, or an adverse change in the financial condition of a payor, could
result in the loss of a significant number of patients and have a material adverse
effect on our business, financial condition and results of operations. Our business could be harmed if payors decrease or delay their payments to us or seek
to recoup payments already made. Our profitability depends on payment from governmental and non-governmental
payors, and we could be materially and adversely affected by cost containment trends
in the health care industry or by financial difficulties suffered by non-governmental
payors. Cost containment measures affect pricing, purchasing and usage patterns in
health care. Payors also influence decisions regarding the use of a particular drug
treatment and focus on product cost in light of how the product may impact the overall
cost of treatment. Recently, a number of payors have contracted with specialty drug
management services or network managers that focus on controlling the cost of
specialty drugs. These entities, similar to PBMs, are retained by payors to help
control the drugs that are provided to patients and to minimize the cost of these
drugs where appropriate. Certain employers and other private payors have also joined
group purchasing arrangements in an effort to control costs. Some payors, including large managed care organizations and some private
physician practices, have recently experienced financial trouble. The timing of
payments and our ability to collect from payors also affects our revenue and
profitability. Payors also have contractual rights to audit our books and records to
determine if they have overpaid us. We had a contractual relationship through a joint
venture with two pharmacies currently involved in ongoing reimbursement audits by the
California agency that administers MediCal. If the audits find that the pharmacies
received overpayments from MediCal, we could be required, under the terms of our prior
contractual relationship, to reimburse the pharmacies for all or a portion of any
amounts recouped by the State of California. Subject to the outcome of the audits, we
could be required to make a significant payment in order to satisfy our alleged
contractual obligations. If we are unable to collect from payors or if payors fail to
pay us in a timely manner, or if payors seek to recoup payments already made to us, it
could have a material adverse effect on our business and financial condition. If any of our relationships with medical centers are disrupted or canceled, our
business could be harmed. We have joint venture relationships with four medical centers that provide
services primarily related to hemophilia, growth hormone-related disorders and RSV.
For the fiscal years ended June 30, 2002, 2003 and 2004, we derived approximately 4%,
4% and 2%, respectively, of our income before income taxes from equity in the net
income of unconsolidated joint ventures. We derived approximately 2% of our income
before income taxes from equity in the net income of unconsolidated joint ventures
during the six months ended December 31, 2004. We own 80% of one of our joint ventures with Childrens Home Care, Inc. and the
financial results of this joint venture are included in our consolidated financial
results. This consolidated joint venture represented approximately 10% of our income
before income taxes for the fiscal year ended June 30, 2002, 17% of our income before
income taxes for the fiscal year ended June 30, 2003, 7% of our income before income
taxes in the fiscal year ended June 30, 2004, and 3% of our income before income taxes
for the six months ended December 31, 2004. During 2003, the OIG issued a Special Advisory Bulletin focused on complex
contractual joint ventures that could potentially violate the anti-kickback statute.
In this bulletin, the OIG discussed the characteristics that potentially indicate a 20




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prohibited arrangement. Some of these characteristics are present in our existing
joint ventures. As a result, our joint venture relationships have been modified or are
in the process of being restructured. Further, the Department of Health and Human Services, or DHHS, published a set of
safe harbor regulations and continues to publish clarifications to the safe harbors
under the federal anti-kickback statute. Arrangements that fully comply with a safe
harbor are deemed not to violate the anti-kickback statute. We have several business
arrangements (for example, our joint venture and management arrangements with medical
centers, service arrangements with physicians and product pricing arrangements with
suppliers) that do not satisfy all of the requirements necessary to fall within the
safe harbors. Failure to satisfy a safe harbor does not mean that an arrangement is
necessarily illegal. We believe our business arrangements comply with the
anti-kickback statute, the Health Insurance Portability and Accountability Act, or
HIPPA, the federal Stark Law and similar state laws. However, if we are found to
violate any of these laws, we could suffer penalties, fines or possible exclusion,
which could adversely affect our revenues and earnings. In addition to joint venture relationships, we also provide pharmacy management
services to several medical centers. Our agreements with medical centers have terms of
between one and five years, and may be cancelled by either party without cause upon
notice of between one and twelve months. Adverse changes in our relationships with
those medical centers could be caused, for example, by:  
    changes caused by consolidation within the hospital industry;
    changes caused by regulatory uncertainties inherent in the structure of the relationships; or
    restrictive changes to regulatory requirements. Any termination or adverse change of these relationships could have a material
adverse effect on our business, financial condition and results of operations. If additional providers obtain access to favorable pricing from the Health Resources
and Services Administration, Office of Pharmacy Affairs drug discount program (the
PHS program) for drugs we handle, our business could be harmed. The federal pricing program of the Public Health Service, commonly known as PHS,
allows qualified hospitals and hemophilia treatment centers to obtain discounts on
blood clotting factor products. While we are able to access PHS pricing through our
contracts to provide contract pharmacy services to hemophilia treatment centers, we
are not eligible to participate directly in these programs. Increased competition from
hospitals and hemophilia treatment centers that have the right to participate directly
in these discount programs may reduce our profit margins. Our acquisition and joint venture strategy may not be successful, which could cause
our business and future growth prospects to suffer. As part of our growth strategy, we continue to evaluate acquisition and joint
venture opportunities, but we cannot predict or provide assurance that we will
complete any future acquisitions or joint ventures. Acquisitions and joint ventures
involve many risks, including:  
    difficulty in identifying suitable candidates and negotiating and consummating acquisitions on attractive terms;
    difficulty in assimilating the new operations;
    increased transaction costs;
    diversion of our managements attention from existing operations;
    dilutive issuances of equity securities that may negatively impact the market price of our stock;
    increased debt; and
    increased amortization expense related to intangible assets that would decrease our earnings. We could also be exposed to unknown or contingent liabilities resulting from the
pre-acquisition operations of the entities we acquire, such as liability for failure
to comply with health care or reimbursement laws, including an obligation to recoup
reimbursement payments previously received by the companies we acquire. We also face
exposure if any seller of an 21




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entity which we acquire, is not able to fulfill its indemnification obligations under
the terms of the purchase agreement. We may suffer impairment of assets or have to
bear a liability for which we are entitled to indemnification but are unable to
collect. Our debt incurred from recent acquisitions may limit our future financial flexibility. The current level of our debt will have several important effects on our future
operations, including, among others:  
    A portion of our cash flow from operations will be dedicated to the
payment of principal on the debt and will not be available for other purposes;
    Our debt covenants will require us to meet financial tests, and may
impose other limitations that may limit our flexibility in planning for and
reacting to changes in our business, including possible acquisition
opportunities;
    Our ability to obtain additional financing for working capital,
capital expenditures, acquisitions, general corporate and other purposes may be
limited;
    Failure to meet our debt covenants could result in foreclosure by our
lenders or an increase in the interest rate or administrative fees associated
with our debt;
    We may be at a competitive disadvantage to similar companies that have less debt; and
    Our vulnerability to adverse economic and industry conditions may increase. Fluctuations in our quarterly financial results may cause our stock price to decline. Our results of operations may fluctuate on a quarterly basis, which could
adversely affect the market price of our common stock. Our results may fluctuate as a
result of:  
    lower prices paid by Medicare or Medicaid for the drugs that we
sell, including lower prices resulting from the MMA and other state and federal
legislation and revisions in pricing methods, or the method of establishing AWP
or ASP;
    below-expected sales or delayed launch of a new drug;
    price and term adjustments with our drug suppliers;
    increases in our operating expenses in anticipation of the launch of a new drug;
    product shortages or an oversupply of product;
    inaccuracies in our estimates of the costs of ongoing programs;
    the timing and integration of our acquisitions;
    making an acquisition that is dilutive to earnings;
    changes in our estimates used to prepare our financial statements;
    effectiveness of our sales force;
    changes in governmental regulations;
    the annual renewal of deductibles and co-payment requirements that affect patient ordering patterns;
    our provision of drugs to treat seasonal illnesses, such as RSV;
    physician prescribing patterns;
    general political and economic conditions;
    interest rate fluctuations; and 22




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
    adverse experience in collection of accounts receivable. Our business would be harmed if the biopharmaceutical industry reduces research,
development and production of the types of drugs that are compatible with the services
we provide. Our business is highly dependent on continued research, development,
manufacturing and marketing expenditures of biopharmaceutical companies, and the
ability of those companies to develop, supply and generate demand for drugs that are
compatible with the services we provide. Our business would be materially and
adversely affected if those companies stopped outsourcing the services we provide or
failed to support existing drugs or develop new drugs. Our business could also be
harmed if the biopharmaceutical industry undergoes any of the following developments:  
    supply shortages;
    adverse drug reactions;
    drug recalls;
    increased competition among biopharmaceutical companies;
    an inability of drug companies to finance product development because of capital shortages;
    a decline in product research, development or marketing;
    a reduction in the retail price of drugs from governmental or private market initiatives;
    changes in the FDA approval process; or
    governmental or private initiatives that would alter how drug
manufacturers, health care providers or pharmacies promote or sell products and
services. Our business could be harmed if the supply of any of the products that we distribute
becomes scarce. The biopharmaceutical industry is susceptible to product shortages. Some of the
products that we distribute, such as some of our hemophilia products, IVIG and
products for the treatment of Alpha-1 antitrypsin deficiency, 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. Our suppliers of IVIG have announced initiatives that could result in decreases
in the future supply of IVIG, which, in addition to other factors, may cause the
pricing of IVIG to rise. There was also an industry wide recombinant factor VIII
product shortage that existed for some time, as a result of the manufacturers being
unable to increase production to meet rising global demand. Supply of this drug has
only recently returned to normal levels. If these products, or any of the other drugs
that we distribute, are in short supply for long periods of time and we are unable to
acquire an amount of the drug sufficient to service our patients, our business could
be harmed. Our industry is subject to extensive government regulation and noncompliance by us,
physicians who prescribe our products and services or our suppliers could harm our
business. The marketing, sale and purchase of drugs and medical supplies is extensively
regulated by federal and state governments, and if we fail or are accused of failing
to comply with laws and regulations, we could suffer a material adverse effect on our
business, financial condition and results of operations. Our business could also be
materially and adversely affected if the suppliers or others we work with are accused
of violating laws or regulations. The applicable regulatory framework is complex, and
the laws are very broad in scope. Many of these laws remain open to interpretation,
and have not been addressed by substantive court decisions. The health care laws and regulations that especially apply to our activities
include:  
    The federal Anti-Kickback Law prohibits the offer or solicitation of
compensation in return for the referral of patients covered by almost all
governmental programs and billing for services rendered pursuant to such
referrals, or the arrangement or recommendation of the purchase of any item,
facility or service covered by those programs. The Health Insurance
Portability and Accountability Act (HIPAA) created new violations for
fraudulent activity applicable to both public and private health care benefit
programs and prohibits inducements to Medicare or Medicaid eligible patients.
The potential sanctions for violations of these laws range from significant
fines, to exclusion from 23




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participation in the Medicare and Medicaid programs, to criminal sanctions.
Although some safe harbor regulations attempt to clarify when an arrangement
will not violate the Anti-Kickback Law, our business arrangements and the
services we provide may not fit within these safe harbors. Failure to satisfy a
safe harbor requires analysis of whether the parties intended to violate the
Anti-Kickback Law. Allegations, investigations, or findings of a violation of
the Anti-Kickback Law or similar state laws could have a material adverse effect
on our business.
    The Department of Health and Human Services (DHHS) has issued
regulations implementing the Administrative Simplification provisions of HIPAA
concerning the maintenance of privacy and security of individually identifiable
health information. These new regulations require the development and
implementation of measures to maintain the privacy and security of health
information and require that certain health claims transactions be conducted in
accordance with uniform standards. These regulations govern health care
providers, health plans and health clearinghouses. Failure to comply with
these regulations, or wrongful disclosure of confidential patient information
could result in the imposition of administrative or criminal sanctions,
including exclusion from the Medicare and state Medicaid programs. In
addition, if we choose to distribute drugs through new distribution channels
such as the Internet, we will have to comply with government regulations that
apply to those distribution channels, which could have a material adverse
effect on our business.
    The Ethics in Patient Referrals Act of 1989, as amended, commonly
referred to as the Stark Law, prohibits physician referrals to entities with
which the physician or their immediate family members have a financial
relationship. Many states have adopted laws similar to the Stark law. A
violation of the Stark Law or similar state laws is punishable by civil
sanctions, including significant fines and exclusion from participation in
Medicare and Medicaid.
    State laws prohibit the practice of medicine, pharmacy and nursing
without a license. To the extent that we assist patients and providers with
prescribed treatment programs, a state could consider our activities to
constitute the practice of medicine. If we are found to have violated those
laws, we could face civil and criminal penalties and be required to reduce,
restructure, or even cease our business in that state.
    Pharmacies and pharmacists must obtain state licenses to operate and
dispense drugs. Pharmacies must also obtain licenses in some states to operate
and provide goods and services to residents of those states. Our entities that
provide nursing for our patients and our nurses must obtain licenses in certain
states to conduct our business. If we are unable to maintain our licenses or
if states place burdensome restrictions or limitations on non-resident
pharmacies or nurses, this could limit or affect our ability to operate in some
states which could adversely impact our business and results of operations.
    Federal and state investigations and enforcement actions continue to
focus on the health care industry, scrutinizing a wide range of items such as
joint venture arrangements, referral and billing practices, product discount
arrangements, home health care services, dissemination of confidential patient
information, clinical drug research trials and gifts for patients. Recently,
the OIG issued a Special Advisory Bulletin focused on complex contractual joint
ventures that could potentially violate the anti- kickback statute. In this
bulletin, the OIG discussed the characteristics that potentially indicate a
prohibited arrangement. Some of these characteristics are present in our
existing joint ventures. Accordingly, some of our existing joint ventures have
been restructured and others may be restructured in the future.
    The False Claims Act encourages private individuals to file suits on
behalf of the government against health care providers such as us. Such suits
could result in significant financial sanctions or exclusion from participation
in the Medicare and Medicaid programs. 24




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If some of the drugs that we provide lose their orphan drug status, we could face
more competition. Our business could be adversely affected by the expiration or challenge to the
orphan drug status that has been granted by the FDA to some of the drugs that we
handle. When the FDA grants orphan drug status, it will not approve a second drug for
the same treatment for a period of seven years unless the new drug is chemically
different or clinically superior. Not all of the drugs that we sell which are related
to our core disease states have orphan drug status. The loss of orphan drug status,
the approval of new drugs notwithstanding orphan drug status or the development of
drugs that are superior to the drugs we sell could result in additional competitive
drugs entering the market, which could harm our business. We rely heavily on a single shipping provider, and our business would be harmed if our
rates are increased or our provider is unavailable. A significant portion of our revenues result from the sale of drugs we deliver to
our patients and a single carrier, FedEx, ships principally all of our products. We
depend heavily on these outsourced shipping services for efficient, cost effective
delivery of our product. The risks associated with this dependence include:  
    any significant increase in shipping rates, including rate increases
resulting from higher fuel prices;
    strikes or other service interruptions by our primary carrier, FedEx,
or by another carrier that could affect FedEx; or
    spoilage of high cost drugs during shipment, since our drugs often
require special handling, such as refrigeration. Disruptions in commercial activities such as those following the September 2001
terrorist attacks on the U.S. or as a result of a natural disaster may adversely
impact our results of operations, our ability to raise capital or our future growth. Our operations have been and could again be harmed by terrorist attacks on the
U.S. For example, transportation systems and couriers that we rely upon to deliver our
drugs have been and could again be disrupted, thereby causing a decrease in our
revenues. In addition, we may experience a rise in operating costs, such as costs for
transportation, courier services, insurance and security. We also may experience
delays in payments from payors, which would harm our cash flow. The U.S. economy in
general may be adversely affected by terrorist attacks or by any related outbreak of
hostilities. Any such economic downturn could adversely impact our results of
operations, impair our cost of or ability to raise debt or equity capital or impede
our ability to continue growing our business. We have a centralized data center located in Memphis, Tennessee and we are in the
process of building a second data center in another city that we expect to be
operational in calendar year 2005. Until the second data center is operational, acts
by terrorists or a natural disaster that causes damage to the data center could cause
us to be unable to operate our business for a period of time. If we are unable to manage our growth effectively, our business will be harmed. Our rapid growth over the past several years has placed a strain on our
resources, and if we cannot effectively manage our growth, our business, financial
condition and results of operations could be materially and adversely affected. We
have experienced a large increase in the number of our employees, the size of our
programs and the scope of our operations. Our ability to manage this growth and be
successful in the future will depend partly on our ability to retain skilled
employees, which has become more difficult due to the national health care
professional shortage. Our ability to manage our growth is also dependent upon our
ability to enhance our management team and improve our management information and
financial control systems. We could be adversely affected by an impairment of the significant amount of goodwill
and other intangibles on our financial statements. Our formation and our acquisitions have resulted in the recording of a
significant amount of goodwill on our financial statements. The goodwill was recorded
because the fair value of the tangible net assets acquired was less than the purchase
price. There can be no assurance that we will realize the full value of this goodwill.
We evaluate on an on-going basis whether events and circumstances indicate that all or
some of the carrying value of goodwill is no longer recoverable, in which case we
would write off the unrecoverable goodwill as a charge to our earnings. As of December
31, 2004, we had goodwill, net of accumulated amortization, of approximately $550.1
million, or 43% of total assets and 86% of stockholders equity. Since our growth strategy may involve the acquisition of other companies, we may
record additional goodwill in the future. The possible write-off of this goodwill
could negatively impact our future earnings. We will also be required to 25




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allocate a portion of the purchase price of any acquisition to the value of
non-competition agreements, patient base and contracts that are acquired. The amount
allocated to these items could be amortized over a fairly short period. As a result,
our earnings and the market price of our common stock could be negatively impacted. We rely on a few key employees whose absence or loss could adversely affect our
business. We depend on a few key executives, and the loss of their services could cause a
material adverse effect to our company. We do not maintain key person life insurance
policies on any of those executives. As a result, we are not insured against the
losses resulting from the death of our key executives. Further, we must be able to
attract and retain other qualified, essential employees for our technical operating
and professional staff, such as pharmacists and nurses. If we are unable to attract
and retain these essential employees, our business could be harmed. We have been named in a consolidated shareholder class action lawsuit and a
shareholders derivative lawsuit asserting claims under the securities laws. The uncertainty associated with these unresolved lawsuits could harm our business
and financial condition. The defense of these lawsuits also could result in litigation
fees and costs, as well as the diversion of resources. Negative developments with
respect to the lawsuits could cause our stock price to decline significantly. The
indemnification provisions contained in our Certificate of Incorporation and Bylaws
require us to indemnify our current and former officers and directors who are named as
defendants against the allegations contained in these suits. Even though we maintain
directors and officers insurance applicable to the lawsuits, there can be no guarantee
that the proceeds of such insurance will be available for defense fees and costs, or
payment of any settlement or judgment in the lawsuits or, if available, will be
sufficient to cover the fees and costs and any settlement or judgment imposed against
us. The ultimate cost and effect of these lawsuits on our financial condition,
results of operations, customer relations and management is unknown at this time. In addition to the securities litigation currently pending against us and our
officers and directors, we may also in the future be the target of similar litigation.
Additional securities litigation could result in substantial costs and divert our
attention and resources. We may need additional capital to finance our growth and capital requirements, which
could prevent us from fully pursuing our growth strategy. In order to implement our growth strategy, we will need substantial capital
resources and will incur, from time to time, short- and long-term indebtedness, the
terms of which will depend on market and other conditions. We cannot be certain that
existing or additional financing will be available to us on acceptable terms, if at
all. As a result, we could be unable to fully pursue our growth strategy. Further,
additional financing may involve the issuance of equity or debt securities that would
reduce the percentage ownership of our then current stockholders. The market price of our common stock may experience substantial fluctuations for
reasons over which we have little control. Our common stock is traded on the Nasdaq National Market System. The market price
of our common stock could fluctuate substantially based on a variety of factors,
including the following:  
    future announcements concerning us, our competitors, the drug
manufacturers with whom we have relationships or the health care market;
    changes in government regulations;
    overall volatility of the stock market;
    changes in the financial estimates we provide to the market;
    changes in estimates by analysts;
    changes in operating results from quarter to quarter; and
    loss of key executives. 26




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Furthermore, stock prices for many companies fluctuate widely for reasons that
may be unrelated to their operating results. These fluctuations, coupled with changes
in our results of operations and general economic, political and market conditions,
may adversely affect the market price of our common stock. Some provisions of our charter documents and the Stockholder Protection Rights Plan
may have anti-takeover effects that could discourage a change in control, even if an
acquisition would be beneficial to our stockholders. Our certificate of incorporation, our bylaws and Delaware law contain provisions
that could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders. In addition, our Board of Directors has
adopted a Stockholder Protection Rights Plan, sometimes referred to as a poison pill,
which would substantially dilute the interest sought by an acquirer. In the event we are unable to satisfy regulatory requirements relating to internal
controls, or if these internal controls over financial reporting are not effective,
our business and our stock price could suffer. Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to do a
comprehensive and costly evaluation of their internal controls. As a result, during
our fiscal year ending June 30, 2005, we will be required to perform an evaluation of
our internal controls over financial reporting and have our auditor publicly attest to
such evaluation. We have prepared an internal plan of action for compliance, which
includes a timeline and scheduled activities with respect to preparation of such
evaluation. Our efforts to comply with Section 404 and related regulations regarding
our managements required assessment of internal control over financial reporting and
our independent auditors attestation of that assessment has required, and continues
to require, the commitment of significant financial and managerial resources. If we
fail to timely complete this evaluation, or if our auditors cannot timely attest to
our evaluation, we could be subject to regulatory scrutiny and a loss of public
confidence in our internal controls, which could have an adverse effect on our
business and our stock price. 27




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to the impact of financial market risk is significant. Our primary
financial market risk exposure consists of interest rate risk related to interest that
we are obligated to pay on our variable-rate debt. We sometimes use derivative financial instruments to manage our exposure to
rising interest rates on our variable-rate debt, primarily by entering into
variable-to-fixed interest rate swaps. We had fixed the interest rate through July 21,
2004 on $120 million of our variable-rate debt through the use of a variable-to-fixed
interest rate swap. As a result, we did not benefit from any decrease in interest
rates nor were we subjected to any detriment from rising interest rates on this
portion of our debt during the period of the swap agreement. We have not yet hedged against our interest rate risk exposure after July 21,
2004. As a result, we will benefit from decreasing interest rates, but rising interest
rates on our debt will also harm us. Accordingly, if we maintain our current level of
total debt, a 100 basis point decrease in interest rates along the entire yield curve
would result in an increase in pre-tax income of approximately $3.73 million over the
next twelve months. However, a 100 basis point increase in interest rates would result
in a decrease in pre-tax income of $3.73 million for the same period. 
 ITEM 4. CONTROLS AND PROCEDURES The Companys Chief Executive Officer and Chief Financial Officer evaluated
the effectiveness of the design and operation of the Companys disclosure controls and
procedures as of the end of the period covered by this report. The Companys Chief
Executive Officer and Chief Financial Officer concluded that as of the end of the
period covered by this report the Company maintains disclosure controls and procedures
that provide reasonable assurance that information required to be disclosed in the
Companys reports under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the SECs
rules and forms, and that such information is accumulated and communicated to the
Companys management, including its Chief Executive Officer and its Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure. There have been no changes in the Companys internal control over financial
reporting during the quarter ended December 31, 2004 that have materially affected, or
are reasonably likely to materially affect, the Companys internal control over
financial reporting. 28




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PART II  OTHER INFORMATION 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. (a) The Company held its annual meeting of stockholders on November 22, 2004 at its
offices in Memphis, Tennessee. Stockholders holding 93.57% of the issued and
outstanding shares of the Companys Common Stock were either present in person or were
represented by proxy. (c) The following matters were voted upon at the meeting:  1.
    Proposal to elect William E. Evans, Nancy-Ann DeParle and Kenneth R.
Masterson to serve as Class III directors to serve until the 2007 annual meeting
of stockholders and until their successors are elected and qualified. The votes
cast for each director were as follows: Dr. Evans
    
    Voted For:
    
    44,066,965
    
    Voted Against:
    
    1,669,146
    
    Abstentions:
    
    0Ms. DeParle
    
    Voted For:
    
    43,789,785
    
    Voted Against:
    
    1,946,326
    
    Abstentions:
    
    0Mr. Masterson
    
    Voted For:
    
    45,037,994
    
    Voted Against:
    
    698,117
    
    Abstentions:
    
    0
  2.
    Proposal to ratify the selection of Deloitte & Touche LLP as independent
registered accountants to audit the Companys financial statements for the fiscal
year ended June 30, 2005. Voted For:
    
    45,644,769
    
    Voted Against:
    
    73,461
    
    Abstentions:
    
    17,881
  3.
    To consider and vote on the approval of the amendment of the Accredo
Health, Incorporated 2002 Long-Term Incentive Plan to increase the number of
            shares reserved and available for Awards from 3,900,000 to 6,900,000. Voted For:
    
    29,229,495
    
    Voted Against:
    
    9,837,638
    
    Abstentions:
    
    37,323
 29




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits Exhibit 31.1
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002Exhibit 31.2
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002* Exhibit 32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* Exhibit 32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  *
    In accordance with Release No. 34-47986, this exhibit is hereby furnished to
the SEC as an accompanying document and is not deemed to be filed for purposes of
Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the
liabilities of that Section, nor shall it be deemed incorporated by reference into
any filing under the Securities Act of 1933. (b) Reports on Form 8-K We filed a report on Form 8-K on October 19, 2004 to furnish as an exhibit, amended
and restated employment agreements with our Executive Officers. We filed a report on Form 8-K on November 1, 2004 to furnish as an exhibit, the press
release reporting our financial results for the quarter ended September 30, 2004. We filed a report on Form 8-K/A on November 3, 2004 to furnish as an exhibit, the
updated and revised press release reporting our financial results for the quarter
ended September 30, 2004. 30




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Signature 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. February 9, 2005
    
    Accredo Health, Incorporated/s/ David D. StevensDavid D. StevensChairman of the Board andChief Executive Officer/s/ Joel R. KimbroughJoel R. KimbroughSenior Vice President, ChiefFinancial Officer and Treasurer
 31




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Exhibit Index ExhibitNumber
    
    Description of Exhibits31.1
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002* 32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002* 32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
 * In accordance with Release No. 34-47986, this exhibit is hereby furnished to the SEC
as an accompanying document and is not deemed to be filed for purposes of Section 18
of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that
Section, nor shall it be deemed incorporated by reference into any filing under the
Securities Act of 1933. 32