**UNITED
STATES**
 **SECURITIES
AND EXCHANGE COMMISSION**
 **WASHINGTON,
D.C. 20549**
 
 **FORM
10-K**
   x
    
    ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE
      ACT OF 1934 for the fiscal year ended**December 31, 2004**
  OR
  o
    
    TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES
      EXCHANGE ACT OF 1934
 
  Commission
File Number: 0-17821
  **ALLION
HEALTHCARE, INC.**
 (Name of
registrant as specified in its charter)
  **Delaware**
    **11-2962027**(State
      or other jurisdiction of
    (I.R.S.
      Employerincorporation
      or organization)
    Identification
      No.)
  ****
 **1660
Walt Whitman Road, Suite 105, Melville, New York 11747**
 (Address
of principal executive offices)
 Registrant’s
telephone number: **(631)
547-6520**
 
 Securities
Registered Pursuant to Section 12(b) of the Act: None
 Securities
Registered Pursuant to Section 12(g) of the Act: None
  Indicate
by checkmark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
 YES 
x NO o
  Indicate
by checkmark if disclosure of delinquent filers pursuant to Rule 405 of
Regulation S-K (§ 229. 229.405 of this chapter) is not contained herein, and
will not be contained to the best of the registrant’s knowledge, in the
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.  x
  Indicate
by checkmark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act).
 YES o NO x
  The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant on June 30, 2004, based on assumed price of
$6.25 per share of Common Stock (as there is no trading market for the Common
Stock), was approximately $13,437,500.
  As of
March 25, 2005, the registrant had outstanding 3,100,000 shares of common
stock.
   
 ****
 **TABLE
OF CONTENTS**
   **PART
      I**
    
    2ITEM
      1.
    Business
    2ITEM
      2.
    Property
    16ITEM
      3.
    Legal
      Proceedings
    17ITEM
      4.
    Submission
      of Matters to A Vote of Security Holders
    17**PART
      II**
    
    17ITEM
      5.
    Market
      For Common Equity and Related Stockholder Matters
    17ITEM
      6.
    Selected
      Financial Data
    19ITEM
      7.
    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
    20ITEM
      7A.
    Quantitative
      and Qualitative Disclosure About Market Risk
    36ITEM
      8.
    Financial
      Statements and Supplementary Data
    37ITEM
      9.
    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
    56ITEM
      9A.
    Controls
      and Procedures
    56ITEM
      9B.
    Other
      Information
    56**PART
      III**
    
    56ITEM
      10.
    Directors
      and Executive Officers of the Registrant
    56ITEM
      11.
    Executive
      Compensation and Other Information
    60ITEM
      12.
    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
    63ITEM
      13.
    Certain
      Relationships and Related Transactions
    65ITEM
      14.
    Principal
      Accountant Fees and Services
    65**PART
      IV**
    
    65ITEM
      15.
    Exhibits
      and Financial Statement Schedules
    65
  i
 
 **INFORMATION
RELATED TO FORWARD-LOOKING STATEMENTS**
  This
Annual Report on Form 10-K and certain information incorporated herein by
reference contain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. All statements included or incorporated by reference in this Annual Report
on Form 10-K, other than statements that are purely historical are forward
looking statements. Words such as “expects,” “anticipates,” “plans,” “believes,”
“seeks,” “estimates,” and other similar expressions or variations of such words
are intended to identify these forward-looking statements.
  These
forward-looking statements, which include statements about our strategy to
expand our business and become profitable, our ability to integrate past
acquisitions and identify additional ones, our expectations regarding
reimbursement rates and our eligibility for specific HIV/AIDS programs, our
access to additional capital, the future demand for our services, expectations
about future treatments for HIV/AIDS patients, and management’s expectations
regarding future operating results are not guarantees of future performance and
are subject to risks and uncertainties that could cause actual results to differ
materially from the results contemplated by the forward-looking
statements.
  All
forward-looking statements included or incorporated by reference in this Report
are based on information available to us as of the date hereof, and we assume no
obligation to update any such forward-looking statements. Readers of this Report
are cautioned not to place undue reliance on such statements.
  The
forward-looking statements and any expectations based on such forward-looking
statements are subject to risks and uncertainties and other important factors,
including, without limitation, changes in reimbursement rates, our compliance
with Medicare and Medicaid reimbursement regulations, our ability to market our
services, our ability to successfully integrate acquisitions and other factors
discussed under in Item 7 of this Report under the heading “Risk Factors” and
elsewhere in this Report. The reader also should consult the cautionary
statements and risk factors listed from time to time in the other reports we
file with the Securities and Exchange Commission.
  ****
 1
 ****
 **PART
I**
  **ITEM
1.**  **BUSINESS**
  OVERVIEW
  We are
a national provider of specialty pharmacy and disease management services
focused on HIV/AIDS patients. We work closely with patients, healthcare
providers such as physicians, nurses, AIDS Service Organizations, or ASOs, and
with government and private payors to improve clinical outcomes and reduce
treatment costs for our patients. We sell HIV/AIDS prescription and
ancilliary medications, and nutritional supplies under our trade name MOMS
Pharmacy. Most of our customers rely on Medicaid and the AIDS Drug
Assistance Program, or ADAP, to pay for their medications. Billing requirements
for these programs are complex. We are one of a limited number of providers that
qualify for certain HIV/AIDS medication reimbursement programs under legislation
recently enacted in California and we believe we qualify for an HIV/AIDS
medication reimbursement program in New York.
  We
believe that the combination of services we offer to patients, healthcare
providers and payors makes us an attractive source of specialty pharmacy and
disease management services, and reduces overall healthcare costs. Our services
include the following:
  ·
    Specialized
      prescription packaging systems, which we call MOMSPak, which improve
      adherence by simplifying the complicated dosing regimens faced by HIV/AIDS
      patients;
  ·
    Reimbursement
      expertise that assists patients and healthcare providers with the complex
      reimbursement processes of private and government payors, and that
      optimizes collection of payment;
  ·
    Services
      that arrange for delivery of medications as directed by our patients or
      their physicians in a discreet, convenient and timely manner, designed to
      help that patients actually receive their
  prescriptions;
  ·
    Specialized
      pharmacists who consult with patients, physicians, nurses and ASOs to
      provide education, counseling, treatment coordination, clinical
      information and compliance monitoring; and
  ·
    Information
      systems and prescription automation solutions that make the provision of
      clinical data and the transmission of prescriptions more efficient and
      accurate.
  Rigorous
patient adherence to precise medication regimens is an important factor in the
treatment of HIV/AIDS, according to the AIDS Research Institute. The complexity,
cost and duration of many HIV/AIDS medication regimens often results in poor
patient adherence, which in turn can lead to diminished patient health,
resistance to medications, higher costs of healthcare, and reduced patient
survival rates. Studies on adherence within the HIV/AIDS population have shown
that if 95% of medication doses are not taken as prescribed, the medication may
be ineffective or the patient may develop drug resistance.
  We have
positioned our distribution centers in or near those metropolitan areas in those
states in which the Centers for Disease Control and Prevention, or CDC, has
indicated in its studies is where more than 50% of the United States HIV/AIDS
patient population reside: New York, California, Florida, New Jersey and
Washington. As of March 25, 2005, we served approximately 8,300 patients, who
were located mainly in these areas.
  We have
generated internal growth by increasing the number of patients we serve
and by filling an increased number of prescriptions per patient. We
entered California through an acquisition completed in May 2003. In the first
quarter of 2005, we increased our presence in California by acquiring two
additional specialty pharmacies. We expect that in 2005, California will account
for approximately 58% of our total net sales. We will continue to evaluate
acquisition opportunities as they arise, especially for other specialty
pharmacies that have established relationships with HIV/AIDS clinics and
hospitals.
   2
  RECENT
DEVELOPMENTS
  During
the second half of 2004 and the first quarter of 2005, there have been several
developments that we believe will have a significant effect on our business and
our future financial results:
 
 ·
    During
      2004, we raised a total of approximately $13 million (before payment of
      fees and expenses) from the sale of additional shares of preferred stock,
      as discussed below in Item 5 under the heading “Unregistered Sales.” We
      discuss our financial resources and our anticipated needs for outside
      financing in Item 7 under the heading “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations - Liquidity and
      Capital Resources.”
 
 ·
    On
      February 28, 2005 we purchased 100% of the stock of Specialty Pharmacies,
      Inc., a California-based company specializing in HIV/AIDS pharmacy
      services and significantly expanded our operations and patient base in the
      San Francisco, California market.
  ·
    On
      March 2, 2005 we entered into a letter of intent with Oris Medical
      Systems, Inc., or Oris Medical, to become the exclusive licensee
      of the LabTrackerTM software system for HIV/AIDS and to acquire Oris
      Medical. If we are able to negotiate a definitive agreement with Oris
      Medical, we expect that this software will help us expand our business, as
      discussed below in this Item 1 under the heading “Our Products and
      Services - Information Systems and Prescription Automation Solutions.”
      There is no assurance that we will be able to reach a definitive agreement
      with Oris Medical. See the discussion in Item 7 below under the heading
      “Risk Factors - Risks Related to Our
Company.”
  ·
    In
      March 2005 we decided to cease our operations in Texas and are in the
      process of closing our Texas facility. We expect to complete this process
      by June 30, 2005 when our lease in Austin, Texas expires. For the year
      ended December 31, 2004, the Texas facility represented $4.5 million of
      our net sales.
  ·
    In
      March 2005 we decided to cease providing services for transplant and
      oncology patients. Currently, we serve these patients from our pharmacies
      in Texas, Florida and New York. Most of these patients receive Medicare
      reimbursement which is not an area of focus for us. We may sell some of
      our business to a third party for a nominal amount.
  OUR
COMPANY; CORPORATE GOVERNANCE MATTERS
  We were
incorporated in Delaware in 1983 under the name The Care Group **,** Inc. The
Care Group, Inc. filed for protection under Chapter 11 of the Bankruptcy Code in
1998. We emerged from bankruptcy in 1999 and changed our name to Allion
Healthcare, Inc. at that time. Our principal executive offices are located at
1660 Walt Whitman Road, Suite 105, Melville, New York, 11747. Our telephone
number is (631) 547-6520 and our fax number is (631) 249-5863.
   3
  Our
internet address is www.allionhealthcare.com. We are providing the address of
our internet website solely for informational purposes. We do not intend the
internet address to be an active link, and the contents of the website are not a
part of this Report.
  We have
also adopted procedures for our stockholders to communicate with our Board of
Directors. Stockholders who wish to contact the Board of Directors, or an
individual director, should contact the Board of Directors or individual
director in writing at 1660 Walt Whitman Road, Suite 105, Melville, New York,
11747. The Secretary will compile all communications and submit them to the
Board of Directors, or individual directors, on a periodic basis.
  HIV/AIDS
  Human
Immunodeficiency Virus, commonly known as HIV, is the virus that causes Acquired
Immune Deficiency Syndrome, commonly known as AIDS. HIV is spread most commonly
by sexual contact with an infected partner. HIV is also spread through contact
with infected blood, including through the use of contaminated needles or
syringes. Once inside a host body, HIV attacks T cells, a major component of the
immune system. The virus then takes over the cells’ reproductive machinery and
reproduces itself causing the cells to weaken and eventually die. When the
infected cells die, they release the recently created virus into the
bloodstream. Other T cells are then invaded and die, and the body is left
vulnerable to diseases that easily would have been fought off by a normally
functioning immune system.
  The
demographic profile of HIV/AIDS patients has shifted since the disease was first
diagnosed in 1981. According to a recent CDC study, most HIV/AIDS patients now
live in the inner-city of a major metropolitan area and are dependent on
government programs to pay for the medications to treat HIV/AIDS. According to
the CDC research report AIDS Epidemic Update December 2004, over the past ten
years in the United States an estimated 40,000 people per year have been
infected with HIV. A disproportionate number of these patients have been
African Americans and Hispanics. The proportion of new cases in African
Americans in the United States rose from 25% in 1981 to 50% in 2001. The
proportion of Hispanics infected with HIV rose from 14% in 1981 to 20% in 2001.
We believe that as more HIV/AIDS patients look to government programs, the
government is likely to take a more active role regulating the pharmacies and
other providers of HIV/AIDS.
  When
HIV/AIDS was first diagnosed, initial treatments were monotherapies and
other treatments that were often administered in a hospital or other clinical
setting. Monotherapy involves treatment with only one drug at a time. Doctors
now use a combination of two or more drugs in an effort to combat resistance to
drugs. The current standard of care for the treatment of HIV/AIDS includes the
use of a triple-drug therapy, also referred to as a “combination therapy”
because a single drug regimen may cause rapid resistance, thus requiring
physicians to frequently change the treatment regimen. The most prevalent
combination threaby is known as highly active antiretroviral therapies, or
HAART. Combination therapies are predominantly oral and are often administered
by the patient outside a clinical setting, further complicating compliance with
the frequently changing multi-therapy regimen.
  Combination
therapy often requires that a patient take variations of the multi-therapy
regimens at many times during the day. For example, a patient may need to take
certain medications either after meals or on an empty stomach, or, after
high-fat or low-fat meals. The number of medications and varying dosages and
schedules often can confuse and overwhelm patients. As a result, many patients
lose confidence in their ability to adhere to their drug regimens and simply
give up, while others lose track of which doses they have taken or inadvertently
miss a dose because of their personal schedules. Alcohol and illicit drug use
are also factors in causing non-compliance and may lead to an increasing amount
of Medicaid fraud. Poor adherence or even slight or occasional deviations from a
prescribed regimen can reduce the potency of therapy and lead to viral
resistance. Given the ability of HIV/AIDS to mutate rapidly in the absence of
antiretroviral medication, taking a combination therapy exactly as prescribed,
without missing or reducing doses, is critical to effective treatment. Once
resistance has developed in a patient, success rates of other antiretroviral
drugs are limited, particularly if the patient’s adherence issues are not
resolved, and treatment options become greatly limited.
   4
  Before
combination therapies became available in 1996, individuals living with HIV had
high mortality rates. Before combination therapies, 50–60% of adults infected
with HIV were diagnosed with an AIDS-defining condition within 10 years of
infection, and 48% of them died due to related complications. In the United
States, HIV/AIDS-associated morbidity and mortality have declined significantly
due to combination therapies. After increasing every year between 1987 and 1994
at an average rate of 16% annually, HIV mortality in the United States leveled
off in 1995 and has since decreased. In 1995, 19% of people living with HIV/AIDS
in the United States died compared to 4% in 2003. HIV/AIDS is now a more
manageable chronic disease.
  We are
one of only a few specialty pharmacy and disease management service providers
that primarily service HIV/AIDS patients. Despite the special needs of the
HIV/AIDS infected population, few national and regional pharmacies have focused
on the special needs of this patient population. We believe that national and
regional pharmacies have avoided focusing on HIV/AIDS patients because of
regulation of the HIV/AIDS industry and due to increased public attention on the
HIV/AIDS community brought on by HIV/AIDS political groups and through the many
political figures who have worked to promote the interests of the HIV/AIDS
community. Most of the pharmacies serving this market have been local or small
regional providers located in a single urban market. These pharmacies often do
not have the resources or sophistication to provide the disease management
services required by patients, healthcare providers and payors to ensure
adherence, which we believe is very important to patient health. We also believe
that neither the retail pharmacies nor the mail order pharmacies offer the range
of services we provide.
  OUR
STRATEGY
  Our
objective is to become the leading specialty pharmacy and disease management
services provider serving HIV/AIDS patients in the United States. Key
elements of our strategy, include:
  ·
    *Increasing
      Sales in the Markets We Currently Serve*.
      Our internal growth has been generated through a combination of an
      increase in the number of patients we serve, an increase in the average
      dollar value of prescriptions and an increase in the number of
      prescriptions per patient. We intend to continue to expand in the major
      metropolitan markets where the majority of HIV/AIDS patients live through
      enhancing our existing and obstaining new relationships with HIV/AIDS
      clinics, hospitals and prescribing physicians and through the use of
      direct contact, outreach programs and community-based education
      programs.
  ·
    *Pursuing
      Strategic Acquisitions*.
      Our growth strategy includes acquiring specialty pharmacies located in
      areas that enable us to serve large numbers of HIV/AIDS patients. We
      acquired our first pharmacy in California – Medicine Made Easy – in
      2003 and since that time we have acquired two other specialty pharmacies
      in California. The patient base of these pharmacies and their
      relationships with area healthcare providers has greatly expanded our
      presence on the West Coast. We will continue to evaluate acquisition
      opportunities as they arise, especially other specialty pharmacies that
      have established relationships with HIV/AIDS clinics and
      hospitals.
  ·
    *Developing
      Marketing Relationships with Drug Manufacturers*.
      We intend to pursue relationships with drug manufacturers to increase
      recognition for our service and our ability to sell our specialty pharmacy
      and disease management services. These organizations have large marketing
      budgets and large sales teams who actively make sales calls to the leading
      prescribers of HIV/AIDS medications. We believe these relationships will
      promote our products and services. In March 2004, we entered into a
      specialized services agreement with Roche Laboratories Inc. to receive
      product pricing discounts in exchange for providing blind patient data
      with respect to Fuzeon®, an injectable HIV
medication.
   5
  ·
    *Qualifying
      for* *HIV*/*AIDS Reimbursement Programs.*Because
      we focus on serving HIV/AIDS patients and providing certain specialized
      pharmacy and disease management services, we have qualified for additional
      reimbursements for HIV/AIDS medications in California and believe we
      qualify in New York for additional reimbursements under Medicaid programs
      in those states. We own two of the ten pharmacies qualified for the
      California pilot program. We intend to continue to seek to qualify for
      programs under other state Medicaid programs that may provide additional
      or preferred reimbursements for the HIV/AIDS medications we
      sell.
  ·
    *Growth
      Through Relationship with Oris/LabTrackerTM*.
      LabTrackerTM enables physicians and healthcare providers to record, track,
      analyze and graph the outcomes of more than 250 possible HIV/AIDS
      treatment combinations. Lab TrackerTM also enables the healthcare providers
      to view, cross-reference and re-sort patient treatment information based
      on dozens of different patient demographics. LabTrackerTM has the ability
      to show the correlation between laboratory results and the medications
      prescribed to a HIV/AIDS patient. Oris Medical has an exclusive license to
      use Ground Zero Software's LabTracker*TM*software system for
      HIV/AIDS. Currently, more that 200 clinics and physicians use the
      LabTracker*TM*system. If we are able to negotiate and sign a
      definitive agreement with Oris Medical, we will have access to use
      LabTrackerTM software, which we expect will assist us in entering new
      geographic markets and gaining access to clinics, physicians, and
      hospitals where we do not currently treat patients.
  OUR
PRODUCTS AND SERVICES
  We offer
a range of specialty pharmacy and disease management services to
assist patients, healthcare providers and payors in managing HIV/AIDS. We
sell HIV/AIDS prescription and ancillary medications, and nutritional
supplies. Patients or physicians generally initiate the prescription process by
contacting us on our toll-free telephone number, through our facsimile number or
through our electronic prescription writer. Some clinics have medication
drop-off boxes in which physicians also may leave prescriptions for us to fill.
A patient may also direct his or her physician to call, fax or electronically
transmit a prescription. If requested by a patient, one of our pharmacists may
contact the patient’s physician directly to obtain prescription information. Our
pharmacists are required to validate and verify the completeness of each
prescription, answer questions and, if appropriate, help coordinate support and
training for patients. As soon as we receive a prescription, we also seek
approval for reimbursement from the payor. Once the prescription and
reimbursement are verified, the order is filled, shipped and
delivered.
  We have
designed our services to meet the following challenges that are of particular
importance to HIV/AIDS patients, healthcare providers and payors:
  Adherence
  *Packaging* . We have
designed our services to improve patient adherence to complex medication
regimens. We package prescriptions in a format customized for the patient, which
organizes the medications into dose-by-dose packets, called MOMSPak, or into
individual doses using pillboxes for our patients, if requested by the patient.
Our customized packaging helps to ensure that our patients are not confused by
the complex regimen associated with their numerous medications, and also helps
to eliminate patient error in determining when they should be taken, and how
they should be administered.
  *Delivery* . We
arrange for independent delivery of medications as directed by our patients or
their physicians in a discreet, convenient and timely manner and help patients
receive their prescriptions. We believe that this increases patient adherence as
it eliminates the need to pick up medications at a local pharmacy.
  Reimbursement
Management
  We have
reimbursement expertise that assists patients and healthcare providers with the
complex reimbursement processes of government and private payors, and that
optimizes collection of payment. By focusing on HIV/AIDS, we have developed
significant expertise in managing reimbursement issues related to the patient’s
condition, treatment program, and the payor. We have developed sophisticated
systems for managing the process of checking eligibility, receiving
authorization, adjudicating claims and ensuring that payment is received. In our
experience, it is critical to understand the process of checking eligibility and
need for authorizations and approvals to facilitate the collection of
payments.
  Due to
the high cost and extended duration required to treat HIV/AIDS, the availability
of adequate health insurance is an on-going concern for our patients and their
families. We work closely with physicians and our patients to monitor coverage
reduction or termination dates and seek alternative coverage options to ensure
the patient’s clinical needs are met and his or her quality of life is not
compromised. The majority of our claims are submitted electronically for our
patients, which substantially eliminates the paper claim submission process.
Because of our ability to facilitate reimbursement from private and government
payors, in many cases, we can provide prescription medications to patients at
lower initial out-of-pocket costs than they might obtain from other
sources.
   6
  The two
largest HIV/AIDS markets in the United States, California and New York, recently
underwent fundamental changes in Medicaid reimbursement for HIV/AIDS
medications. California recently approved a three-year HIV/AIDS Pharmacy Pilot
Program, which provides additional reimbursement for HIV/AIDS medications for up
to ten qualified pharmacies. We own two of the ten pharmacies that qualified for
this program. In New York, we believe that we will be the only
specialized HIV pharmacy services provider to qualify for a higher
reimbursement rate under the revised reimbursement mechanisms of the New York
state-mandated Medicaid HIV/AIDS program.
  We work
with government and private payors to obtain appropriate reimbursement. Our
billing and reimbursement specialists typically secure pre-approval from a payor
before any shipment of medications. Our billing and reimbursement specialists
also review such issues as pre-certification or other prior approval
requirements, lifetime limits, pre-existing condition clauses and the
availability of special state programs. Because the majority of our
prescriptions are adjudicated through electronic submissions we are reasonably
certain we will receive payment from the payor.
  Disease
Management
  The
medications we distribute to our patients require timely delivery, may require
temperature maintained distribution, and very often require dosage monitoring.
Our employees have developed expertise in HIV/AIDS that allows them to provide
customized care to our patients. By focusing on the HIV/AIDS community, we have
been able to design our services to help patients understand and manage their
medication needs and schedules.
  Upon
initiating service, we work closely with the patient and the patient’s physician
and other care providers to implement the prescribed therapy and provide the
following services:
  ·
    programs
      to monitor utilization compliance and
outcomes;
  ·
    clinical
      information and consultation regarding the patient’s illness, medications
      being used and treatment regimens;
  ·
    educational
      information on the patient’s illness, including advancements in research,
      technology and medication regimens;
  ·
    assistance
      in setting realistic expectations for a patient’s therapy, including
      anticipated outcomes and side effects;
  ·
    systems
      for inventory management and record keeping;
and
  ·
    assistance
      in coordinating treatments outside of the home / hospital
      setting.
  We
believe that these specialty pharmacy and disease management services benefit
government and private payors by helping our patients avoid potentially costly
episodes that can result from non-compliance with a prescribed care regimen.
Improved patient compliance avoids costs for the payor by reducing the incidence
of physician intervention, hospitalization and emergency room visits. Our staff
works closely with patient care coordinators to routinely monitor the patient’s
care regimen.
  Information
Systems and Prescription Automation Solutions
  We use
licensed information systems that allow patients and healthcare providers to
manage and treat HIV/AIDS. We believe the transmission of electronic
prescriptions reduces confusion and potential medication errors. Our electronic
prescription transmittal software, EZrx, allows healthcare providers to view
their patients’ prescription history and combine data on medications and dosages
with the patients’ lab results. In addition, EZrx enables physicians to request
new prescriptions and renewal prescriptions online, thereby saving physicians
and their staff time that would otherwise be spent completing the necessary
patient prescriptions.
   7
  We
recently entered into a letter of intent with Oris Medical to be the exclusive
licensee of Ground Zero Software’s LabTrackerTM software system for HIV/AIDS.
LabTrackerTM enables physicians and healthcare providers to record, track,
analyze and graph the outcomes of more than 250 possible HIV/AIDS treatment
combinations. Lab TrackerTM also enables the healthcare providers to view,
cross-reference and re-sort patient treatment information based on dozens of
different patient demographics. LabTrackerTM has the ability to show the
correlation between laboratory results and the medications prescribed to a
HIV/AIDS patient. Currently, healthcare providers that desire to use this
feature are required to manually input prescription information. These reports
contain more accurate, timely and comprehensive information about the
interaction between a drug and the health of a HIV/AIDS patient. We believe this
information allows healthcare providers to alter drug regimens as needed. If we
are able to negotiate a definitive agreement with Oris Medical to be the
exclusive licensee of LabTrackerTM, we expect that healthcare providers will be
able to import prescription information electronically through the LabTrackerTM
software. We believe this capability, coupled with the features of LabTrackerTM,
will significantly enhance our ability to attract and retain patients and to
develop enhanced business relationships with healthcare providers. There is no
assurance that we will be able to reach a definitive agreement with Oris
Medical. See the discussion in Item 7 below under the heading “Risk Factors -
Risks Related to Our Company.”
  MARKETING
  We market
our services to healthcare providers and patients through advertising, and the
activities of our sales team, which is experienced in HIV/AIDS. We provide our
services under the trade name of MOMS Pharmacy.
  We
believe MOMS Pharmacy is a recognized brand-name within the HIV/AIDS community. **** We have a
website at www.momspharmacy.com to
directly market our products to the HIV/AIDS community and service
organizations, which contains educational material and information of interest
for the community. We are providing the address of this internet website in this
Report solely for informational purposes. We do not intend the internet address
to be an active link, and the contents of the website are not a part of this
Report.
  SUPPLIERS AND
PHARMACEUTICAL ARRANGEMENTS
  We ensure
the timely delivery of our approximately 1,000 branded and generic prescription
medications by purchasing the medications we use to fill prescriptions from
wholesale distributors. In 2003, we entered into a five-year agreement with
AmerisourceBergen Corporation to provide us with the HIV/AIDS medications we
sell, although we will continue to purchase some medications from other
wholesalers and from manufacturers. As part of this agreement, we receive
improved payment terms relative to the terms we could get from other
pharmaceutical distributors. Pursuant to this agreement, we agreed to purchase
certain minimum amounts in the future. The terms of our agreement with
AmerisourceBergen and its impact on our financial results and condition are
discussed below in Item 7 under the heading “Management’s Discussion and
Analysis of Results of Operations and Financial Condition.”
  We
actively pursue relationships with pharmaceutical manufacturers and are
currently negotiating partnerships with pharmaceutical companies. Historically,
and in the future, these relationships are formed through partnering agreements,
joint ventures and marketing agreements. We actively look to work with the
manufacturers and marketers of the leading HIV/AIDS medications. These
organizations have large marketing budgets and large sales teams. The HIV/AIDS
sales teams at these pharmaceutical companies are actively making sales calls on
the leading prescribers of HIV/AIDS medications. Often they have strong
relationships and the ability to inform the physician about our products
and services. We have agreed to provide Roche with detailed data and
other information about our sales of Fuzeon®
that assists Roche in better understanding its customers.
  We have
entered into a specialized services agreement with Roche Laboratories Inc. to
receive product pricing discounts in exchange for providing blind patient data
with respect to Fuzeon®, an injectable HIV medication manufactured by Roche.
Roche has entered into a specialty agreement with only a limited number of
pharmacies.
   8
  COMPETITION
  Our
industry is highly competitive, fragmented and undergoing consolidation, with
many public and private companies focusing on different products or diseases.
Each of our competitors provides a different mix of products and services than
we do. Some of our current and potential competitors include:
  ·
    specialty
      pharmacy distributors such as, Accredo Health, Inc., BioScrip, Inc.,
      Curative Health Services, Inc., and Priority Healthcare
    Corp.;
  ·
    pharmacy
      benefit management companies such as, Medco Health Solutions, Inc.,
      ExpressScripts, Inc. and Caremark, Rx,
Inc.;
  ·
    specialty
      pharmacy divisions of national wholesale drug
  distributors;
  ·
    hospital-based
      pharmacies;
  ·
    retail
      pharmacies, such as CVS Corp. and Walgreen
Co.;
  ·
    manufacturers
      that sell their products both to distributors and directly to clinics and
      physician offices; and
  ·
    hospital-based
      care centers and other alternate site healthcare
  providers.
  Many of
our existing and potential competitors have substantially greater financial,
technical, marketing and distribution resources than we do. Additionally, many
of these companies have greater name recognition and more established
relationships with HIV/AIDS patients. Furthermore, these competitors may be able
to adopt more aggressive pricing policies and offer customers more attractive
terms than we can.
  THIRD
PARTY REIMBURSEMENT COST CONTAINMENT AND LEGISLATION
  As of
January 1, 2004, Medicare adopted new reimbursement methodologies for covered
prescription drugs, which reduced reimbursement for many drugs. In 2005, CMS
changed the reimbursement methodology to be based on average sales price (ASP)
rather than average wholesale price (AWP). Medicare will again change the
reimbursement methodology in 2006 to be based on pricing established by
competitive bid. Because only a small amount of our net sales are from patients
reimbursed by Medicare, this change has not had a significant effect on
us.
  As of
September 1, 2004 as part of the passage of the state of California budget,
reimbursement rates for pharmacy services provided under Medi-Cal were reduced.
Under the changed reimbursement rate, prescriptions are reimbursed at AWP
less 17%, and the provider is paid a $7.00 dispensing fee. The previous
reimbursement rate was AWP less 10% with a $4.30 dispensing fee. On September
28, 2004, California approved a three-year HIV/AIDS Pharmacy Pilot Program bill
that funds an additional $9.50 fee per prescription for qualified HIV pharmacies
that participate in the program. The payments are retroactive and applies to
services rendered since September 1, 2004.
  In New
York, reimbursement rates for pharmacy services provided under Medicaid were
reduced in September 2004. Under the changed reimbursement rate, prescriptions
are reimbursed at the AWP less 12.75% plus a dispensing fee. The previous
reimbursement rate was AWP less 12% plus a dispensing fee of $3.50 to $4.50.
Approved specialized HIV pharmacies will continue to be reimbursed at AWP less
12% plus a dispensing fee. We believe we have been approved as a specialized HIV
pharmacy qualifying for the more favorable reimbursement rate. The legislation
authorizing the more favorable reimbursement rate is currently effective until
March 31, 2006.
   9
  Cost
containment initiatives are a primary trend in the United States health care
industry. The increasing prevalence of managed care, centralized purchasing
decisions, consolidation among and integration of healthcare providers and
competition for patients has affected, and continues to affect, pricing,
purchasing, and usage patterns in health care. Efforts by payors to eliminate,
contain or reduce costs through coverage exclusions, lower reimbursement rates,
greater claims scrutiny, closed provider panels, restrictions on required
formularies, mandatory use of generics, limitations on payments in certain
therapeutic drug categories, claim delays or denials and other similar measures
could erode our profit margins or materially harm the results of our
operations.
  Some
government and private payors may attempt to control costs further by selecting
certain companies to be their exclusive providers of pharmaceutical benefits. If
such arrangements were with our competitors, we would be unable to obtain
reimbursement for purchases made by patients insured by such
payors.
  We derive
a significant portion of our net sales from Medicaid and ADAP, both highly
regulated government programs, subject to frequent changes and cost containment
measures. Medicaid is a state program partly funded by the Federal government.
In recent years, these programs have reduced reimbursement to providers. The
Balanced Budget Act of 1997 increased state discretion over the administration
of Medicaid programs and reduced spending levels for the Medicare and Medicaid
programs. We expect continued financial pressure on these programs.
Approximately 25 states have implemented “preferred drug list” programs, under
which drugs would not appear on an approved and reimbursable Medicaid formulary
unless the Medicaid programs receive discounts or other concessions. The drug
industry has instituted litigation to halt these programs in some of these
states, but the outcome of the litigation is unknown. If the states prevail in
these lawsuits, then this could result in reductions in the reimbursement that
we receive from Medicaid programs for our services and could materially and
adversely affect our business, financial condition and results of operation. In
addition, a number of state Medicaid programs have reduced their reimbursement
rates in response to AWP prices published by First DataBank.
  The
impact of changes in reimbursement rates and programs and of cost containment
initiatives generally on our financial results is discussed below in Item 7
under the heading “Management’s Discussion and Analysis of Financial Condition
and Results of Operations.”
  GOVERNMENT
REGULATION
  Marketing,
repackaging, dispensing, selling and purchasing drugs is highly regulated and
regularly scrutinized by state and Federal government agencies for compliance
with laws and regulations relating to the following topics, including, but not
limited to:
  ·
    the
      payment of inducements for patient
referrals;
  ·
    manufacturer
      calculated and reported AWP and ASP
amounts;
  ·
    restrictions
      on joint ventures and management
agreements;
  ·
    prohibition
      on referrals from physicians with whom we have a financial
      relationship;
  ·
    professional
      licensure;
  ·
    repackaging,
      storing and distributing prescription
pharmaceuticals;
 ·
    incentives
      to patients; and
  ·
    product
      discounts.
  The laws
and regulations are very complex and generally broad in scope resulting in
differing interpretations and a lack of consistent court decisions. Compliance
with laws continue to be a significant operational requirement for us. We
believe that we currently comply in all material respects, and intend to
continue to comply, with all laws and regulations with respect to our operations
and conduct of business. However, the application of complex standards to the
detailed operation of our business always creates areas of uncertainty, and
there can be no assurance that all of our business practices would be
interpreted by the appropriate regulatory agency to be in compliance in all
respects with the applicable requirements. Moreover, regulation of the health
care industry is in a state of flux. Any failure or alleged failure to comply
with applicable laws and regulations could have a material adverse effect on our
operating results and financial condition.
   10
  In
addition, we are unable to predict or determine the future course of federal,
state and local regulation, legislation or enforcement or what additional
federal or state legislation or regulatory initiatives may be enacted in the
future relating to our business or the health care industry in general, or what
effect any such legislation or regulation might have on us. We cannot provide
any assurance that federal or state governments will not impose additional
restrictions or adopt interpretations of existing laws that could have a
material adverse effect on our business or financial position. Consequently, any
future change, interpretation or any violation (or alleged violation) of law and
regulations could have a material adverse affect on our business, financial
condition and results of operations. The following are particular areas of
government regulation that apply to our business.
  *Federal
Food, Drug, and Cosmetics Act* . This
law, as amended by the Prescription Drug Marketing Act,
imposes requirements for the labeling, packaging and repackaging,
dispensing and advertising of prescription medication; and also prohibits, among
other things, the distribution of unapproved adulterated or misbranded drugs. To
the extent that this law applies to us, we believe that we comply with a
reasonable interpretation of the repackaging, labeling,
compounding, documentation, record-keeping and storage requirements.
  *Federal
Controlled Substances Act.* This
federal law contains pharmacy registration, packaging and labeling requirements,
as well as record-keeping requirements related to a pharmacy’s inventory and its
receipt and disposition of all controlled substances. Each state has also
enacted similar legislation governing pharmacies’ handling of controlled
substances. We maintain federal and state controlled substance registrations for
each of our facilities where applicable, and follow procedures intended to
comply with all such record keeping requirements.
  *Federal
Mail Order Provisions* . The
United States Postal Service and the Federal Trade Commission regulate mail
order sellers, requiring truth in advertising, a reasonable supply of drugs to
fill orders, the consumer’s right to a refund if an order cannot be filled
within 30 days, and in certain cases, child-resistant packaging. To the extent
applicable, we believe we substantially comply with these requirements.
  *Pharmacy
Drug Use Review Law* . Federal
law requires that states offering Medicaid prescription drug benefits implement
a drug use review program. The program requires “before and after” drug use
reviews and the use of certain approved compendia and peer-reviewed medical
literature as the source of standards for such drug use reviews. States offering
Medicaid prescription drug benefits must develop standards for pharmacy patient
counseling and record-keeping. These standards apply as well to non-resident
pharmacies. We believe our pharmacists monitor these requirements, provide the
necessary patient counseling and maintain the appropriate records.
  *Anti-Kickback
Laws* . Being a
health care business, we are subject to various laws that regulate our
relationships with referral sources such as physicians, hospitals and other
providers of health care services. Under the government payment programs for
health care services (Medicare, Medicaid, etc.), the federal government enforces
the federal statute that prohibits the offer, payment, solicitation or receipt
of any remuneration to or from any person or entity, directly or indirectly,
overtly or covertly, in cash or in kind to induce or exchange for: the referral
of patients covered by the programs; or the purchasing, leasing, ordering, or
arranging for or recommending the lease, purchase or order of any item, good,
facility or service covered by the programs. Violations by individuals or
entities are punishable by criminal fines, civil penalties, imprisonment or
exclusion from participation in reimbursement programs, such as Medicare and
Medicaid.
  States
also have similar laws proscribing kickbacks, some of which are not limited to
services for which government-funded payment may be made. State laws (and their
respective exceptions or safe harbors) vary and are subject to interpretations
of courts or regulatory agencies.
   11
  Anti-kickback
laws are very broad in scope and are subject to modifications and variable
interpretations. In an effort to clarify the Federal anti-kickback law, the
Department of Health and Human Services (DHHS) has adopted a set of “safe
harbor” rules, which specify various payment practices that are protected from
civil or criminal liability. Not all of our business arrangements and the
services we provide may fit within these safe harbors. A practice that does not
fall within a safe harbor is not necessarily unlawful, but may be subject to
scrutiny and challenge. Failure to satisfy the requirements of a safe harbor
requires an analysis of whether the parties intend to violate the anti-kickback
law. In the absence of an applicable safe harbor, a violation of the
anti-kickback law may occur even if only one purpose of a payment arrangement is
to induce patient referrals or purchases or induce the provision of a
prescription drug reimbursable by a federal healthcare program such as Medicare
or Medicaid. Anti-kickback laws have been cited as a partial basis, along with
the state consumer protection laws discussed below, for investigations and
multi-state settlements relating to financial incentives provided by drug
manufacturers to retail pharmacies in connection with pharmaceutical marketing
programs. We review our business practices regularly to comply with the federal
anti-kickback law and similar state laws. We have a variety of relationships
with referral sources such as physicians, clinics and hospitals. As we grow, we
may pursue additional arrangements with such parties. Where applicable, we
attempt to structure these relationships to fit into the appropriate safe
harbor; however, it is not always possible to meet all requirements of a safe
harbor. While we feel that our relationships comply with the anti-kickback laws,
if we are found to violate any of these laws, we could suffer penalties, fines,
or possible exclusion from participation in federal and state health care
programs, which could reduce our net sales and profits.
  *Health
Insurance Portability And Accountability Act of 1996 (HIPAA)* . Among
other things, HIPAA broadened the scope of the DHHS Secretary’s power to impose
civil monetary penalties on healthcare providers, and added an additional
category to the list of individuals and entities who may be excluded from
participating in any Federal health care program like Medicaid. HIPAA encourages
the reporting of health care fraud by allowing reporting individuals to share in
any recovery made by the government, and requires the DHHS Secretary to create
new programs to control fraud and abuse and conduct investigations, audits and
inspections. HIPAA also created new health care fraud crimes including expanding
the coverage of previous laws by, among other things, to include:
  ·
    knowingly
      and willfully attempting to defraud any health care benefit program
      (including government and private, commercial plans);
  and
  ·
    knowingly
      and willfully falsifying, concealing, or covering up a material fact or
      making any materially false or fraudulent statements in connection with
      claims and payment for health care services by a health care benefit plan
      (including government and private, commercial
plans).
  We
believe that our business arrangements and practices comply with these HIPAA
provisions. However, a violation could subject us to penalties, fines, or
possible exclusion from Medicare or Medicaid. Such sanctions could reduce our
net sale or profits.
  *OIG
Fraud Alerts and Advisory Opinions* . The
Office of Inspector General of DHHS periodically issues Fraud Alerts and
Advisory Opinions identifying certain questionable arrangements and practices
that it believes may implicate the Federal fraud and abuse laws. In a December
1994 Special Fraud Alert relating to “prescription drug marketing schemes,” the
OIG stated that investigation may be warranted when a prescription drug
marketing activity involves the provision of cash or other benefits to
pharmacists in exchange for such pharmacists’ performance of marketing tasks in
the course of their pharmacy practice, including, for example, sales-oriented
“educational” or “counseling” contacts or physician and/or patient outreach
where the value of the compensation is related to the business generated. We
believe that we have structured our business arrangements to comply with federal
fraud and abuse laws. However, if we are found to have violated any of these
laws, we could suffer penalties, fines or possible exclusion from the Medicare,
Medicaid or other government programs, which could adversely affect our
operations.
  *State
Unfair and Deceptive Trade Practices and Consumer Protection
Laws* . State
laws regulating unfair and deceptive trade practices and consumer protection
statutes have been used as bases for the investigations and multi-state
settlements relating to pharmaceutical industry promotional drug programs in
which pharmacists are provided incentives to encourage patients and/or
physicians to switch from one prescription drug to another. We do not
participate in any such programs. However, if we are ever characterized as
having violated any of these laws, we could suffer penalties and fines, which
could adversely affect our operations. **** It should
also be noted that a number of states involved in these consumer protection
driven enforcement actions have requested that the FDA exercise greater
regulatory oversight in the area of pharmaceutical promotion activities by
pharmacists. It is not possible to determine whether the FDA will act in this
regard or what effect, if any, FDA involvement would have on our operations.
  12
  *The
Stark Law* . Federal
law prohibits physicians from making a referral for certain health items or
services if they, or their family members, have a financial relationship with
the entity receiving the referral. No bill may be submitted in connection with a
prohibited referral. Violations are punishable by civil monetary penalties upon
both the person making the referral and the provider rendering the service. Such
persons or entities are also subject to exclusion from federal health care
programs, such as Medicaid. In 1995, the Centers for Medicare and Medicaid
Services (CMS) published final regulations under the Stark Law which provide
some guidance on interpretation of the scope and exceptions of the Stark Law as
they apply to clinical laboratory services (Stark I). In addition, CMS released
Phase I of the Stark final regulations which became effective, in large part on
January 4, 2002, which covers additional health services, including outpatient
prescription drugs and which describes the parameters of the statutory
exceptions in more detail and sets forth additional exceptions for physician
referrals and physician financial relationships. Phase II of the Stark Law final
regulations became effective on July 26, 2004. Phase II clarifies portions of
Phase I, addresses certain exceptions to the Stark Law not addressed in Phase I,
and creates several new exceptions. As a result of Phase II’s comment period and
the fact that Phase II did not address application of the Stark Law to Medicaid,
CMS plans to release Phase III regulations at a future date. Another feature of
the Phase II regulations is that they include new provisions relation to
indirect ownership and indirect compensation relationships between physicians
and entities offering designated health services. These provisions are complex
and have not been interpreted by the courts. We believe we have structured our
relationships with physicians to comply with these Phase II
provisions.
  Additionally,
a number of states have enacted similar referral prohibitions, which may cover
financial relationships between entities and health care practitioners other
than physicians, as well. The Stark Law applies to our relationships with
physicians and physician referrals for our products and services. We believe we
have structured our relationships to comply with the Stark Law as well as the
applicable state provisions similar to the Stark Law. However, if our practices
are found to violate the Stark Law or a similar state prohibition, we may be
subject to sanctions or be required to alter or discontinue some of our
practices. This could reduce our net sales or profits.
  *Beneficiary
Inducement Prohibition* . The
federal civil monetary penalty law prohibits the offering of remuneration or
other inducements to beneficiaries of federal health care programs to influence
the beneficiaries’ decision to seek specific governmentally reimbursable items
or services, or to choose a particular provider. The federal civil monetary
penalty law and its associated regulations exclude items provided to patients to
promote the delivery of preventive care. However, permissible incentives do not
include cash or cash equivalents. From time to time, we loan some items at no
charge to our patients to assist them with adhering to their drug therapy
regimen. Although these items are not expressly included on the list of excluded
items set forth in the statute and regulations, we nevertheless believe that our
provision of these items does not violate the civil monetary penalty law and
regulations in part because we do not believe that providing these items is
likely to influence patient choice of goods or services. A determination that we
violated the statute or regulations, however, could result in sanctions that
reduce our net sales or profits.
  *False
Claims; Insurance Fraud Provisions* . We are
also subject to federal and state laws prohibiting individuals or entities from
knowingly and willfully making claims for payment to Medicare, Medicaid, or
other third-party payors that contain false or fraudulent information. These
laws provide for both criminal and civil penalties, including being excluded
from federal health care programs such as Medicaid, and being required to repay
previously collected amounts. Healthcare providers who submit claims which they
knew or should have known were false, fraudulent, or for items or services that
were not provided as claimed, may be excluded from Medicaid, required to repay
previously collected amounts, and subject to substantial civil monetary
penalties.
  *Government
Investigations* . The
government increasingly examines arrangements between healthcare providers and
potential referral sources to ensure that they are not designed to exchange
remuneration for patient care referrals. Investigators are increasingly willing
to look behind formalities of business transactions to determine the underlying
purpose of payments. Enforcement actions have increased over the years and are
highly publicized. The OIG, in its Fiscal Year 2002 Work Plan, identified
“pharmaceutical fraud” as one of its “special focus areas.” In the OIG’s Fiscal
Year 2003, 2004, 2005 Work Plans, “pharmaceutical fraud” was identified as an
“investigative focus area.” To our knowledge, we are not currently the subject
of any investigation. Any future investigation may cause publicity that would
cause potential patients to avoid us, reducing potential net sales and
profits.
  In
addition to investigations and enforcement actions initiated by government
agencies, we could be the subject of an action brought under the Federal False
Claims Act by a private individual (such as a former employee, a customer or a
competitor) on behalf of the government. Actions under the Federal False Claims
Act, commonly known as “whistleblower” lawsuits, are generally filed under seal
to allow the government adequate time to investigate and determine whether it
will intervene in the action, and defendant healthcare providers are often
without knowledge of such actions until the government has completed its
investigation and the seal is lifted.
   13
  *Privacy
and Confidentiality; Electronic Transactions and Security* . Many of
our activities involve the receipt or use of confidential health information,
including the transfer of the confidential information to a third-party payor
program, such as Medicaid. Federal and state laws protect the confidentiality of
such records and health information. Pursuant to the privacy provisions of
HIPAA, DHHS promulgated regulations, that had a compliance deadline of April 14,
2003 and that impose extensive requirements on the way in which healthcare
providers, health plans and their business associates use and disclose protected
health information. This final rule gives individuals significant rights to
understand and control how their protected health information is used and
disclosed. Direct providers, such as a pharmacy, must obtain an acknowledgement
from their patients that the patient has received the pharmacy’s Notice of
Privacy Practices. For most uses and disclosures of protected health information
that do not involve treatment, payment or health care operations, the rule
requires that all providers and health plans obtain a valid individual
authorization. In most cases, use or disclosure of protected health information
must be limited to the minimum amount necessary to achieve the purpose of the
use or disclosure. Standards are provided for removing all individually
identifiable health information in order to produce de-identified data that may
be transferred without obtaining the patient’s authorization. Sanctions for
failing to comply with the privacy standards issued pursuant to HIPAA include
criminal penalties and civil sanctions.
  In
addition to the federal health information privacy regulations described above,
most states have enacted confidentiality laws that limit the disclosure of
confidential medical information. The final privacy rule under HIPAA does not
preempt state laws regarding health information privacy that are more
restrictive than HIPAA. The failure to comply with these federal and state
provisions could result in the imposition of administrative or criminal
sanctions.
  On
October 16, 2002 (which was extended to October 16, 2003 for those providers who
submitted a “plan” describing how they will come into compliance) all healthcare
providers who transmit certain health claims transactions electronically were
required to comply with the HIPAA final regulations establishing transaction
standards and code sets.
  In
addition, pursuant to HIPAA, in February 2003, DHHS issued regulations pursuant
to HIPAA that govern the security of protected health information that is
maintained or transmitted electronically. The compliance date for these
regulations is April 21, 2005. The regulations impose additional administrative
burdens on healthcare providers, such as pharmacies, relating to the storage and
utilization of, and access to, health information. These HIPAA security
regulations may require that we invest significant capital in upgrading
information systems hardware, software and procedures.
  Laws
governing Medicare, Medicaid, the Civilian Health and Medical Program of the
Uniformed Services, or CHAMPUS, and other government programs may change, and
various administrative rulings, interpretations and determinations may make
compliance difficult. Any changes may materially increase or decrease program
payments or the cost of providing services. Final determinations of government
program reimbursement often require years, because of audits, providers’ right
of appeal and numerous technical requirements. We believe we make adequate
provision for adjustments. However, future reductions in reimbursement could
reduce our net sales and profits.
  *Medicare
Prescription Drug Benefit* . In the
past, Medicare covered only a limited number of outpatient prescription drugs.
In December 2003, the Medicare Prescription Drug Modernization Act, which
includes a new Medicare Part D prescription drug benefit, was passed. Final
regulations implementing the law providing broader coverage for outpatient
prescription drugs will become effective on January 1, 2006. Because only a
small number of our patients are covered by Medicare and we expect to stop
servicing Medicare patients in the first quarter of 2005, this change should not
have any significant effect on us.
  *Reform* . The
U.S. health care industry continues to undergo significant change. Future
changes in the nature of the health system could reduce our net sales and
profits. We cannot provide any assurance as to the ultimate content, timing or
effect of any health care reform legislation, nor is it possible at this time to
estimate the impact of potential legislation, which may be material, on us.
Further, although we exercise care in structuring our operations to comply in
all material respects with the laws and regulations summarized in this
Government Regulation section, we can not assure you that (i) government
officials charged with responsibility for enforcing such future laws will not
assert that we or certain transactions in which we are involved are in violation
thereof, and (ii) such future laws will ultimately be interpreted by the courts
in a manner consistent with our interpretation. Therefore, it is possible that
future legislation and regulation and the interpretation thereof could have a
material adverse effect on us.
   14
  State
Regulation of The Practice of Pharmacy
  We are
licensed to do business as a pharmacy in each state in which we operate a
dispensing pharmacy. Many of the states into which we deliver prescription
medications have laws and regulations that require out-of-state mail service
pharmacies to register with, or be licensed by, the board of pharmacy or similar
regulatory body in the state. These states generally permit the dispensing
pharmacy to follow the laws of the state within which the dispensing pharmacy is
located.
  However,
various states have enacted laws and adopted regulations requiring, among other
things, compliance with all laws of the states into which the out-of-state
pharmacy dispenses medications, whether or not those laws conflict with the laws
of the state in which the pharmacy is located. To the extent that such laws or
regulations are found to be applicable to our operations, and that such laws of
other states where our pharmacies dispense medications are more stringent than
those of the states in which our pharmacies are located, we would be required to
comply with them. In addition, to the extent that any of these laws or
regulations prohibit or restrict the operation of mail service pharmacies and
are found to be applicable to us, they could have a harmful effect on our
prescription mail service operations.
  Some
federal and state pharmacy associations and some boards of pharmacy have
attempted to develop laws or regulations restricting the activity of
out-of-state pharmacies.
  Pharmacists
must obtain state licenses to dispense medications. Our pharmacists are licensed
in those states where their activity requires it. Pharmacists must also comply
with professional practice rules. We monitor our pharmacists’ practices for
compliance with such state laws and rules. We do not believe that the activities
undertaken by our pharmacists violate rules governing the practice of pharmacy
or medicine. In an effort to combat fraud, New York State recently enacted
emergency regulations requiring the use of an official New York State
prescription for all prescribing done in-state. The emergency regulations are
expected to become permanent.
  Licensing
and Registration
  We are
licensed as an in-state pharmacy in New York, California, Texas and Florida. We
satisfy the criteria to deliver prescription to patients in other states that
require us to be licensed as an out-of-state pharmacy. We believe that we
substantially comply with all state licensing laws applicable to our
business.
  Laws
enforced by the federal Drug Enforcement Administration, as well as some similar
state agencies, require our pharmacy locations to individually register in order
to handle controlled substances, including prescription drugs. A separate
registration is required at each principal place of business where the applicant
manufactures, distributes, or dispenses controlled substances. Federal and state
laws require that we follow specific labeling and record-keeping requirements
for controlled substances. We maintain federal and state controlled substance
registrations for each of our facilities that require it, and follow procedures
intended to comply with all such record-keeping requirements.
  *Pharmacists* .
Pharmacists must obtain state licenses to dispense drugs. Our pharmacists are
licensed in those states where their activity requires it. Pharmacists must also
comply with professional practice rules. We monitor our pharmacists’ practices
for compliance with such state laws and rules. We do not believe that the
activities undertaken by our pharmacists violate rules governing the practice of
pharmacy or medicine.
  *Pharmacy
Counseling.* Federal
law requires that states offering Medicaid prescription drug benefits implement
a drug use review program. The program requires “before and after” drug use
reviews, the use of predetermined standards, and patient education. Its purpose
is to improve the quality of care by ensuring drug prescriptions are medically
necessary, and not likely to cause adverse effects. Participating states must
develop standards for pharmacy counseling. These standards apply as well to
non-resident pharmacies like us. We believe our pharmacists monitor these
requirements and provide necessary counseling.
   15
  *Federal
Mail Order* . Federal
law imposes standards for:
  ·
    the
      labeling, packaging and repackaging, advertising and adulteration of
      prescription drugs; and
  ·
    the
      dispensing of controlled substances and prescription
  drugs.
  The
Federal Trade Commission and the United States Postal Service regulate mail
order drug sellers. The law requires truth in advertising, a reasonable supply
of drugs to fill orders, and a right to a refund if an order cannot be filled
within thirty days. To the extent applicable, we believe that we substantially
comply with all of these requirements.
  *Prescription
Drug Marketing Act* . This
federal law exempts many drug and medical devices from federal labeling and
packaging requirements, as long as they are not adulterated or misbranded and
were prescribed by a physician. The law also prohibits the sale, purchase or
trade of drug samples that are not intended for sale or intended to promote the
sale of the drug. Records must be kept of drug sample distribution, and proper
storage and maintenance methods used. To the extent that this law applies to us,
we believe that it complies with the documentation, record keeping and storage
requirements.
  *Liability
Insurances.* Providing
health care services and products entails an inherent risk of liability. In
recent years, participants in the health care industry have become subject to an
increasing number of lawsuits, many of which involve large claims and
significant defense costs. The company may from time to time be subject to such
suits as a result of the nature of its business. We maintain general liability
insurance, including professional and product liability, in an amount deemed
adequate by its management. There can be no assurance, however, that claims in
excess of, or beyond the scope of, its insurance coverage will not arise. In
addition, the company’s insurance policies must be renewed annually. Although,
we have not experienced difficulty in obtaining insurance coverage in the past,
there can be no assurance that it will be able to do so in the future on
acceptable terms or at all.
  EMPLOYEES
  As of
March 25, 2005, we had 125 full-time employees and 15 part-time employees, all
of whom were engaged in management, sales, marketing, pharmacy services,
customer service, administration or finance. None of our employees are covered
by a collective bargaining agreement. We have never experienced an
employment-related work stoppage and consider our employee relations to be
good.
  ITEM
2.PROPERTY
  Our
principal executive offices and our New York pharmacy are located in
approximately 8,215 square feet of space in Melville, New York, which we have
leased through June 30, 2009. We also lease space for our regional pharmacy
operations in the following locations:
  Location
    
    Principal
      Use
    
    Square
      Footage
    
    Property
      InterestMelville,
      NY
    
    Pharmacy
      and Executive Offices
    
    8,215
    
    Leased
      - expiring August 31, 2009Austin,
      TX
    
    Pharmacy
    
    3,600
    
    Leased
      - expiring June 30, 2005Miami,
      FL
    
    Pharmacy
    
    2,700
    
    Leased
      - expiring September 30, 2005Torrance,
      CA
    
    Pharmacy
    
    7,876
    
    Leased
      - expiring December 31, 2005
 
 At this
time, we believe we have adequate space for our current operations. We plan on
renewing our leases prior to expiration or moving to a comparable space at a
comparable price.
  In
January 2005, we acquired facilities in Van Nuys and San Diego, California in
connection with our acquisition of North American Home Health Supply, Inc. In
February 2005, we acquired facilities in San Francisco, California and Seattle,
Washington in connection with our acquisition of Specialty Pharmacies, Inc. We
plan to continue operations out of these locations.
  16
  In March
2005, we decided to cease our operations in Texas and are in the process of
closing our pharmacy in Austin, Texas. We hope to cease these operations by June
30, 2005 and do not plan to renew our lease for this property. Our plans to
discontinue our Texas operations are described in more detail in Item 7 under
the heading “Management’s Discussion and Analysis of Financial Condition and
Results of Operations.”
  ITEM
3.LEGAL
PROCEEDINGS
 
 *New
Jersey Medicaid Audit.* During
the first quarter of 2003, Medicaid commenced a review of our billing
practices in New Jersey. In particular, Medicaid reviewed whether we followed
the appropriate procedures and whether we obtained the requisite patient
consents at the time of delivery. During 2003, we accrued an estimated cost
of $200,000 for the New Jersey Medicaid Audit. In April 2004, we entered
into a settlement agreement with Medicaid of New Jersey for $200,000. We do
not anticipate any additional expense related to this audit. In July
2004, we were granted a license to bill New Jersey Medicaid from New
York, as a result we will no longer serve New Jersey Medicaid patients from
Texas.
  *New
York Medicaid Audit* . In May
2004, we were notified that MOMS Pharmacy, Inc., our wholly-owned subsidiary and
a New York corporation, is the subject of an audit and review being conducted by
the New York State Department of Health. As part of the audit, the Department
withheld payment of certain Medicaid claims we had submitted. The Department
refunded $800,000 of the $920,000 which it initially withheld, but it may
conclude that we are subject to certain financial penalties and fines, in which
case some or all of the payments withheld ultimately may not be paid to
us.
  In
addition to the matters noted above, we are involved from time to time in legal
actions arising in the ordinary course of our business. We currently have no
pending or threatened litigation that we believe will result in an outcome that
would materially affect our business. Nevertheless, there can be no assurance
that future litigation to which we become a party will not have a material
adverse effect on our business.
  ITEM
4.SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
  No
matters were submitted to a vote of our security holders during the fourth
quarter of 2004.
  **PART
II**
  ITEM
5.MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
  MARKET
FOR COMMON STOCK
  None of
our securities are listed on any exchange, nor are our securities traded in
any market. We are unable to provide any information as to if and when our
securities will be publicly traded. As of March 25, 2005, there were
approximately 126 holders of record of our common stock.
  DIVIDEND
POLICY
  We have
never paid cash dividends on our capital stock and have no intention of paying
any cash dividends in the foreseeable future. Payments of future dividends, if
any, will be at the discretion of our Board of Directors, after taking into
account such factors as it considers relevant, including our financial
condition, the performance of our business, the perceived benefits to our
company and our stockholders of reinvesting earnings, anticipated cash needs of
our business, the tax consequences of retained earnings and the tax consequences
to our company and our stockholders of making dividend payments. If any dividend
payment is made on our common stock, then holders of our outstanding shares of
preferred stock are entitled to participate in such payment as if they had
converted their shares into common stock.
  UNREGISTERED
SALES
  There
were no unregistered sales of our common stock during the fiscal year ended
December 31, 2004. During 2004, we completed unregistered sales of two new
classes of our preferred stock, both of which are convertible into shares of our
common stock.
   17
  In April
and May 2004, we raised an aggregate of $8,806,958 through the issuance of
1,491,828 shares of our Series D convertible preferred stock at $6.00 per share
in private placements with several investors. The terms and rights of the Series
D convertible preferred shares are set forth in our Certificate of Designation
of Series D Preferred Stock. There will be no dividends payable on these shares
unless our Board of Directors, in its sole discretion, declares a dividend with
respect to the common stock. In the event of any liquidation, the Series D
convertible preferred shares shall share on a pari passu basis in liquidation
with the Series A, B and C preferred stock outstanding. In conjunction with the
offering and for services rendered, we issued 24,000 shares of Series D
preferred stock to a placement agent, issued warrants to purchase 114,759 shares
of common stock with an exercise price of $6.00 per share to placement agents
and paid fees of $746,383. We used the proceeds of the offering to repay notes
held by the previous owners of MME and to repay a revolving credit line. The
Series D convertible preferred stock was sold pursuant to Regulation D of the
Securities Act of 1933.
  In
December 2004, we raised an aggregate of $4,150,081 through the issuance of
664,013 shares of our Series E convertible preferred stock at $6.25 per share in
private placements with several investors. The terms and rights of the Series E
convertible preferred shares are set forth in our Certificate of Designation of
Series E Preferred Stock. There will be no dividends payable on these shares
unless our Board of Directors, in its sole discretion, declares a dividend with
respect to the common stock. In the event of any liquidation, the Series E
convertible preferred stock shall share on a pari passu basis in liquidation
with the Series A, B, C and D preferred stock outstanding. The holders of the
Series E convertible preferred stock may, at their option and from time to time,
convert their shares of Series E stock into our common stock. In
conjunction with the offering and for services rendered, we issued five-year
warrants to purchase 51,201 shares of common stock with an exercise price of
$6.25 per share to placement agents and paid fees of $320,006. We used the
proceeds of this offering to finance our acquisition of Specialty Pharmacies.
The Series E convertible preferred stock was sold pursuant to an exemption from
registration under Rule 506 of the Securities Act of 1933 (and similar
exemptions from registration under applicable state securities
laws).
  SECURITIES
AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
  The
following table sets forth certain information concerning compensation plans
under which our equity securities are authorized for issuance:
  Plan
      Category
    
    (a)
      Number of securities
      to
      be issued upon exercise
      of
      outstanding options,
      warrants
      and rights
    
    (b)
      Weighted-average exercise
      price
      of outstanding options,
      warrants
      and rights
    
    (c)
      Number of securities remaining available under equity compensation plans
      (excluding securities
      reflected
      in column (a))Equity
      compensation plans approved by security holders
    
    
    1,667,750
    (1)
    $
    3.03
    
    
    882,250Equity
      compensation plans not approved by security holders
    
    
    1,162,387
    (2)
    
    4.38
    
    
    —TOTAL
    
    
    2,830,137
    
    $
    3.58
    
    
    882,250
 (1)
    Includes
      options granted pursuant to our 1998 Stock Option Plan and 2002 Stock
      Option Plan.
 (2)
    Includes
      warrants granted to individuals and corporations as consideration for
      services provided within the meaning of Statement of Financial Accounting
      Standards No. 123 and for purchase consideration for acquisitions. The
      warrants were granted by us upon authorization of our Board of Directors
      and were not issued pursuant to a single equity compensation plan that
      exists to grant warrants in exchange for goods and services. The terms of
      the warrants vary from grant to grant.
    18
  ITEM
6.SELECTED
FINANCIAL DATA
  The
following selected financial data should be read in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and our Financial Statements and the Notes thereto included
elsewhere in this Report. The selected financial data as of and for the fiscal
years ended December 31 2000, 2001, 2002, 2003 and 2004 have been derived from
our audited financial statements. The information set forth below is not
necessarily indicative of the results of future operations.
  Years
      Ended December 31,(in
      thousands, except per share)
    
    2000
    
    2001
    
    2002
    
    2003
    
    2004**Statement
      of Operations Data:**Net
      Sales
    
    $
    9,168
    
    $
    16,236
    
    $
    27,457
    
    $
    48,223
    
    $
    64,606Cost
      of Sales
    
    
    7,659
    
    
    13,705
    
    
    23,272
    
    
    41,970
    
    
    57,092Gross
      Profit
    
    
    1,509
    
    
    2,531
    
    
    4,185
    
    
    6,253
    
    
    7,514Operating
      ExpensesSelling,
      general and Administrative Expenses
    
    
    2,416
    
    
    3,919
    
    
    4,756
    
    
    8,744
    
    
    9,891Operating
      Loss
    
    
    (907
    )
    
    (1,388
    )
    
    (571
    )
    
    (2,491
    )
    
    (2,377
    )Other
      Income (Expense)Interest
      Expense
    
    
    (307
    )
    
    (157
    )
    
    (104
    )
    
    (244
    )
    
    (227
    )Costs
      of Withdrawn Public Offering and Other
    
    
    0
    
    
    0
    
    
    (479
    )
    
    0
    
    
    0Legal
      Settlement (Expense) Income
    
    
    0
    
    
    0
    
    
    150
    
    
    (200
    )
    
    0Other
      Income (Expense)
    
    
    73
    
    
    445
    
    
    0
    
    
    0
    
    
    0Loss
      Before Income Taxes
    
    
    (1,141
    )
    
    (1,100
    )
    
    (1,004
    )
    
    (2,935
    )
    
    (2,604
    )Provision
      (Benefit) for Taxes
    
    
    (130
    )
    
    14
    
    
    35
    
    
    20
    
    
    76Net
      Loss from Continuing Operations
    
    
    (1,011
    )
    
    (1,114
    )
    
    (1,039
    )
    
    (2,955
    )
    
    (2,680
    )Discontinued
      Operations
    
    
    260
    
    
    0
    
    
    0
    
    
    0
    
    
    0Net
      Loss
    
    
    ($751
    )
    
    ($1,114
    )
    
    ($1,039
    )
    
    ($2,955
    )
    
    ($2,680
    )Basic
      and Diluted Loss Per Common Share
    
    
    ($0.24
    )
    
    ($0.36
    )
    
    ($0.34
    )
    
    ($0.95
    )
    
    ($0.86
    )Basic and Diluted Weighted Average of
      Common
      Shares Outstanding
    
    
    3,097
    
    
    3,100
    
    
    3,100
    
    
    3,100
    
    
    3,100Cash
      Dividends Declared on Common Stock
    
    $
    0
    
    $
    0
    
    $
    0
    
    $
    0
    
    $
    0**Balance
      Sheet Data:**Cash
      and Cash Equivalents
    
    $
    728
    
    $
    1,559
    
    $
    213
    
    $
    641
    
    $
    6,980Working
      Capital
    
    $
    845
    
    $
    912
    
    $
    (261
    )
    $
    (1,884
    )
    $
    4,848Total
      Assets
    
    $
    2,071
    
    $
    4,709
    
    $
    4,622
    
    $
    12,415
    
    $
    19,996Total
      Long Term Liabilities
    
    $
    1,500
    
    $
    1,720
    
    $
    1,860
    
    $
    3,019
    
    $
    215Total
      Stockholders’ Equity (Deficit)
    
    $
    (588
    )
    $
    295
    
    $
    (744
    )
    $
    2,393
    
    $
    11,514
 19
   ITEM 7.MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
  *The
following discussion of our financial condition and results of operations should
be read in conjunction with “Financial Data” and our Financial Statements and
Notes thereto, which appear in Item 8 of this Report.*
  OVERVIEW
  We are a
national provider of specialty pharmacy and disease management services focused
on HIV/AIDS patients. We work closely with patients, healthcare providers such
as physicians, nurses, clinics and AIDS Service Organizations, or ASOs, and with
government and private payors to improve clinical outcomes and reduce treatment
costs for our patients. We sell HIV/AIDS and ancillary medications, and
nutritional supplies under our trade name MOMS Pharmacy.  The
following discussion and analysis provides information that our management
believes is relevant to an assessment and understanding of our results of
operations and financial condition. This discussion should be read in
conjunction with the consolidated financial statements and notes thereto
appearing below in Item 8 of this Report.
  We
operate our business as a single segment configured to serve key geographic
areas most efficiently. As of March 25, 2005, we operated seven distributions
centers that are located strategically in California (3 separate locations), New
York, Texas, Florida and Washington to serve major metropolitan areas in which
high concentrations of HIV/AIDS patients reside. In discussing our results of
operations, we address changes in the net sales contributed by each of these
distribution centers because we believe this provides a meaningful indication of
the historical performance of our business. ****
  The key
components of our financial results are our sales, our gross profit and our
operating expenses.
  *Sales* . We sell
HIV/AIDS prescription and ancillary medications, and nutritional supplies. In 2004,
approximately 88% of our net sales came from payments from Medicaid and ADAP.
These are both highly regulated government programs that are subject to frequent
changes and cost containment measures. We continually monitor changes in
reimbursement for HIV/AIDS medications. We currently qualify under Medicaid
initiatives in California for a special HIV/AIDS pilot program and believe we
qualify for a Medicaid HIV/AIDS reimbursement initiative in New York. These
initiatives provide us with additional reimbursement amounts. There can be no
assurance that the California or New York legislators will not change these
programs in a manner adverse to us, fail to renew these programs or terminate
these programs early.
  *Gross
Profit* . Our
gross profit reflects net sales less the cost of goods sold. Cost of goods sold
is the cost of pharmaceutical products we purchase from wholesalers, and is
primarily dependent on contract pricing with our main wholesaler,
AmerisourceBergen. The amount that we are reimbursed by government and
private payors has generally increased as the price of the pharmaceuticals we
purchase has increased. However, as a result of cost containment initiatives
prevalent in the healthcare industry, private and government payors have reduced
reimbursement rates, which prevents us from recovering the full amount of any
price increases. For this reason, our gross margin (which is gross profit as a
percentage of net sales) has declined from 15.2% in 2002 to 13.0% in 2003 to
approximately 11.6% in 2004.
  *Operating
Expenses* . Our
operating expenses are made up of both variable and fixed costs. Variable costs
increase as net sales increase. Our principal variable costs are labor and
delivery. Fixed costs do not vary directly with changes in net sales. Our
principal fixed costs are facilities and equipment and insurance. As we grow,
subject to constraints such as facility size, we do not expect to increase fixed
costs as the result of increased volume. In addition, we believe that as we
increase the efficiency of our operations we will be able to decrease our
variable costs relative to net sales.
   20
  *Growth
of Our Business* . We have
expanded our business by acquiring other specialty pharmacies and expanding our
existing business. Since the beginning of 2003, we have acquired three specialty
pharmacies in California. The acquisition we completed in 2003 contributed
approximately $14 million of the $21 million increase in our net sales in 2003,
as compared to 2002. The two businesses we acquired in the first quarter of 2005
had aggregate annual net sales of approximately $49 million in 2004, as compared
to our 2004 net sales of $64 million. Our internal growth comes from increasing the
number of patients we serve. In addition, we have experienced increases in net
sales due to increases in the number and cost of prescriptions that are
purchased by each patient. Prior to our acquisitions in California, we operated
distribution facilities in New York, Florida and Texas. As discussed above, we
decided to cease our Texas operations in March 2005. We began operating in
Florida in 2002, and while our Florida operations continue to grow, they remain
a relatively small part of our business.
  CRITICAL
ACCOUNTING POLICIES
  Our
critical accounting policies affect the amount of income and expense we record
in each period as well as the value of our assets and liabilities and our
disclosures regarding contingent assets and liabilities. In applying these
critical accounting policies, we must make estimates and assumptions to prepare
our financial statements that, if made differently, could have a positive or
negative effect on our financial results. We believe that our estimates and
assumptions are both reasonable and appropriate, in light of applicable
accounting rules. However, estimates involve judgments with respect to numerous
factors that are difficult to predict and are beyond management’s control. As a
result, actual amounts could differ materially from estimates.
  Management
believes that the following accounting policies represent “critical accounting
policies,” which the SEC defines as those that are most important to the
portrayal of a company’s financial condition and results of operations and
require management’s most difficult, subjective, or complex judgments, often
because management must make estimates about uncertain and changing matters. We
discuss these and other significant accounting policies related to our
continuing operations in Note 3 of the notes to our consolidated financial
statements included in Item 8 of this Report.
  *Revenue
Recognition* . Net
sales refer to our sales of medications and nutritional supplements to patients
and are reported net of the amount billed to patients, government and private
payors and others in the period when delivery to our patients is completed. Any
customer can initiate the filling of prescriptions by having a doctor call
in prescriptions to our pharmacists, faxing over a prescription, or mailing
prescriptions to one of our facilities. Once we have verified that the
prescriptions are valid and have received authorization from a customer’s
insurance company, the pharmacist then fills the prescriptions and ships the
medications to the customers through our outside delivery service, an express
courier service, or postal mail.
  *Allowance
for Doubtful Accounts* . We are
reimbursed for the medications we sell by government and private payors. The net
sales and related accounts receivable are recorded net of payor contractual
discounts to reflect the estimated net billable amounts for the products
delivered. We estimate the allowance for contractual discounts on a
payor-specific basis, given our experience or interpretation of the contract
terms if applicable. However, the reimbursement rates are often subject to
interpretation that could result in payments that differ from our estimates.
Additionally, updated regulations and contract negotiations occur frequently,
necessitating our continual review and assessment of the estimation process.
While management believes the resulting net carrying amounts for accounts
receivable are fairly stated at each quarter-end and that we have made adequate
provision for uncollectible accounts based on all available information, no
assurance can be given as to the level of future provisions for uncollectible
accounts, or how they will compare to the levels experienced in the
past.
  *Intangible
Asset Impairment* . In
assessing the recoverability of our intangible assets, we must make
assumptions regarding estimated future cash flows and other factors to determine
the fair value of the respective assets. If we determine that impairment
indicators are present and that the assets will not be fully recoverable, their
carrying values are reduced to estimated fair value. Impairment indicators
include, among other conditions, cash flow deficits, a historic or anticipated
decline in net sales or operating profit, adverse legal or regulatory
developments, accumulation of costs significantly in excess of amounts
originally expected to acquire the asset, and a material decrease in the fair
value of some or all of the assets. Changes in strategy and/or market conditions
could significantly impact these assumptions, and thus we may be required to
record impairment charges for these assets. We adopted Statement of Financial
Accounting Standards No. 144 “Accounting for the Impairment or Disposal of
Long-Lived Assets” (“SFAS No. 144”) effective January 1, 2002, and the adoption
of the Statement had no impact on our consolidated financial position or results
of operations.
   21
  *Goodwill
and Other Intangible Assets* . In
accordance with Statement of Financial Accounting Standard (“FAS”) No. 141,
“Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”,
goodwill and intangible assets associated with acquisitions that are deemed to
have indefinite lives are no longer amortized but are subject to annual
impairment tests. Such impairment tests require the comparison of the fair value
and carrying value of reporting units. Measuring fair value of a reporting unit
is generally based on valuation techniques using multiples of sales or earnings,
unless supportable information is available for using a present value technique,
such as estimates of future cash flows. We assess the potential impairment of
goodwill and other indefinite-lived intangible assets annually and on an interim
basis whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Some factors we consider important which could
trigger an interim impairment review include the following:
  ·
    Significant
      underperformance relative to expected historical or projected future
      operating results;
  ·
    Significant
      changes in the manner of our use of the acquired assets or the strategy
      for our overall business; and
  ·
    Significant
      negative industry or economic trends.
  If we
determine through the impairment review process that goodwill has been impaired,
we record an impairment charge in our consolidated statement of income. Based on
our 2004 impairment review process, we have not recorded any impairments during
the year ended December 31, 2004.
  RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS
  We
describe recent accounting pronouncements applicable to us at Item 8 of this
Report under Note 3 to our consolidated financial statements.
  RESULTS
OF OPERATIONS
  Years
Ended December 31, 2004 and 2003
  *Net
Sales* . Net
sales in 2004 increased to $64,605,721 from $48,222,993 in 2003, an
increase of 34.0%. The following table sets forth the net sales for each of our
distribution centers in 2004 and 2003:
  Years
      ended December 31,2004
    
    2003Distribution
      Center
    
    Net
      Sales
    
    Net
      SalesNew
      York
    
    $
    36,507,850
    
    $
    27,808,291California 
      (1)
    
    $
    21,803,119
    
    $
    13,767,864Texas
    
    $
    4,525,719
    
    $
    5,720,436Florida
    
    $
    1,769,033
    
    $
    926,402Total
    
    $
    64,605,721
    
    $
    48,222,993
 
 (1)
California operations were acquired in May 2003.
 
  22
  Our net
sales growth in New York and Florida was due primarily to an increase in the
number of prescriptions filled from our existing facilities. Net sales in New
York increased by $8,699,561 for the year ended December 31, 2004, as compared
to the same period in 2003. Net sales in Florida increased by $842,631 for the
year ended December 31, 2004, as compared to the same period in 2003. Net sales
in California increased by $8,035,255 for the year ended December 31, 2004 as
compared to 2003, primarily because we operated in California for all of 2004,
as compared to just eight months in 2003 (as we acquired our initial California
operation in May 2003), due to improved operations and an increase in
the number of prescriptions we filled in California. Net sales in Texas
decreased by $1,194,717 as compared with the same period in 2003, due to
discontinuation of service to patients that moved to other pharmacies.
  Our net
sales increase in 2004 was partially offset by reductions in reimbursement rates
in California and New York for the last four months of the year. However, we
have qualified for a pilot program in California and we believe we qualify for
additional reimbursement in New York for specialized HIV pharmacies, as
discussed above in Item 1 under the heading “Third Party Reimbursement Cost
Containment and Legislation.” The payments anticipated from California and New
York are expected to be retroactive for services rendered since
September 1, 2004, but no amounts will be recognized as sales until they
are actually received.
  *Gross
Profit* . Gross
profit increased to $7,514,046 in 2004 from $6,253,487 in 2003, but our gross
margin declined to 11.6% from 13.0%. Our gross profit increased primarily due to
an increase in net sales. Our gross margin declined primarily due to a reduction
in reimbursement rates by Medicaid and Medi-Cal, as discussed above in Item 1
under the heading “Third Party Reimbursement Cost Containment and
Legislation.”
  *Selling,
General and Administrative Expenses* .
Selling, general and administrative expenses increased to $9,891,461 in 2004
from $8,744,127 in 2003, but as a percentage of net sales they declined to 15.3%
from 18.1%. The decrease as a percentage of net sales was primarily due to a
reduction in labor costs as a percentage of sales, staff reductions in
California, decreases in bad debt expense and a decrease in professional
fees.
  The main
components of the increase in selling, general and administrative expenses of
$1,147,334 for the year ended December 31, 2004 as compared to the same period
in 2003 consisted of the following:
  Components
      of Selling, General and Administrative Expense
    
    Change
      ($)Labor
      costs
    
    $
    467,000Shipping
      (associated with acquisition of MME)
    
    
    266,000Insurance
      costs (commercial, employee medical and workers
    compensation)
    
    
    157,000Rent,
      repair and maintenance (resulting from acquisition of MME and our move to
      our facility in Melville, NY)
    
    
    153,000Travel
      expenses
    
    
    93,000Legal
      and settlement expenses related to New York Medicaid audit
    
    
    132,000
  *Operating
Loss* .
Operating loss declined to $2,377,415 in 2004 from $2,690,640 in 2003, which
represents 3.7% and 5.6% of net sales, respectively. The decline in operating
loss (both in absolute dollars and as a percentage of sales) reflects the effect
of a greater increase in sales (up 34.0% in 2004 from 2003 excluding the legal
settlement in 2003 associated with a New Jersey Medicaid audit) than in
operating expenses (up 13.1% in 2004 from 2003 excluding the legal settlement in
2003 associated with a New Jersey Medicaid audit), partially offset by the
decline in our gross margin, as discussed above.
  *Other
Income (Expense)* . Other
income (expense) decreased to an expense to $226,531 in 2004 from $243,882 in
2003. For the year ended December 31, 2004, other income (expense) is comprised
of interest expense of $226,531. For the year ended December 31, 2003, other
income (expense) included interest expense of $243,882. The decline in interest
expense to $226,531 in 2004 from 2003 reflected lower outstanding borrowing
balances in 2004. As discussed below in Item 7 under the heading “Management’s
Discussion and Analysis of Financial Condition and Results of Operations –
Liquidity and Capital Resources,” we substantially increased our borrowings in
the first quarter of 2005 to fund a portion of the purchase price of the two
businesses that we acquired. Consequently, interest expense is likely to be
substantially higher in 2005 than it was in 2004.
 
 
 23
  *Provision
for Taxes* . We
recorded a tax provision for $76,202 in 2004, as compared to a tax provision of
$19,646 for the comparable period in the prior year. The provision for taxes
relates primarily to state franchise tax payments due to the state of Delaware,
which increased due to an increase in the number of shares of our capital stock
outstanding as a result of the completion of an offering in 2004 of our Series D
and Series E convertible preferred stock. Because we operated at a loss in 2004
and 2003, we did not pay any income taxes and, thus, did not record any amount
for income taxes owed.
  Years
Ended December 31, 2003 and 2002
  *Net
Sales* . Net
sales for the year ended December 31, 2003 increased to $48,222,993 from
$27,457,438 for the year ended December 31, 2002, an increase of 75.63%. The
following table sets forth the net sales for each of our distribution centers in
2002 and 2003:
  Years
      ended December 31,2003
    
    2002Distribution
      Center
    
    Net
      Sales
    
    Net
      SalesNew
      York
    
    $
    27,808,291
    
    $
    21,416,134California
      (1)
    
    $
    13,767,864
    
    
    —Texas
    
    $
    5,720,436
    
    $
    6,016,072Florida
    
    $
    926,402
    
    $
    25,232Total
    
    $
    48,222,993
    
    $
    27,457,438
 
 (1)
California operations were acquired in May 2003.
 
 Our May
2003 acquisition of Medicine Made Easy, or MME, significantly increased our net
sales in 2003, as compared to 2002. The MME acquisition is discussed above in
Item 1 under the heading “Business Overview.” Prior to May 2003, we did not have
any operations in California. Excluding California, our net sales increased by
25.5% in 2003 from 2002. Our net sales in New York and Florida increased in
2003 as compared to 2002 as a result of growth in the number of
patients served and prescriptions filled from our existing facilities. In
addition, we did not begin to operate in Florida until December 2002, so the
increase in sales in Florida in 2003 from 2002 also reflects the fact that we
operated in Florida for all of 2003, as compared to just one month in 2002. In
2003, net sales in Texas decreased by approximately $296,000 as compared with
the same period in 2002. This decline resulted primarily from our decision to
restrict service to New Jersey patients during a New Jersey Medicaid audit,
which negatively affected our Texas operations. In 2004, we began to service our
New Jersey patients from our New York facility.
  *Gross
Profit* . Gross
profit increased to $6,253,487 in 2003 from $4,185,502 in 2002, but our gross
margin declined to 13.0% from 15.2% of net sales, respectively. Our gross margin
for the year ended December 31, 2003 decreased by approximately 2.3% as compared
with gross margins for the year ended December 31, 2002, because of a 2%
prescription reimbursement rate decrease by New York Medicaid and ADAP in July
2003, and because we devoted more of our efforts to servicing the HIV/AIDS
market (as compared to other markets that included payors with higher
reimbursement rates).
  *Selling,
General and Administrative Expenses* .
Selling, general and administrative expenses increased to $8,744,127 in 2003
from $4,756,037 in 2002, and as a percentage of net sales they increased to
18.1% from 17.3%. The increase as a percentage of net sales was primarily due to
the impact of the May 2003 acquisition of MME, which operated at a loss in 2003,
as well as the effect of a full year of operations in Florida in 2003, as
compared to one month in 2002.
   24
  The main
components of the increase in selling, general and administrative expenses of
$3,988,090 for the year ended December 31, 2003 as compared to the same period
in 2002 consisted of the following:
  Components
      of Selling, General and Administrative Expense
    
    Change
      ($)Labor
      costs
    
    $
    1,470,000General
      operating expenses (related to MME acquisition)
    
    
    819,000Depreciation
      and amortization (related to MME acquisition)
    
    
    275,000Clinical,
      administrative and sales personnel costs (FL and NY)
    
    
    153,000Professional
      fees (primarily related to NJ audit, HIPAA compliance and consulting
      expenses)
    
    
    569,000Bad
      debt expense
    
    
    188,000Shipping
      costs
    
    
    138,000Insurance
    
    
    133,000
 **
 *Operating
Loss.* Operating loss increased to $2,690,640 in 2003 from $420,535 in 2002, which
represents 5.6% and 1.5% of net sales, respectively. The increase in operating
loss (both in absolute dollars and as a percentage of net sales) reflects
primarily the effect of additional expenses relating to the MME operations that
we acquired in 2003 which contributed approximately $894,000 in operating loss
for the eight months that we owned that business in 2003, as well as the
negative impact on our gross margin of a 2% prescription reimbursement rate
decrease by New York Medicaid and ADAP in July 2003. Additionally this change
resulted from a legal settlement expense of $200,000 in 2003 relating to a New
Jersey Medicaid audit. In 2002 the Company benefited from income of $150,000
relating to a legal settlement with New Geri Care of Brooklyn. The settlement
represented the amount New Geri Care of Brooklyn failed to pay for inventory it
acquired in connection with the purchase of certain assets from us in September
2001.
  *Other
Income (Expense).* Other
income (expense) decreased to $243,882 in 2003 from expense of $583,223 in
2002. For the year ended December 31, 2003, other income (expense) is comprised
of interest expense of $243,882. The increase in interest expense is primarily
attributable to our increased short-term borrowing from our revolving credit
facility and interest on the secured promissory notes that we issued to the
sellers of MME.
  For the
year ended December 31, 2002, we had substantially lower interest expense of
$104,358 (due to lower outstanding borrowings).  In December 2002, we
ceased efforts to complete a public offering of our common stock and as a
result, we wrote off $413,757 of deferred offering costs relating to the
terminated offering. In addition, we wrote off $65,108 of expenses related to
acquisitions that were not consummated.
  *Provision
for Taxes* . For the
year ended December 31, 2003, we recorded a tax provision for $19,646, as
compared to a tax provision of $35,002 for the comparable period in the prior
year. The provision for taxes relates primarily to franchise tax payments, which
increased due to increased shares in our capital stock outstanding as a result
of the sales in 2003 of our Series C convertible preferred stock. Because
we operated at a loss in 2003 and 2002, we did not pay any taxes and, thus, did
not record any amount for taxes owed.
  LIQUIDITY
AND CAPITAL RESOURCES ****
  Our
business has operated at a loss historically. As a result, we have required
third-party financing to fund our losses, as well as our capital requirements
and our acquisitions. We have not historically had substantial capital
expenditures. We have secured third-party financing through periodic sales of
shares of our convertible preferred stock, as well as from available bank
borrowings. There is no assurance that in the future we will be able to secure
additional third-party financing on favorable terms or at all. If we are unable
to secure necessary third-party financing, or if the terms of such financing are
unfavorable, our business and our financial condition would be materially and
adversely affected. See the discussion below under the heading “Risk Factors —
Risks Related to Our Company.”
  We
believe that we have adequate cash on hand and available from our bank lines to
fund any operating losses and satisfy our debt repayment obligations we might
incur if our business does not perform as we expect over the next 12 months.
   25
  Operating
Requirements
  We have
historically funded our operating requirements through the issuance of
shares of our convertible preferred stock and bank borrowings. We require cash
to purchase the medications that we need to fill prescriptions. Our wholesalers
require payment within 31 days of delivery of the medications to us. We are
reimbursed by third-party payors, on average, within 30 days after a
prescription is filled and a claim is submitted in the appropriate format. Our
operations used $2,396,121 of cash in 2004, which was a slight decline from
2003, when our operations used $2,694,845 of cash. The change reflects primarily
our lower operating loss in 2004, as well as the impact of increases in
working capital. In September 2003, we began to purchase our medications
primarily from AmerisourceBergen under a new wholesaling contract, which had
significantly more favorable payment terms than we had been able to secure
previously from our wholesalers. In 2002, our operations used $442,111 of cash.
In 2002, we had a substantially smaller business that required less cash to
operate.
  The
credit terms that we receive from our suppliers significantly impacts our
liquidity. The five-year purchase agreement that we signed with
AmerisourceBergen in September 2003 significantly improved our supplier payment
terms, from 13 to 31 days, and thus our overall liquidity. Since entering into
that agreement, we have purchased nearly all of our medications from
AmerisourceBergen. We continue to purchase medications from other wholesalers
and from manufacturers on various payment terms. The contract with
AmerisourceBergen requires certain minimum purchase commitments over the term of
the agreement, as discussed below under the heading “ – Contractual
Obligations.” If we do not meet the minimum purchase commitments at the end of
the five-year agreement term, we will be charged 0.20% of the unpurchased volume
commitment. Pursuant to the terms of this agreement, AmerisourceBergen has a
subordinated security interest in all of our assets.
  Long-Term
Requirements
  We expect
that the cost of additional acquisitions to grow our business will be our
primary long-term funding requirement. In addition, as our business grows, we
anticipate that we will need to invest in additional capital equipment, such as
the machines we use to create the MOMSPak for dispensing medication to our
patients. We also may be required to expand our existing facilities or to invest
in modifications or improvements to new or additional facilities. Historically,
we have funded the cost of acquisitions and other non-operating expenses through
third-party financing. We are in regular discussions with our stockholders about
potential future sales of additional shares of our stock. We also may, in the
future, seek to raise additional capital by pursuing an initial public offering
of our common stock. There is no assurance that any of these financing
alternatives will be successful. The completion of an initial public offering is
particularly subject to substantial risks and uncertainties, including changes
in the condition of the capital markets.
  Capital
Resources
  At
December 31, 2004 we had cash and cash equivalents of $6,979,630, up from
$640,790 at December 31, 2003. The increase in cash and cash equivalents
reflects the impact of net proceeds (after payment of fees and expenses) of
$11,607,449 from the sale of shares of our Series D and Series E convertible
preferred stock, reduced by the repayment of $2,650,000 of outstanding debt and
our 2004 operating losses and other expenses.
  We have a
revolving credit facility with GE Capital for an amount up to a maximum of $6.0
million available to us for short-term borrowings, which expires in April 2006.
Borrowings under the facility are based on our accounts receivable and bear
interest at the “Prime Rate” plus 2%. At December 31, 2004, the Prime Rate was
5.25%. At December 31, 2004, our borrowing capacity was approximately $4.5
million, and our borrowings under this facility were $1,154. As discussed below,
in the first quarter of 2005 we borrowed an additional $4.5 million under this
facility to fund a portion of North American and Specialty Pharmacies
acquisitions, which are discussed above in Item 1 under the heading "Recent
Developments." Our borrowings are collateralized by a primary security interest
in all of our assets. This security interest is senior to the security interest
granted to AmerisourceBergen, pursuant to the terms of an intercreditor
agreement between GE Capital and AmeriscourceBergen. As of December 31, 2004, we
were in compliance with all of these covenants required under this credit
facility.
   26
  In
addition to the revolving credit line, as of December 31, 2004, we had a $1.5
million line of credit with West Bank, a Des Moines, Iowa bank. Interest on this
credit line accrued interest at the Prime Rate per annum. As of December 31,
2004 we had not borrowed any amounts under this line of credit, however, in the
first quarter of 2005, we borrowed $1.5 million under this credit line to fund a
portion of our recent acquisitions. This line of credit has been guaranteed by
one of our directors (who also is one of our principal investors). The line of
credit matures in September 2005.
  Funding
of 2005 Acquisitions
  We used a
portion of our cash balances, as well as our credit facilities, to fund the
acquisitions of North American Home Health and Specialty Pharmacies that we
completed during the first quarter of 2005. We used approximately $4.0 million
of our cash and cash equivalents, as well as $4.5 million of borrowings under
our facility with GE Capital and $1.5 million of borrowings under the revolving
credit line with West Bank. Following these borrowings, we have additional
borrowing capacity of approximately $1.0 million. We also issued a total of $3.9
million of promissory notes to the former owners of the two acquired businesses,
as discussed below under the heading “Contractual Obligations.”
  We are
currently exploring alternatives to refinance our existing bank borrowings,
including seeking additional borrowing capacity as a result of the expansion of
our business. There is no assurance that we will be successful in obtaining new
or additional bank credit facilities, or that such facilities will be available
to us on favorable terms or at all. If necessary, we expect to be able to renew
or refinance the West Bank credit line when it comes due in September
2005.
  CONTRACTUAL
OBLIGATIONS
  At
December 31, 2004, our contractual cash obligations and commitments over the
next five years were as follows:
  Payments
      due by PeriodTotal
    
    
    Less
      than 1 year
    
    
    1-3
      years
    
    
    4-5
      years
    
    
    More
      than 5 yearsLong-Term
      Debt Obligation (2)
    
    $
    1,350,000
    
    $
    1,350,000
    
    $
    0
    
    $
    0
    
    $
    0Capital
      (Finance) Lease Obligations (2)
    
    
    323,946
    
    
    130,640
    
    
    193,306
    
    
    0
    
    
    0Operating
      Lease Obligations
    
    
    1,070,497
    
    
    376,104
    
    
    584,337
    
    
    110,056
    
    
    0Revolving
      Credit Line
    
    
    1,154
    
    
    1,154
    
    
    0
    
    
    0
    
    
    0Purchase
      Obligations (1)
    
    
    331,267,941
    
    
    91,892,941
    
    
    239,375,000
    
    
    0
    
    
    0Total
    
    $
    334,013,538
    
    $
    93,750,839
    
    $
    240,152,643
    
    $
    110,056
    
    $
    0
  (1) If we
fail to satisfy the minimum purchase obligation under our purchase agreement
with AmerisourceBergen, we would be required to pay an amount equal to 0.2% of
the unpurchased commitments at the end of the five-year term of the
contract.
 (2) Interest expense payments on these amounts are
expected to approximate $77,000 over the next three years.
 
 In the
first quarter of 2005, in connection with the two acquisitions that we
completed, we incurred $6.0 million of borrowings under our bank credit lines.
Of this amount, $1.5 million comes due in September 2005, and the remainder
comes due in April 2006. In addition, we issued a total of $3.9 million of
promissory notes to the former owners of the two businesses that we acquired, of
which $2.6 million matures in February 2006 and the remainder is payable in
2007.
  OFF-BALANCE
SHEET ARRANGEMENTS
  We do not
have any off-balance sheet arrangements.
   27
  **RISK
FACTORS**
  *You
should consider each of the following factors as well as the other information
in this Report, including the financial statements and related notes included in
Item 8 below, in evaluating our business and our prospects. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently consider
immaterial may also impair our business operations. If any of the following
risks actually occur, our business and financial results could suffer
materially.*
  RISKS
RELATED TO OUR COMPANY
  **If
demand for our products and services is reduced, our business and ability to
grow would be harmed.**
  Because
we provide specialty pharmacy and disease management services that are focused
almost exclusively on patients infected with HIV or diagnosed with AIDS, a
reduction in demand for HIV/AIDS medications would significantly harm our
business as we would not be able to quickly shift our business to provide
medications for other diseases. Reduced demand for our products and services
could be caused by a number of circumstances, including but not limited to the
following:
  ·
    a
      cure and/or vaccine for HIV/AIDS;
  ·
    patient
      shifts to treatment regimens other than those we
offer;
  ·
    new
      treatments or methods of delivery of existing HIV/AIDS medications that do
      not require our specialty pharmacy and disease management services;
  ·
    recalls
      of certain HIV/AIDS medications;
  ·
    adverse
      reactions caused by the HIV/AIDS medications we
sell;
  ·
    the
      expiration or challenge to the “orphan drug” status or drug patent of the
      medications we sell;
  ·
    competing
      treatment from a new HIV/AIDS medication or a new use of an existing
      HIV/AIDS medication; or
  ·
    a
      new strain of HIV develops that is resistant to available HIV/AIDS
      medications, such as the new strain of HIV recently identified by the New
      York Department of Health that develops into AIDS within two to three
      months.
  **We
have a history of losses and we may never achieve or maintain
profitability.**
  Our
predecessor company, The Care Group, Inc., filed for protection under Chapter 11
of the Bankruptcy Code in September 1998. We emerged from bankruptcy in February
1999 and, since that time, have continued to experience operating losses. Our
operations to date have been funded in part by private placements of our common
and preferred stock and the sale of certain operations. We may never achieve or
maintain profitability. If we fail to achieve profitability at all or within the
time frame expected by investors, your investment in our stock could result in a
significant or total loss.
  **Changes
in reimbursement by third party payors could harm our
business.**
  Our gross
profit margins are determined by reimbursement rates from government and
private payors and supplier prices. The prices we receive for our products
depend primarily on the reimbursement rates paid by our government and private
payors due to the fact that nearly all of our sales are subject to reimbursement
by third party payors. Cost containment initiatives are a primary trend in the
United States health care industry. The increasing prevalence of managed care,
centralized purchasing decisions, consolidation among and integration of
healthcare providers and competition for patients has affected, and continues to
affect, pricing, purchasing, and usage patterns in health care. Efforts by
payors to eliminate, contain or reduce costs through coverage exclusions, lower
reimbursement rates, greater claims scrutiny, closed provider panels,
restrictions on required formularies, mandatory use of generics, limitations on
payments in certain therapeutic drug categories, claim delays or denials and
other similar measures could erode our profit margins or materially harm the
results of our operations.
   28
  We are
primarily dependent on reimbursement from government payors, such as the state
AIDS Drug Assistance Program, or ADAP, and Medicaid programs, both highly
regulated governmental programs that are subject to frequent changes and
cost-containment measures. In recent years, these programs have reduced
reimbursement to providers. Changes to the programs themselves, the amounts
programs pay, or coverage limitations established by the programs for the
medications we sell, may reduce our earnings. For example, these programs could
revise their pricing methodology for medications we sell, decide not to cover
certain medications or cover only a certain number of units prescribed within a
specified time period. We are likely to experience some form of revised drug
pricing as ADAP and Medicaid HIV/AIDS medication expenditures have garnered
significant attention from government agencies during the past few years.
  We
estimate that approximately 90% of our gross sales for the year ended December
31, 2004 consisted of reimbursement from federal and state programs. Any
reduction in amounts reimbursable by government programs for our services or
changes in regulations governing such reimbursements could harm our business,
financial condition and results of operations. Our disqualification from
participating in the state Medicaid programs of New York, New Jersey, California
or Florida would dramatically reduce our net sales and our ability to achieve
profitability.
  We are
also dependent on reimbursement from private payors. Many payors seek to limit
the number of providers that supply drugs to their enrollees. From time to time,
payors with which we have relationships require that we and our competitors bid
to keep their business, and there can be no assurance that we will be retained
or that our margins will not be adversely affected when that happens. The loss
of a payor relationship 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.
  **If
we do not continue to qualify for preferred reimbursement programs in California
and do not qualify for the program in New York, our net sales could
decline.**
  As of
September 1, 2004 as part of the passage of the state of California budget,
reimbursement rates for pharmacy services provided under the Medicaid
reimbursement administered in California, or Medi-Cal, were reduced. On
September 28, 2004, California approved an HIV/AIDS Pharmacy Pilot Program bill
which funds an additional $9.50 fee per prescription for qualified HIV
pharmacies that participate in the program through January 1, 2008, unless
extended.
 
 In New
York, reimbursement rates for pharmacy services provided under Medicaid were
reduced in August 2004. Approved specialized HIV pharmacies will continue to be
reimbursed at the old, higher rate structure through March 31, 2006.
 
 We
believe that these preferred reimbursements in California and New York provide
us with a competitive advantage. However, there can be no assurance that the
California or New York legislatures will not change these programs in a manner
adverse to us or will not terminate early or elect not to renew these programs.
If either of these programs is not renewed or is terminated early, our net sales
could be adversely affected. Additionally, if either California or New York
permit additional companies to take advantage of these preferred reimbursement
programs, our competitive advantage in these states could be adversely
impacted.
   29
 ****
 **Our
success in identifying and integrating acquisitions may impact our
business.**
  As part
of our strategy, we continually evaluate acquisition opportunities. We may make
acquisitions to grow our patient base, which involves risks. There can be no
assurance that we will complete any future acquisitions or that such
transactions, if completed, will be integrated successfully or will contribute
favorably to our operations and financial condition. In addition, acquisitions
may expose us to unknown or contingent liabilities of acquired businesses,
including liabilities for failure to comply with health care or reimbursement
laws. While we try to negotiate indemnification provisions that we consider to
be appropriate for the transactions, there can be no assurance that liabilities
relating to the prior operations of these and other acquired companies will not
have a material adverse effect on our business, financial condition and results
of operations. Furthermore, future acquisitions may result in dilutive issuances
of equity securities, incurrence of additional debt, amortization of expenses
related to acquired goodwill and intangible assets and exposure to unknown or
contingent liabilities, any of which could have a material adverse effect on our
business, financial condition and results of operations.
 **If
we are not able to effectively market our services to clinics that focus on
serving HIV/AIDS patients and the health care providers affiliated with these
clinics, we may not be able to grow our patient base as rapidly as we have
planned** ***.***
  Our
success, in part, depends on our ability to develop and maintain relationships
with clinics that focus on serving HIV/AIDS patients and health care providers
affiliated with these clinics. These clinics and health care providers are an
important patient referral source for our business. We believe that developing
and maintaining these relationships will allow us to rapidly expand the number
of patients we serve. If we are unable to effectively market our services to
these clinics and health care providers, or if our existing relationships with
clinics are terminated, our ability to grow our patient base will be harmed and
could dramatically reduce our net sales and our ability to achieve
profitability.
  **If
we fail to manage our growth effectively, our business could be
harmed.**
  Our
business has grown over the past several years as a result of internal growth
due to an increase in the number of patients we serve and prescriptions per
patient, as well as growth through acquisitions. If we are unable to manage our
growth effectively, our losses could increase. The management of our growth will
depend, among other things, upon our ability to improve our operational,
financial and management controls, reporting systems and procedures. In
addition, we may not be able to successfully hire, train and manage additional
sales marketing, customer support, pharmacy and delivery personnel quickly
enough to support our growth. To provide this support, we may need to open
additional offices, which will result in additional budgets on our systems and
resources and require additional capital expenditures.
  **We
are highly dependent on our relationship with AmerisourceBergen, the loss of
which could adversely affect our business.**
  In
September 2003, we entered into a five-year purchase agreement with
AmerisourceBergen. Currently, we purchase almost 100% of our prescription
medications from AmerisourceBergen. The wholesale distributor industry has
experienced rapid consolidation and, as a result, there are only a few
alternative wholesale distributors from whom we can purchase the medications we
offer to HIV/AIDS patients. In the event that our relationship with
AmerisourceBergen terminates or is not renewed, we might not be able to enter
into a new agreement with another wholesale distributor on a timely basis or on
terms favorable to us. Our inability to enter into a new supply agreement could
cause a shortage of the supply of medications we keep in stock. If we are unable
to purchase the medication to service our customers, our business could be
harmed.
  **If
we are not able to negotiate favorable credit terms with our suppliers, we may
have to rely disproportionately on other financing sources to increase our
inventory volume.**
  Our
business plan assumes that we will be able to increase substantially the number
of customers to whom we provide prescription medications. Because we often face
a significant delay between the time we purchase medications from suppliers and
when we receive reimbursement or payment from third-party payors, we depend on
the extension of credit from our suppliers to meet our working capital needs.
These suppliers sometimes shorten their credit terms as companies grow. In the
past, our ability to grow has been limited in part by our inability to negotiate
favorable credit terms from our suppliers. We may become limited in our ability
to continue to increase our inventory volume if we are unable to maintain credit
terms from our suppliers or, alternatively, if we are unable to obtain financing
from third party lenders to support our inventory needs in the
future.
  **Our
net sales could be adversely affected if we do not meet our minimum purchase
requirements under our agreement with AmerisourceBergen.**
  Our
supply agreement with AmerisourceBergen requires us to make minimum purchases
during the 5-year term of the agreement that will be no less than $400 million.
If we do not meet the minimum purchase commitments as set forth in the agreement
at the end of the agreement, we will be required to pay an amount equal to of
0.20% of the unpurchased volume. We would also be required to pay this amount in
the event we terminate our agreement with AmerisourceBergen without cause or in
the event we default under the agreement. If we were required to pay this
penalty, we would incur a possibly significant expense with all corresponding
net sales.
   30
  **Our
MOMSPak automated packaging system and a prolonged malfunction could hurt our
relations with the patients we serve and our ability to
grow.**
  A portion
of the prescriptions we fill require our customers to take multiple medications
many times a day. We rely on our MOMSPak packaging system to create the MOMSPak
for dispensing patient medication. We expect that prescriptions packaged in a
MOMSPak will increase substantially in the future as more of the patients we
serve switch to the MOMSPak from traditional pill boxes. We currently lease
three MOMSPak machines. If these machines fail to function properly for a
prolonged period, we may have to fill prescriptions by hand using pill boxes or
by otherwise sorting the various drug combinations into individual doses. Delays
or failure to package medications by our MOMSPak packaging system could result
in our loss of a substantial portion of our patients who receive their
prescriptions in MOMSPaks.
  We
believe that one component of our ability to compete effectively is our MOMSPak,
created by our MOMSPak prescription packaging system. We developed our MOMSPak
packaging system with software and other technology that we licensed from
third-parties. We have not attempted to obtain patent protection for our MOMSPak
system and do not intend to in the future. As a consequence, our competitors may
develop technology that is substantially equivalent to our MOMSPak system and we
could not prevent them from doing so. If our competitors or other third parties
were able to recreate the MOMSPak, one of our competitive advantages in serving
patients with HIV/AIDS could be lost.
  **A
disruption in our telephone system or our computer system could harm our
business.**
  We
receive and take prescription orders over the telephone, by facsimile or through
our electronic prescription writer. We also rely extensively upon our computer
system to confirm payor information, patient eligibility and authorizations; to
check on medication interactions and patient medication history; to facilitate
filling and labeling prescriptions for delivery and billing, and to help ensure
collection of payments. Our success depends, in part, upon our ability to
promptly fill and deliver complex prescription orders as well as on our ability
to provide reimbursement management services for our patients and their
healthcare providers. Any continuing disruption in our telephone, facsimile or
computer systems could adversely affect our ability to receive and process
prescription orders, make deliveries on a timely basis and receive reimbursement
from our payors. This could adversely affect our relations with the patients and
healthcare providers we serve and potentially result in a partial reduction in
orders from, or a complete loss of, these patients.
   31
  **We
rely on third-party delivery services to deliver our products to the patients we
serve. Price increases or service interruptions in our delivery services could
adversely affect our results of operations and our ability to make deliveries on
a timely basis.**
  Delivery
is essential to our operations and represents a significant expense in the
operation of our business that we cannot pass on to our customers. As a result,
any significant increase in shipping rates could have an adverse effect on our
results of operations. Similarly, strikes or other service interruptions by
these delivery services would adversely affect our ability to deliver our
products on a timely basis. In addition, some of the medications we ship require
special handling, including refrigeration to maintain temperatures within
certain ranges. The spoilage of one or more shipments of our products could have
a material adverse effect on our results of operations.
 ****
 **We
rely on a few key employees whose absence or loss could adversely affect our
business.**
  Many key
responsibilities within our business have been assigned to a small number of
employees. The loss of their services could adversely affect our business. In
particular, the loss of the services of Michael P. Moran, our Chairman,
President and Chief Executive Officer, James G. Spencer, our Secretary and Chief
Financial Officer, Mikelynn Salthouse, our Vice President, HIV Sales, or Robert
Fleckenstein, our Vice President of Pharmacy Operations could disrupt our
operations. We do not have employment contracts with any of these key employees
and several of our key employees are not restricted from competing with us if
they cease working for us or from soliciting our employees. Additionally, as a
practical matter, any employment agreement we may enter into will not assure the
retention of such employee. In addition, we do not maintain “key person” life
insurance policies on any of our employees. As a result, we are not insured
against any losses resulting from the death of our key employees. Further, as we
grow we must be able to attract and retain other qualified technical operating
and professional staff, such as pharmacists. If we cannot attract and retain, on
acceptable terms, the qualified employees necessary for the continued
development of our business, we may not be able to sustain our business or
grow.
 **We
may not be able to obtain insurance to protect our business from
liability.**
  Our
business exposes us to risks inherent in the provision of drugs and related
services. Regulatory claims, lawsuits or complaints relating to our products and
services may be asserted against us in the future. Although we currently
maintain professional and general liability insurance, there can be no assurance
that the scope of coverage or limits of such insurance will be adequate to
protect us against future claims. In addition, there can be no assurance that we
will be able to maintain adequate liability insurance in the future on
acceptable terms or with adequate coverage against potential
liabilities.
  RISKS
RELATED TO THE SPECIALTY PHARMACY INDUSTRY
  **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. All of the medications, supplies and services that we provide
are also available from our competitors. Our current and potential competitors
may include:
  ·
    other
      specialty pharmacy distributors;
  ·
    specialty
      pharmacy divisions of wholesale drug
distributors;
  ·
    pharmacy
      benefit management companies;
  ·
    hospital-based
      pharmacies;
  ·
    other
      retail pharmacies;
  ·
    manufacturers
      that sell their products both to distributors and directly to clinics and
      physicians offices; and
  ·
    hospital-based
      care centers and other alternate site health care
    providers.
   32
  Many of
our competitors have substantially greater resources and marketing staffs and
more established operations and infrastructure than we have. A significant
factor in effective competition will be our ability to maintain and expand
relationships with patients, healthcare providers and private and government
payors.
  **If
we are found to be in violation of Medicare and Medicaid reimbursement
regulations, we could become subject to retroactive adjustments and
recoupments.**
  As a
Medicare and Medicaid provider, we are subject to retroactive adjustments due to
prior-year audits, reviews and investigations; government fraud and abuse
initiatives; and other similar actions. Federal regulations also provide for
withholding payments to recoup amounts payable under the programs. While we
believe we are in material compliance with applicable Medicare and Medicaid
reimbursement regulations, there can be no assurance that we, pursuant to such
audits, reviews, and investigations, among other things, will be found to be in
compliance in all respects with such reimbursement regulations. A determination
that we are in violation of any such reimbursement regulations could result in
retroactive adjustments and recoupments and have a material adverse effect on
us. As a Medicaid provider, we are also subject to routine, unscheduled audits.
The extrapolative methodology, which uses an adjustment factor derived from a
statistical sampling to calculate the money that must be paid to Medicaid, may
result in an adverse impact on our results of operations should an audit result
in a negative finding. There can be no assurance at this time as to the impact
on us of future Medicaid rate changes or audits.
  **Our
industry is subject to extensive government regulation and noncompliance
by us or our suppliers could harm our business.**
  The
marketing, sale and purchase of medications are extensively regulated by federal
and state governments. If we fail or are accused of failing to comply with laws
and regulations, our business, financial condition and results of operations
could be harmed. Many of the medications that are most often dispensed
by us receive greater attention from law enforcement officials than those
medications that are most often dispensed by traditional pharmacies due to the
high cost of HIV/AIDS medications and the potential for illegal use. Our
business could also be harmed if the entities with which we contract or have
business relationships, such as pharmaceutical manufacturers, distributors,
physicians or HIV/AIDS clinics, are accused of violating laws or regulations.
The applicable regulatory framework is complex and evolving, and the laws are
very broad in scope. There are significant uncertainties involving the
application of many of these legal requirements to our business. Many of the
laws remain open to interpretation and have not been addressed by substantive
court decisions that clarify their meaning. We are unable to predict what
additional federal or state legislation or regulatory initiatives may be enacted
in the future relating to our business or the health care industry in general,
or what effect any such legislation or regulation might have on us. We cannot
provide any assurance that Federal or state governments will not impose
additional restrictions or adopt interpretations of existing laws that could
increase our cost of compliance with such laws or reduce our ability to become
profitable. If we are found to have violated any of these
laws, we could be required to pay fines and penalties, which could
materially adversely affect its profitability, and its ability to conduct its
business as currently structured. The health care laws and regulations that
especially apply to our activities include the following:
  ·
    The
      federal “Anti-Kickback Law” prohibits the offer, solicitation, payment or
      receipt of anything of value in return for the referral of patients
      covered by federally funded health care programs, including Medicare,
      Medicaid, and ADAP, or for the arrangement or recommendation of the
      purchase of any item, facility or service covered by those programs.
      Several states also have similar laws proscribing kickbacks that are not
      limited to services for which Medicare and Medicaid payment may be
      made.
  ·
    The
      federal civil monetary penalty law prohibits the offering of remuneration
      or other inducements to beneficiaries of federal health care programs to
      influence the beneficiaries’; decision to seek specific governmentally
      reimbursable items or services, or to choose a particular provider. The
      federal civil monetary penalty law and its associated regulations exclude
      items provided to patients to promote the delivery of preventive care.
      However, permissible incentives would not include cash or cash
      equivalents. We from time to time loan some items at no charge to our
      patients to assist them with adhering to their drug therapy regimen.
      Although these items are not expressly included on the list of excluded
      items set forth in the statute and regulations, we nevertheless believe
      that our provision of these items does not violate the civil monetary
      penalty law and regulations. A determination that we violated the statute
      or regulations, however, could result in sanctions that reduce our net
      sales or profits.
   33
  ·
    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 his or her immediate family members have a “financial
      relationship.” A violation of the Stark Law is punishable by civil
      sanctions, including significant fines and exclusion from participation in
      Medicare and Medicaid. Many states have also enacted similar prohibitions,
      which may cover financial relationships between entities and health care
      practitioners, other than physicians, as
well.
  ·
    There
      are a number of federal statutory provisions that prohibit a person from
      submitting, or causing the submission, of a claim to the federal or a
      state government for an item or service when the person knows or should
      know that the claim is false or fraudulent. The Federal False Claims Act
      contains such a prohibition, as well as a provision encouraging private
      individuals to file suits on behalf of the government against health care
      providers such as us. A violation of these provisions could result in
      criminal penalties, significant financial sanctions or exclusion from
      participation in the Medicare and Medicaid programs. Federal false claims
      actions may be based on underlying violations of the kickback and/or
      self-referral prohibitions, as well. State law also proscribes fraudulent
      acts against third-party payors, including the ADAP and Medicaid
      programs.
  ·
    In
      addition to investigations and enforcement actions initiated by
      governmental agencies, we could be the subject of an action brought under
      the Federal False Claims Act by a private individual (such as a former
      employee, a customer or a competitor) on behalf of the government. Actions
      under the Federal False Claims Act, commonly known as “whistleblower”
      lawsuits, are generally filed under seal to allow the government adequate
      time to investigate and determine whether it will intervene in the action,
      and defendant health care providers are often without knowledge of such
      actions until the government has completed its investigation and the seal
      is lifted.
  ·
    Federal
      and state investigations and enforcement actions continue to focus on the
      health care industry, scrutinizing a wide range of items such as referral
      and billing practices, product discount arrangements, dissemination of
      confidential patient information, clinical drug research trials,
      pharmaceutical marketing programs, and gifts for patients. It is difficult
      to predict how any of the laws implicated in these investigations and
      enforcement actions may be interpreted to apply to our business. The
      pharmaceutical industry continues to garner much attention from federal
      and state governmental agencies. In its Fiscal Year 2002 Work Plan, the
      OIG identified “pharmaceutical fraud” as one of its “special focus areas”
      and committed itself to conduct further assessments relating to Medicaid
      medication reimbursement issues. In the OlG’s 2003, 2004, and 2005 Work
      Plans, the OIG emphasized its continuing focus on pharmaceutical fraud.
      The Department of Justice has “identified prescription drug issues”
      (including product substitution without authorization, controlled
      substances controls, free goods/diversion, medication errors, sale of
      samples, and contracting with pharmacy benefit management companies) as
      being among the “top 10” areas in the health care industry meriting his
      office’s attention.
  ·
    The
      Office of Inspector General of DHHS periodically issues Fraud Alerts and
      Advisory Opinions identifying certain questionable arrangements and
      practices which it believes may implicate the Federal fraud and abuse
      laws. In a December 1994 Special Fraud Alert relating to “prescription
      drug marketing schemes,” the OIG stated that investigation may be
      warranted when a prescription drug marketing activity involves the
      provision of cash or other benefits to pharmacists in exchange for such
      pharmacists’ performance of marketing tasks in the course of their
      pharmacy practice, including, for example, sales-oriented “educational” or
      “counseling” contacts or physician and/or patient outreach where the value
      of the compensation is related to the business
  generated.
   34
  ·
    The
      Department of Health and Human Services has promulgated regulations
      implementing what are commonly referred to as the Administrative
      Simplification provisions of the Health Insurance Portability and
      Accountability Act of 1996, or HIPAA, concerning the maintenance,
      transmission, privacy and security of electronic health information,
      particularly individually identifiable information. Each state may also
      have similar statutes and regulations governing the maintenance,
      transmission, privacy and security of electronic health information,
      including individually identifiable information. In addition, if we choose
      to distribute medications through new distribution channels such as the
      Internet, we will have to comply with government regulations that exist
      now and that may be promulgated in the future. Compliance with these
      regulations could cause us to incur additional, and possibly large,
      expenses. If we are found to have violated any of the provisions
      of HIPAA, then we could be subjected to fines, penalties, and
      criminal penalties.
  ·
    HIPAA
      created new health care fraud crimes expanding the coverage of previous
      laws by criminalizing the defrauding of any health care benefit program,
      including both governmental and private, commercial
  plans.
  ·
    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
      medications. Nonresident pharmacies must also obtain licenses in some
      states to operate and provide goods and services to residents of those
      states. If we are unable to maintain our licenses, or obtain new licenses,
      as required, or if states place burdensome restrictions or limitations on
      nonresident pharmacies, this could limit or affect our ability to operate
      in some states which could adversely impact our business and results of
      operations.
  ·
    State
      consumer protection laws generally prohibit false advertising and unfair,
      deceptive trade practices. These state consumer protection laws have been
      the basis for investigations and multi-state settlements relating to
      prescription medication promotional practices of drug manufacturers
      involving pharmacies and/or physicians.
  ·
    The
      Federal Food Drug and Cosmetics Act, as amended by the Prescription Drug
      Marketing Act, imposes requirements for the labeling, packaging and
      repackaging, dispensing and advertising of prescription medication. It
      also prohibits, among other things, the distribution of unapproved,
      adulterated or misbranded drugs. In the past, FDA has viewed particular
      combination packaging arrangements as constituting new drugs which must be
      tested and labeled in the packaging combination. On occasion, FDA has also
      sought to apply drug compounding guidance to analogous arrangements. We
      believe that sufficient legal authority, and pharmacy industry practice,
      supports our position that our activities do not require FDA approval or
      registration with FDA as a manufacturer. However, FDA may disagree with
      our interpretation and we could be required to defend our
      position; although no such action has ever been initiated against
      us.
  ·
    Federal
      Controlled Substances Act contains pharmacy registration, packaging and
      labeling requirements, as well as record-keeping requirements related to a
      pharmacy’s inventory and its receipt and disposition of all controlled
      substances. Each state has also enacted similar legislation governing
      pharmacies’ handling of controlled
substances.
  ·
    The
      United States Postal Service and the Federal Trade Commission regulate
      mail order sellers, requiring truth in advertising, a reasonable supply of
      drugs to fill orders, the consumer’s right to a refund if an order cannot
      be filled within 30 days, and in certain cases, child-resistant
      packaging.
  ·
    Federal
      law requires that states offering Medicaid prescription drug benefits
      implement a drug use review program. The program requires “before and
      after” drug use reviews and the use of certain approved compendia and
      peer-reviewed medical literature as the source of standards for such drug
      use reviews. States offering Medicaid prescription drug benefits must
      develop standards for pharmacy patient counseling and record-keeping.
      These standards apply as well to nonresident
pharmacies.
  ·
    In
      the past, Medicare covered only a limited number of outpatient
      prescription drugs. In December of 2003, the Medicare Prescription Drug
      Modernization Act, which includes a new Medicare Part D prescription drug
      benefit was passed. Final regulations implementing the law providing broad
      coverage for outpatient prescription drugs will become effective on
      January 1, 2006. Since only a small number of our patients are covered by
      Medicare, this change should not have a significant effect on
      us.
  ****
 35
 
 **Recent
investigations into reporting of average wholesale prices could reduce our
pricing and margins.**
  Many
government payors, including the state ADAP and Medicaid programs, which
comprise most of our business, pay us directly or indirectly for the medications
we handle at average wholesale price, or AWP, or at a percentage of AWP. Private
payors with whom we may contract also reimburse for medications at AWP or at a
percentage of AWP. We are aware of several whistleblower lawsuits against, and
settlements entered into by, various drug manufacturers relating to the alleged
reporting of artificially inflated AWPs to independent price reporting services.
Various federal and state governmental agencies, including the Department of
Justice, the OIG and the National Association of Medicaid Fraud Control Units,
have conducted investigations into whether the reported AWP of many medications
is an appropriate or accurate measure of their market price. Based on figures
that fraud investigators determined to be closer to what medical providers
actually pay, in May 2000, one of the independent price reporting services began
reporting revised AWPs for approximately 400 national drug codes, comprising 48
medications. Most state Medicaid programs have incorporated these revised prices
into their medication payment methodology in some manner. Although none of these
48 medications are HIV/AIDS antiretrovirals, federal and state governmental
attention continues to focus on the validity of using AWP and the resulting
Medicaid medication payments, including payments for HIV/AIDS
antiretrovirals.
  As of
January 1, 2004, Medicare adopted new pricing that reduced reimbursement for
many drugs. In 2005, the agency that administers the Medicare and Medicaid
Programs, the Centers for Medicine & Medicaid Services (known as CMS), will
change reimbursement to be based on average sales price (ASP) or under a
competitive acquisition program (CAP) rather than AWP. This change in pricing
may result in reduced reimbursement amounts for drugs that we
dispense.
  We cannot
predict the eventual results of any payment reforms, future government
investigations or recommended strategies for states to employ to lower drug
costs. Modifications to reimbursement payments, if adopted could have a
significant impact to our financial condition and results of
operation.
  **Our
business could be affected by reforms in the health-care
industry.**
  Health
care reform measures have been considered by Congress and other federal and
state bodies during recent years. The intent of the proposals generally has been
to reduce health care costs and the growth of total health care expenditures, to
expand health care coverage for the uninsured and to eliminate fraud, waste and
financial abuse. Although comprehensive health care reform has been considered,
only limited proposals have been enacted. Comprehensive health care reform may
be considered again and efforts to enact reform bills are likely to continue.
Implementation of government health care reform may adversely affect development
and marketing expenditures by biotechnology companies, which could decrease the
business opportunities available to us or the demand for its specialty services.
We are unable to predict the likelihood of such legislation or similar
legislation being enacted into law or the effects that any such legislation
would have on our business.
  ITEM
7A.QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
  INTEREST
RATE SENSITIVITY
  Our
primary financial market risk exposure consists of interest rate risk related to
interest that we are obligated to pay on our debt, the majority of which is
variable-rate debt. The fair value of our variable rate debt is sensitive to
changes in interest rates. If market rates decline, the required payments will
decrease, and as rates increase, the amount we are required to pay will
increase. Under our current policy, we do not use interest rate derivative
instruments to manage our risk of interest rate fluctuations.
  We have
not hedged against our interest rate risk exposure. As a result, we will benefit
from decreasing interest rates, but rising interest rates on our debt will also
harm us.
  
 36
   **ITEM
8.**  **FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA**
  The
following financial statements required by this item are included in this Report
beginning on page 38.
  Report of
the Independent Auditor
  Consolidated
Balance Sheets as of December 31, 2004 and 2003
  Consolidated
Statements of Operations for the years ended December 31, 2004, 2003 and
2002
  Consolidated
Statements of Stockholders’ Equity for the years ended December 31, 2004, 2003
and 2002
  Consolidated
Statements of Cash Flows for the years ended December 31, 2004 and
2003
  Notes to
Consolidated Financial Statements
 37
 **Report
of Independent Registered Public Accounting Firm**
  Board of
Directors and Stockholders
 Allion
Healthcare, Inc.
 Melville,
New York
  We have
audited the accompanying consolidated balance sheets of Allion Healthcare, Inc.
as of December 31, 2004 and 2003 and the related consolidated statements of
operations, stockholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2004. We have also audited the schedule listed in
the accompanying index. These financial statements and schedule are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall presentation of the financial statements and schedule. We believe that
our audits provide a reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Allion Healthcare, Inc at
December 31, 2004 and 2003, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2004, in conformity
with accounting principles generally accepted in the United States of
America.
  Also, in
our opinion, the schedule presents fairly, in all material respects, the
information set forth therein.
  ****/s/ BDO Seidman, LLPMelville, New
    YorkMarch 23, 2005
  
 38
 
 ALLION
HEALTHCARE, INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 AS OF
DECEMBER 31, 2004 AND 2003
 
 2004
    
    2003ASSETSCURRENT
      ASSETS:Cash and cash equivalents
    
    $
    6,979,630
    
    $
    640,790Accounts
      receivable, (net of allowance fordoubtful
      accounts of $296,320 in 2004 and$437,031
      in 2003)
    
    
    4,678,596
    
    
    3,074,488Inventories
    
    
    733,581
    
    
    1,296,655Prepaid
      expenses and other current assets
    
    
    722,984
    
    
    107,399Total
      current assets
    
    
    13,114,791
    
    
    5,119,332Property
      and equipment, net
    
    
    561,732
    
    
    527,667Goodwill
    
    
    4,472,068
    
    
    4,472,068Intangible
      assets, net
    
    
    1,643,449
    
    
    2,117,601Other
      assets
    
    
    203,622
    
    
    178,777TOTAL
      ASSETS
    
    $
    19,995,662
    
    $
    12,415,445LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued expenses
    
    $
    6,784,658
    
    $
    5,750,909Revolving
      credit line
    
    
    1,154
    
    
    —Notes
      payable-subordinated
    
    
    1,250,000
    
    
    1,150,000Current
      portion of capital lease obligations
    
    
    130,640
    
    
    89,460Other
      current liabilities
    
    
    100,000
    
    
    12,685Total
      current liabilities
    
    
    8,266,452
    
    
    7,003,054LONG
      TERM LIABILITIES:Notes
      payable
    
    
    —
    
    
    2,750,000Capital
      lease obligations
    
    
    193,306
    
    
    162,160Other
    
    
    21,409
    
    
    106,951Total
      liabilities
    
    
    8,481,167
    
    
    10,022,165COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS’
      EQUITYConvertible
      preferred stock, $.001 par value, shares authorized 20,000,000; issued and
      outstanding 4,570,009 in 2004 and2,414,168
      in 2003
    
    
    4,570
    
    
    2,414Common
      stock, $.001 par value; shares authorized80,000,000;
      issued and outstanding 3,100,000 in2004
      and 2003
    
    
    3,100
    
    
    3,100Additional
      paid-in capital
    
    
    22,060,733
    
    
    10,261,526Accumulated
      deficit
    
    
    (10,553,908
    )
    
    (7,873,760
    )Total
      stockholders’ equity
    
    
    11,514,495
    
    
    2,393,280TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
    
    $
    19,995,662
    
    $
    12,415,445
  See
accompanying notes to consolidated financial statements.
 
 39
 
 ALLION
HEALTHCARE, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 YEARS
ENDED DECEMBER 31, 2004, 2003 AND 2002
 
 2004
    
    2003
    
    2002NET
      SALES
    
    $
    64,605,721
    
    $
    48,222,993
    
    $
    27,457,438COST
      OF GOODS SOLD
    
    
    57,091,675
    
    
    41,969,506
    
    
    23,271,936Gross
      profit
    
    
    7,514,046
    
    
    6,253,487
    
    
    4,185,502OPERATING
      EXPENSES:Selling,
      general and administrative expenses
    
    
    9,891,461
    
    
    8,744,127
    
    
    4,756,037Legal
      settlement expense (income)
    
    
    —
    
    
    200,000
    
    
    (150,000
    )Operating
      loss
    
    
    (2,377,415
    )
    
    (2,690,640
    )
    
    (420,535
    )OTHER
      INCOME (EXPENSE):Interest
      expense
    
    
    (226,531
    )
    
    (243,882
    )
    
    (104,358
    )Costs
      of withdrawn public offering
      and
      other
    
    
    —
    
    
    —
    
    
    (478,865
    )Total
      other expense
    
    
    (226,531
    )
    
    (243,882
    )
    
    (583,223
    )LOSS
      BEFORE INCOME TAXES
    
    
    (2,603,946
    )
    
    (2,934,522
    )
    
    (1,003,758
    )PROVISION
      FOR TAXES
    
    
    76,202
    
    
    19,646
    
    
    35,002NET
      LOSS
    
    
    ($2,680,148
    )
    
    ($2,954,168
    )
    
    ($1,038,760
    )BASIC
      AND DILUTED LOSS PERCOMMON
      SHARE
    
    
    ($0.86
    )
    
    ($0.95
    )
    
    ($0.34
    )BASIC
      AND DILUTED WEIGHTED AVERAGE OF COMMON SHARES OUTSTANDING
    
    
    3,100,000
    
    
    3,100,000
    
    
    3,100,000
  See accompanying notes to consolidated financial
statements.
  40
 
 ALLION
HEALTHCARE, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENT OF STOCKHOLDER’S EQUITY (DEFICIT)
 YEARS
ENDED DECEMBER 31, 2004, 2003 AND 2002
  Preferred
      Stk.
      $.001
      par value
    
    
    Common
      Stk.
      $.001
      par valueShares
    
    
    Par
      Value
    
    
    Shares
    
    
    Par
      Value
    
    
    Additional
      Paid-In Capital
    
    
    Accumulated
      Deficit
    
    
    TotalBalance,January
      1, 2002
    
    
    1,179,168
    
    $
    1,179
    
    
    3,100,000
    
    $
    3,100
    
    $
    4,171,725
    
    $
    (3,880,832
    )
    $
    295,172Net
      Loss
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (1,038,760
    )
    
    (1,038,760
    )Balance,December
      31, 2002
    
    
    1,179,168
    
    
    1,179
    
    
    3,100,000
    
    
    3,100
    
    
    4,171,725
    
    
    (4,919,592
    )
    
    (743,588
    )Issuance
      of Preferred Stock
    
    
    1,235,000
    
    
    1,235
    
    
    —
    
    
    —
    
    
    6,062,447
    
    
    —
    
    
    6,063,682Issuance
      of Warrants for acquisition
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    27,354
    
    
    —
    
    
    27,354Net
      Loss
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (2,954,168
    )
    
    (2,954,168
    )Balance,December
      31, 2003
    
    
    2,414,168
    
    
    2,414
    
    
    3,100,000
    
    
    3,100
    
    
    10,261,526
    
    
    (7,873,760
    )
    
    2,393,280Issuance
      of Preferred Stock
    
    
    2,155,841
    
    
    2,156
    
    
    —
    
    
    —
    
    
    11,799,207
    
    
    —
    
    
    11,801,363Net
      Loss
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (2,680,148
    )
    
    (2,680,148
    )Balance,December
      31, 2004
    
    
    4,570,009
    
    $
    4,570
    
    
    3,100,000
    
    $
    3,100
    
    $
    22,060,733
    
    $
    (10,553,908
    )
    $
    11,514,495
 
 See
accompanying notes to consolidated financial statements.
 
 41
 
 
 ALLION
HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED
STATEMENTS OF CASH FLOWS
  CASH
      FLOWS FROM OPERATING ACTIVITIES:
    
    2004
    
    2003
    
    2002Net
      loss
    
    
    ($2,680,148
    )
    
    ($2,954,168
    )
    
    ($1,038,760
    )Adjustments
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
      and amortization
    
    
    716,981
    
    
    606,057
    
    
    315,661Provision
      for doubtful accounts
    
    
    (140,711
    )
    
    266,851
    
    
    28,905Loss
      on sale of asset
    
    
    —
    
    
    5,575
    
    
    —Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    (1,463,397
    )
    
    (346,869
    )
    
    (598,887
    )Inventories
    
    
    563,075
    
    
    (404,292
    )
    
    (277,183
    )Prepaid
      expenses and other assets
    
    
    (491,413
    )
    
    (140,918
    )
    
    201,941Accounts
      payable and accrued expenses
    
    
    1,078,083
    
    
    —
    
    
    —Deferred
      rent
    
    
    21,409
    
    
    272,919
    
    
    926,212Net
      cash used in operating activities
    
    
    (2,396,121
    )
    
    (2,694,845
    )
    
    (442,111
    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Payments
      for acquisition of Medicine Made Easynet
      of Cash acquired of $92,854
    
    
    —
    
    
    (2,257,146
    )
    
    —Purchase
      of property and equipment
    
    
    (138,208
    )
    
    (117,183
    )
    
    (67,917
    )Sale
      of property and equipment
    
    
    27,500
    
    
    —
    
    
    —Net
      cash used in investing activities
    
    
    (101,708
    )
    
    (2,374,329
    )
    
    (67,917
    )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from sale of Preferred Stock net of fees
    
    
    11,607,449
    
    
    6,063,682
    
    
    —Proceeds
      from line of credit
    
    
    33,590,405
    
    
    20,725,000
    
    
    5,250,000Payment
      of deferred financing cost
    
    
    —
    
    
    (101,564
    )
    
    (265,188
    )Repayment
      of line of credit
    
    
    (33,589,251
    )
    
    (21,190,081
    )
    
    (5,778,855
    )Repayment
      of long-term debt
    
    
    (112,934
    )
    
    
    
    
    (42,462
    )Repayment
      of Notes Payable
    
    
    (2,650,000
    )
    
    —
    
    
    —Net
      cash provided by (used in) financing activities
    
    
    8,845,669
    
    
    5,497,037
    
    
    (836,505
    )NET
      INCREASE (DECREASE) IN CASH AND CASHEQUIVALENTS
    
    
    6,338,840
    
    
    427,863
    
    
    (1,346,533
    )CASH
      AND CASH EQUIVALENTS, BEGINNINGOF
      YEAR
    
    
    640,790
    
    
    212,927
    
    
    1,559,460CASH
      AND CASH EQUIVALENTS, END OF YEAR
    
    $
    6,979,630
    
    $
    640,790
    
    $
    212,927SUPPLEMENTAL
      DISCLOSURE:Income
      taxes paid
    
    $
    75,407
    
    $
    15,666
    
    $
    13,982Interest
      paid
    
    $
    225,830
    
    $
    227,216
    
    $
    106,491Assets
      acquired via capital lease
    
    $
    165,623
    
    
    —
    
    $
    365,000
 
  See
accompanying notes to consolidated financial statements.
 
 42
 
 **ALLION
HEALTHCARE, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
  **NOTE
1. THE COMPANY**
  As of
December 31, 2004, Allion Healthcare, Inc., referred to as the Company, was the
parent corporation of four wholly owned subsidiaries, which operate under the
MOMS Pharmacy name as one reportable segment. These subsidiaries are located in
New York, California, Texas and Florida. The Company is licensed to dispense
prescription medication in all 50 U.S. States. The Company focuses on delivering
its specialty pharmacy and disease management services primarily to HIV/AIDS
patients.
  **NOTE
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
  BASIS OF
PRESENTATION. **** The
consolidated financial statements include the accounts of the Company and its
four wholly owned subsidiaries. All significant inter-company accounts and
transactions have been eliminated in consolidation.
  INVENTORIES. **** Inventories
consist entirely of pharmaceuticals available for sale. Inventories are recorded
at lower of cost or market, cost being determined on a first-in, first-out
(“FIFO”) basis.
  USE OF
ESTIMATES BY MANAGEMENT. **** The
preparation of the Company’s financial statements in conformity with generally
accepted accounting principles require the Company’s management to make certain
estimates and assumptions that affect the amounts reported in these financial
statements and accompanying notes. Such estimates primarily relate to accounts
receivable, intangibles and deferred tax valuation. Actual results could differ
from those estimates.
  PROPERTY
AND EQUIPMENT. **** Property
and equipment are stated at cost and are depreciated using the straight-line
method over their estimated useful lives. Machinery and equipment under capital
leases are amortized over the lives of the respective leases or useful lives of
the asset, whichever is shorter.
  REVENUE
RECOGNITION. Net sales are recognized as medications or products are delivered
to customers. A substantial portion of the Company’s net sales are billed to
third-party payors, including insurance companies, managed care plans and
governmental payors. Net sales are recorded net of contractual adjustments and
related discounts. Contractual adjustments represent estimated differences
between billed net sales and amounts expected to be realized from third-party
payors under contractual agreements.
  INCOME
TAXES. **** The
Company recognizes deferred tax assets and liabilities for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax basis
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount currently
estimated to be realized.
  CASH
EQUIVALENTS. **** For
purposes of the consolidated statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.
  CREDIT
RISK. **** Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents and trade receivables. The
Company places its cash equivalents with financial institutions. The Company has
substantially all of its cash in four bank accounts. The balances are insured by
FDIC up to $100,000. Such cash balances, at times, may exceed FDIC limits. The
Company has not experienced any losses in such accounts. The Company’s trade
receivables represent a broad customer base. The Company routinely assesses the
financial strengths of its customers. As a consequence, concentrations of credit
risk are limited. ****
  43
 NET LOSS
PER SHARE INFORMATION. Basic earnings per share is computed using the weighted
average number of common shares outstanding during the period. Diluted per share
amounts include dilutive common equivalent shares. Common equivalent shares,
consist of the incremental common shares issuable upon the exercise of stock
options and warrants; common equivalent shares are excluded from the calculation
if their effect is anti-dilutive. Diluted loss per share for the years ended
December 31, 2004, 2003 and 2002 do not include the impact of common stock
options and warrants then outstanding of 2,830,137, 2,359,973 and 1,984,200,
respectively, as the effect of their inclusion would be
anti-dilutive.
  STOCK-BASED
COMPENSATION PLANS. The Company accounts for its stock option awards to
employees under the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees.” Under the intrinsic value based method, compensation cost is the
excess, if any, of the fair market value of the stock at grant date or other
measurement date over the amount an employee must pay to acquire the stock. The
Company makes pro forma disclosures of net income and earnings per share as if
the fair value based method of accounting had been applied as required by
Statement of Financial Accounting Standards No. 123 (“SFAS 123”, “Accounting for
Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based
Compensation - Transition and Disclosure.”) The Company has not granted options
below fair market value on the date of grant. Had compensation expenses been
determined as provided by SFAS No. 123 using the Black-Scholes option pricing
model, the pro forma effect on the Company’s net loss per share would have been
the following for the years ended December 31, 2004, 2003 and 2002,
respectively.
  YEAR
      ENDEDDecember
      31,
      2004
    
    December
      31,
      2003
    
    December
      31,
      2002Net
      loss, as reported
    
    
    ($2,680,148
    )
    
    ($2,954,168
    )
    
    ($1,038,760
    )Deduct:
      Total stock-based employeecompensation
      expense determinedunder
      fair value method used
    
    
    (441,485
    )
    
    (72,725
    )
    
    (262,784
    )Net
      loss, pro forma
    
    
    ($3,121,633
    )
    
    ($3,026,893
    )
    
    ($1,301,544
    )Net loss per
      share;Basic
      and diluted, as reported
    
    
    ($0.86
    )
    
    ($0.95
    )
    
    ($0.34
    )Basic
      and diluted, as pro forma
    
    
    ($1.01
    )
    
    ($0.98
    )
    
    ($0.42
    )
 
 The fair
value of each option grant is estimated on the date of the grant using the
Black-Scholes option-pricing model. The following range of weighted-average
assumptions were used for grants during the years ended December 31, 2004, 2003
and 2002.
  2004
    
    2003
    
    2002Dividend
      yield
    
    
    0.00
    %
    
    0.00
    %
    
    0.00
    %Volatility
    
    
    1.00
    %
    
    1.00
    %
    
    1.00
    %Risk-free
      interest rate
    
    
    4.40
    %
    
    4.02
    %
    
    3.35
    %Expected
      life
    
    
    Eight
      Years
    
    
    Eight
      Years
    
    
    Eight
      Years
 
 The
weighted average grant date fair value of options granted during 2004, 2003 and
2002 were $1.77, $0.38 and $0.55 respectively.
  The
Black-Scholes option valuation 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 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 stock options.
  44
 ALLOWANCE
FOR DOUBTFUL ACCOUNTS. **** Management
regularly reviews the collectibility of accounts receivable by tracking
collection and write-off activity. Estimated write-off percentages are then
applied to each aging category by payor classification to determine the
allowance for estimated uncollectible accounts. The allowance for estimated
uncollectible accounts is adjusted as needed to reflect current collection,
write-off and other trends, including changes in assessment of realizable value.
While management believes the resulting net carrying amounts for accounts
receivable are fairly stated at each quarter-end and that the Company has made
adequate provisions for uncollectible accounts based on all information
available, no assurance can be given as to the level of future provisions for
uncollectible accounts, or how they will compare to the levels experienced in
the past. The Company’s ability to successfully collect its accounts receivable
depends, in part, on its ability to adequately supervise and train personnel in
billing and collection, and minimize losses related to system
changes.
  SHIPPING
AND HANDLING COSTS. Shipping and handling costs that are incurred are not
included in cost of sales. These costs are included in selling, general and
administrative expenses. Shipping and handling costs were approximately
$889,000, $720,000 and $359,000 in 2004, 2003 and 2002 respectively. Shipping
and handling costs are not billed to customers.
  LONG-LIVED
ASSETS. Amortization of intangible assets is provided using the straight-line
method over the estimated useful lives of the assets of five years. The carrying
values of intangible and other long-lived assets are periodically reviewed to
determine if any impairment indicators are present. If it is determined that
such indicators are present and the review indicates that the assets will not be
fully recoverable, based on undiscounted estimated cash flows over the remaining
amortization and depreciation period, their carrying values are reduced to
estimated fair value. Impairment indicators include, among other conditions,
cash flow deficits, an historic or anticipated decline in net sales or operating
profit, adverse legal or regulatory developments, accumulation of costs
significantly in excess of amounts originally expected to acquire the asset and
a material decrease in the fair market value of some or all of the assets.
Assets are grouped at the lowest level for which there are identifiable cash
flows that are largely independent of the cash flows generated by other asset
groups. No such impairment existed at December 31, 2004.
  GOODWILL
AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS. In accordance with Statement of
Financial Accounting Standard (“FAS”) No. 141, “Business Combinations”, and No.
142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets
associated with the Medicine Made Easy, referred to as MME, acquisition that are
deemed to have indefinite lives are no longer amortized but are subject to
annual impairment tests. Such impairment tests require the comparison of the
fair value and carrying value of reporting units. Measuring fair value of a
reporting unit is generally based on valuation techniques using multiples of
sales or earnings, unless supportable information is available for using a
present value technique, such as estimates of future cash flows. The Company
assesses the potential impairment of goodwill and other indefinite-lived
intangible assets annually and on an interim basis whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Some
factors considered important which could trigger an interim impairment review
include the following:
  ·
    Significant
      underperformance relative to expected historical or projected future
      operating results;
  ·
    Significant
      changes in the manner of our use of the acquired assets or the strategy
      for our overall business; and
  ·
    Significant
      negative industry or economic trends.
  If it’s
determined through the impairment review process that goodwill has been
impaired, an impairment charge would be recorded in the consolidated statement
of operations. Based on the 2004 impairment review process, there was no
impairment charge.
  ADVERTISING
COSTS. Advertising costs are expensed as incurred. Advertising costs in 2004,
2003 and 2002 were approximately $78,000, $131,000 and $29,000, respectively and
were included in selling, general and administrative expenses.
 
 RECLASSIFICATIONS. Certain prior years' balance have
been reclassifed to conform with the current years' presentation.
  45
 **NOTE
3. RECENT ACCOUNTING PRONOUNCEMENTS**
  On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principals
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and amends
SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No.
123(R) is similar to the approach described in SFAS No. 123. However, SFAS
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R)
permits public companies to adopt its requirements using one of two
methods:
  A.
“modified prospective” method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of Statement 123(R) for
all share-based payments granted after the effective date and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees prior to the
effective date of statement 123(R) that remain unvested on the effective
date.
 
 B.
“modified retrospective” method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based
on the amounts previously recognized under SFAS No. 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption.
 
 SFAS No.
123(R) must be adopted in the first interim or annual period beginning after
June 15, 2005, which in our case would be the quarterly period beginning July 1,
2005 and ending September 30, 2005. Early adoption will be permitted in periods
in which financial statements have not yet been issued. We expect to adopt
Statement 123(R) on July 1, 2005.
  As
permitted by SFAS No. 123, we currently account for share-based payments to
employees using the intrinsic value method prescribed in APB Opinion No. 25.
Accordingly, the adoption of SFAS No. 123(R)’s fair value method may have a
significant impact on our results of operations, although it will have no impact
on our overall financial position. The impact of adoption of SFAS No. 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future and on required changes in the method of
computation of fair value. However, had we adopted SFAS No. 123(R) in prior
periods, the impact of that standard would have approximated the impact of SFAS
No. 123 as described in our disclosure of pro forma net income and earnings per
share in Note 2 to our consolidated financial statements.
  **NOTE
4. ACQUISITION**
  On May 1,
2003, the Company acquired Medicine Made Easy, referred to as MME. MME fills
specialty oral and injectable prescription medications and biopharmaceuticals.
MME began operations in January 1999 in the State of California. The aggregate
consideration for the acquisition was $4,950,000, subject to post-closing
adjustments, and warrants to purchase 227,273 shares of the Company’s common
stock for $11.00 per share. The purchase price was paid as follows: (i) $300,000
in cash prior to closing as a lock-up fee; (ii) $2,250,000 in cash at closing.;
(iii) $1,150,000 by subordinated secured promissory notes payable on May 1,
2004.; and (iv) $1,250,000 by subordinated secured promissory notes payable on
May 1, 2005. These notes payable accrue interest at a rate of Prime Rate plus 2%
per annum. The Prime Rate as of December 31, 2004 was 5.25%. The notes payable
are secured by cash, cash equivalents, accounts receivable, inventory, fixed and
other assets of the Company, and are subordinated to the Company’s senior
indebtedness.
  46
 **Purchase
      Price Paid**Cash
      paid to seller prior to closing
    
    $
    300,000Cash
      paid at closing
    
    
    2,250,000Notes
      payable-subordinated
    
    
    2,400,000Direct
      acquisition costs
    
    
    496,898Liabilities
      assumed
    
    
    2,060,551Fair
      value of warrants issued
    
    
    27,354Total
    
    $
    7,534,803**Allocation
      of Purchase Price**Net
      current assets
    
    $
    1,018,906Property
      and equipment
    
    
    202,461Identified
      intangible assets
    
    
    1,841,368Goodwill
      (not
      deductible for tax purposes)
    
    
    4,472,068Total
    
    $
    7,534,803
 
 The
operations of MME were included in the consolidated financial statements as of
May 1, 2003. Under SFAS 141, “Business Combinations”, the Company made an
adjustment to current assets and goodwill in the amount of $235,000 as of
December 31, 2003 as a result of the Company reaching an agreement on the
California AIDS Drug Assistance Program (ADAP) Audit.
  The
following pro forma results were developed assuming the acquisition of Medicine
Made Easy occurred January 1, 2002. In addition, the sale of the Series C
convertible preferred stock is also presumed to have occurred on January 1,
2002.
  Year
      Ended
      December
      31, 2003
      (Unaudited)
    
    Year
      Ended
      December
      31, 2002
      (Unaudited)Revenue
    
    $
    55,865,003
    
    $
    49,203,059Net
      loss
    
    $
    (3,654,185
    )
    $
    (2,034,752
    )Basic
      and diluted loss per share
    
    $
    (1.18
    )
    $
    (0.66
    )
  **NOTE
5. INTANGIBLE ASSETS**
  Intangible
assets as of December 31, 2004 and 2003 are as follows:
  December
      31, 2004
    
    December
      31, 2003Useful
      Life
    
    Cost
    
    Accumulated
      Amortization
    
    Cost
    
    Accumulated
      AmortizationIntangible
      assets:Customer
      lists
    
    
    5
      Years
    
    $
    2,030,745
    
    $
    (978,831
    )
    $
    2,030,745
    
    $
    (572,682
    )California
      License
    
    
    Perpetual
    
    
    478,616
    
    
    —
    
    
    478,616
    
    
    —Non-Compete
      Covenant
    
    
    3
      Years
    
    
    147,007
    
    
    (81,671
    )
    
    147,007
    
    
    (32,668
    )Software
    
    
    5
      Years
    
    
    50,000
    
    
    (16,667
    )
    
    50,000
    
    
    (6,667
    )Other
    
    
    5
      Years
    
    
    45,000
    
    
    (30,750
    )
    
    45,000
    
    
    (21,750
    )Total
    
    
    
    
    $
    2,751,368
    
    $
    (1,107,919
    )
    $
    2,751,368
    
    $
    (633,767
    )
 
 Amortization
of intangible assets for the year ended December 31, 2004, 2003 and 2002 was
approximately $474,151, $377,000 and $182,000, respectively. The annual
amortization on these assets for 2005, 2006, 2007 and 2008 will be approximately
$474,151, $366,483, $243,149 and $81,050, respectively. As of 2008 intangibles
will be fully amortized.
  47
 **NOTE
6.**  **PROPERTY
AND EQUIPMENT**
  Useful
      Lives in Years
    
    December
      31,
      2004
    
    December
      31,
      2003Machinery
      and equipment undercapital
      lease obligations
    
    
    4
    
    $
    530,623
    
    $
    365,274Machinery
      and equipment
    
    
    3-5
    
    
    345,607
    
    
    322,126Leasehold
      Improvements
    
    
    2 -
      5.5
    
    
    191,535
    
    
    154,034Furniture
      and fixtures
    
    
    3-5
    
    
    38,333
    
    
    4,9441,106,098
    
    
    846,378Less:
      accumulated depreciation andamortization
    
    
    
    
    
    544,366
    
    
    318,711$
    561,732
    
    $
    527,667
 
 Depreciation
and amortization expense relating to property and equipment for the years ended
December 31, 2004, 2003 and 2002 was approximately $242,830, $229,000 and
$72,000, respectively.
  **NOTE
7. REVOLVING CREDIT LINE**
  The
Company has an available short-term revolving credit facility for up to $6.0
million. At December 31, 2004, the Company’s borrowing capacity was
approximately $4.5 million and its borrowings under this facility was $1,154.
This credit facility expires on April 21, 2006. Borrowings under the facility
are based on the Company’s accounts receivable, bear interest at Prime + 2%
and are collateralized by a perfected and primary security interest in all of
the Company’s assets, accounts receivable, trademarks **,** licenses
and values of any kind of the Company. The prime rate at December 31, 2004 was
5.25%. In connection with this credit line, the Company must comply with certain
financial covenants. As of December 31, 2004, the Company was in compliance with
its covenants under its revolving credit-facility.
  The
Company has a line of credit from a bank for $1.5 million that accrues interest
at Prime Rate per annum, with the full principal payable in September of
2005. At December 31, 2004 there was nothing drawn on the line of credit. The
Company anticipates the note will be renewed. The Prime Rate at December 31,
2004 was 5.25%. This bank loan has been guaranteed by one of the Company’s
principal investors.
  **NOTE
8. NOTES PAYABLE**
  As part
of the acquisition of MME, the Company issued two notes. One note for $1,150,000
was paid on May 1, 2004. The second note is for $1,250,000 and is due May 1,
2005. These notes accrue interest at Prime Rate plus 2% per annum. The Prime
Rate as of December 31, 2004 and 2003 was 5.25% and 4.00%, respectively. These
notes payable are secured by cash, cash equivalents, accounts receivable,
inventory, fixed and other assets of the Company, and are subordinated to the
Company’s senior debt.
  **NOTE
9. INCOME TAXES**
  A
reconciliation of the income tax expense (benefit) computed at the statutory
Federal income tax rate to the reported amount follows:
  Year
      Ended December 31,2004
    
    2003
    
    2002Federal
      statutory rate:
    
    
    34
    %
    
    34
    %
    
    34
    %Tax
      benefit at Federal statutory rates
    
    $
    (885,342
    )
    $
    (997,737
    )
    $
    (341,278
    )Change
      in valuation allowance
    
    
    938,894
    
    
    1,093,502
    
    
    405,721Permanent
      differences
    
    
    113,191
    
    
    77,833
    
    
    8,316State
      income taxes
    
    
    (90,541
    )
    
    (153,952
    )
    
    (37,757
    )$
    76,202
    
    $
    19,646
    
    $
    35,002
  48
 At
December 31, 2004, the Company had net operating loss carryforwards for tax
purposes of approximately $8,864,072 expiring at various dates from 2005 through
2024.
  Deferred
tax assets (liabilities) comprise of the following:
  December
      31,
      2004
    
    December
      31,
      2003Allowance
      for doubtful accounts
    
    $
    119,000
    
    $
    175,000Benefit
      of net operating loss carryforward
    
    
    3,506,000
    
    
    2,550,000Intangibles
      (tax basis difference)
    
    
    165,000
    
    
    117,000Contribution
      Carryover
    
    
    18,000
    
    
    18,000Sec
      263A adjustment
    
    
    19,000
    
    
    19,000Book/Tax
      Depreciation Differences
    
    
    (25,000
    )
    
    (15,000
    )3,802,000
    
    
    2,864,000Valuation
      allowance
    
    
    (3,802,000
    )
    
    (2,864,000
    )Net
      deferred tax assets
    
    $
    —
    
    $
    —
 
 Deferred
tax assets related to net operating loss carry-forwards have been fully reserved
by a valuation allowance. Pursuant to Section 382 of the Internal Revenue Code
of 1986, as amended, future ownership changes and other limitations may apply to
the utilization of this asset.
  **NOTE
10. LEASE COMMITMENTS**
  The
Company leases commercial space in four locations. They are as
follows:
  Location
    
    Principal
      Use
    
    Property
      InterestMelville,
      NY
    
    Pharmacy
      and Executive Offices
    
    Leased
      - expiring June 30, 2009Torrance,
      CA
    
    Pharmacy
    
    Leased
      - expiring December 31, 2005Austin,
      TX
    
    Pharmacy
    
    Leased
      - expiring June 30, 2005Miami,
      FL
    
    Pharmacy
    
    Leased
      - expiring September 30, 2005
 
 At
December 31, 2004, the Company’s lease commitments provide for the following
minimum annual rentals.
  Year
    
    Minimum
      Rent2005
    
    $
    376,1052006
    
    
    187,6542007
    
    
    194,6912008
    
    
    201,9922009
    
    
    110,056$
    1,070,497
 
 During
the years ended December 31, 2004, 2003 and 2002, rental expense
approximated to $479,600, $330,000 and $158,000 respectively.
  49
 **NOTE
11. STOCKHOLDERS’ EQUITY**
  a.  Common
shares reserved
  Common
shares reserved at December 31, 2004, are as follows:
  Stock Option Plans
    1,667,750Warrants
    1,312,387Convertible Preferred Stock
    4,570,009
 b.  Stock
Options
  Under the
terms of the Company’s Stock Option Plans, the Board of Directors may grant
incentive and nonqualified stock options to employees, officers, directors,
agents, consultants and independent contractors of the Company. In connection
with the introduction of the 2002 Stock Option Plan, 2,750,000 shares of common
stock were reserved for future issuance. The Company grants stock options with
exercise prices equal to the fair market value of the common stock on the date
of the grant, as determined by the Board of Directors. Options generally vest
over a two to five year period and expire ten years from the date of the
grant.
  A summary
of the status of the Company’s stock option plans as of December 31, 2004, 2003,
2002 and changes during the years then ended is presented below:
 2004
    
    2003
    
    2002Stock
      Options
    
    Shares
    
    Weighted
      Average Exercise Price
    
    Shares
    
    Weighted
      Average Exercise Price
    
    Shares
    
    Weighted
      Average Exercise PriceOutstanding,
      beginning of year
    
    
    1,365,200
    
    $
    1.80
    
    
    1,341,700
    
    $
    1.61
    
    
    1,001,400
    
    $
    0.97Granted
    
    
    589,250
    
    
    6.01
    
    
    50,000
    
    
    5.00
    
    
    495,000
    
    
    3.50Exercised
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Cancelled
    
    
    (286,700
    )
    
    3.09
    
    
    (26,500
    )
    
    2.91
    
    
    (4,700
    )
    
    2.24Outstanding,
      end of year
    
    
    1,667,750
    
    $
    3.03
    
    
    1,365,200
    
    $
    1.71
    
    
    1,491,700
    
    $
    1.80Options
      exercisable at year end
    
    
    1,133,758
    
    $
    1.75
    
    
    1,001,268
    
    $
    1.20
    
    
    954,408Weighted
      average fair value of
      options
      under the plan granted
      during
      the year
    
    
    
    
    $
    1.77
    
    
    
    
    $
    0.38
    
    
    
    
    $
    0.55
  
 The
following table summarizes information about stock options outstanding at
December 31, 2004:
  Options
      Outstanding
    
    Options
      ExercisableRange
      of Exercise Price
    
    Number
      of Outstanding
    
    Weighted
      Average RemainingContractual Life
    
    Weighted
      Average Exercise Price
    
    Number
      Outstanding
    
    Weighted
      Average Exercise Price$.17
      - $.66
    
    
    555,000
    
    
    4.09
    
    $
    .18
    
    
    555,000
    
    $
    .18$1.00
      - $2.00
    
    
    241,000
    
    
    5.50
    
    $
    1.51
    
    
    241,000
    
    $
    1.51$3.00
    
    
    24,500
    
    
    6.96
    
    $
    3.00
    
    
    14,903
    
    $
    3.00$3.50
    
    
    210,000
    
    
    7.50
    
    $
    3.50
    
    
    175,002
    
    $
    3.50$5.00
    
    
    50,000
    
    
    8.76
    
    $
    5.00
    
    
    20,834
    
    $
    5.00$6.00
      - 6.25
    
    
    587,250
    
    
    9.42
    
    $
    6.01
    
    
    127,019
    
    
    6.001,667,750
    
    
    
    
    
    
    
    
    1,133,758
  50
 c.
Warrants
  In January
2000, the Company issued 375,000 common stock warrants to a director of the
Company, which have an exercise price of $1.00 per share. The warrants were
issued as consideration for guarantying the Company's facility with West
Bank. These warrants expire ten years from the date of grant.
  On May 1,
2003, the Company issued warrants to the previous owners of Medicine Made Easy.
These warrants can be exercised to purchase 227,273 shares of the Company’s
common stock for $11.00 a share and expire in May 2008. The fair value of the
warrants was $27,354, and was included in the purchase price of
MME.
  In
July 2003, the Company issued 125,000 warrants, which have an exercise
price of $5.00 per share, to a director of the Company in connection with the
extension of the guarantee for the West Bank credit facility. These warrants
expire ten years from the date of grant.
  In April
and May 2004, the Company issued warrants to purchase 114,759 shares of common
stock with an exercise price of $6.00 per share to the placement agents in
conjunction with the Company’s Series D private placement. These warrants expire
5 years from the date of issue.
  In
December 2004 the Company issued warrants to purchase 51,201 shares of common
stock, which have an exercise price of $6.25, in conjunction with the
Company’s Series E convertible preferred stock to the placement agent. These
warrants expire 5 years from the date of issue.
  The
Company has issued 117,500 warrants in prior years to various individuals and
corporations for consulting purposes. These warrants can be exercised to
purchase 117,500 shares of the Company’s common stock for prices ranging from
$0.17 a share to $1.00 a share. These warrants expire at various dates from
February 1, 2009 through June 30, 2010.
  d.
Convertible Preferred Stock
  The
Company has authorized 20,000,000 shares of preferred stock, $.001 par value,
which the Board of Directors has authority to issue from time to time in series.
The Board of Directors also has the authority to fix, before the issuance of
each series, the number of shares in each series and the designation,
preferences, rights and limitations of each series.
  In March
2000, the Company sold 512,500 shares of Series A convertible preferred stock to
a group of investors, the net proceeds to the Company were approximately
$1,025,000.
  In April
2001, the Company sold 333,334 shares of Series B convertible preferred stock to
a group of investors. The net proceeds to the Company were approximately
$988,000. In October 2001, the Company sold an additional 333,334 shares of
Series B convertible preferred stock to a group of investors. The net proceeds
to the Company were approximately $999,000.
  In April
2003, the Company raised $6,063,682, net of costs of $111,318 related to this
issuance in a private placement with several investors. The Company sold
1,235,000 shares of Series C convertible preferred stock at $5.00 per share.
There will be no dividends payable on the shares, unless the Company, in its
sole discretion declares a dividend. In the event of any liquidation, these
shares shall share on a pari passu basis in liquidation with the Series A and B
preferred stock outstanding. A portion of the proceeds of the sale of the Series
C convertible preferred stock was used in connection with the Company’s
$1,475,000 settlement of its lawsuit with Morris and Dickson. $2,250,000 of the
proceeds was used to fund the acquisition of Medicine Made Easy. $841,789 of the
proceeds was used to repay Company indebtedness. The Company has additional
indebtedness to the sellers of Medicine Made Easy as described more fully in
Note 8.
  In April
and May 2004, the Company raised an aggregate of $8,806,958 through the issuance
of 1,491,828 shares of Series D convertible preferred stock at $6.00 per share
in private placements with several investors. The terms and rights of the Series
D convertible preferred shares are set forth in the Certificate of Designation
of Series D Preferred Stock of the Company. There will be no dividends payable
on these shares, unless the Company, in its sole discretion, declares a dividend
with respect to the common stock. In the event of any liquidation, the shares
shall share on a pari passu basis in liquidation with the Series A, B and C
preferred stock outstanding. In conjunction with the offering and for services
rendered, the Company issued 24,000 shares of Series D convertible preferred
stock to a placement agent, issued warrants representing 114,759 shares of
common stock with an exercise price of $6.00 per share to placement agents and
paid fees of $745,198. The Company used $1,150,000 of the proceeds to pay off
notes to the previous owners of MME (the acquisition discussed in Note 4 above)
and the remaining balances of its revolving credit lines.
  51
 In
December 2004 the Company completed a private placement of shares of its Series
E convertible preferred stock, par value $.001 per share. The Company sold a
total of 664,013 shares of Series E convertible preferred stock at a price of
$6.25 per share to certain accredited investors for an aggregate purchase price
of $4,150,081. The Company used a placement agent to assist it with the private
placement. In connection with the placement, the Company paid a fee of $410,478
in cash, and it issued 5-year warrants to purchase 51,201 shares of Company
common stock (representing 8% of the number of shares of Series E preferred
stock). The warrants will have a per share exercise price of $6.25, subject to
customary provisions regarding anti-dilution and “net issue”
exercise.
  The
Series A, Series B, Series C, Series D and Series E preferred stock have senior
preference and priority as to dividends, distributions and payments upon the
liquidation, dissolution or winding up of affairs before any payments to holders
of the common stock. Each share of Series A, Series B, Series C, Series D and
Series E preferred stock is convertible, at the option of the holder at any
time, into one (1) share of common stock.
  **NOTE
12. FAIR VALUE OF FINANCIAL INSTRUMENTS**
  The
methods and assumptions used to estimate the fair value of the following classes
of financial instruments were:
  Current
Assets and Current Liabilities: The carrying amount of cash, receivables and
payables and certain other short-term financial instruments approximate their
fair value.
  Long-Term
Debt: The fair value of the Company’s long term debt, including the current
portions, was estimated using a discounted cash flow analysis, based on the
Company’s assumed incremental borrowing rates for similar types of borrowing
arrangements. The carrying amount of variable and fixed rate debt at December
31, 2004 approximates its fair value.
  **NOTE
13. RELATED PARTY TRANSACTIONS**
  A
director of the Company has guaranteed a $1,500,000 loan from a bank. This loan
accrues interest at Prime Rate per annum, with the full principal payable
in September of 2005. The Prime Rate at December 31, 2004 was
5.25%.
  **NOTE
14. LITIGATION**
  New
Jersey Medicaid Audit. During
the first quarter of 2003, Medicaid commenced a review of the
Company's billing practices in New Jersey. In particular, Medicaid reviewed
whether the appropriate procedures were followed by the Company and whether
the requisite patient consents were obtained by the Company at the time of
delivery. During 2003 the Company accrued an estimated cost of
$200,000 for the New Jersey Medicaid Audit. In April 2004 the
Company entered into a settlement agreement with Medicaid of New Jersey for
$200,000. The Company does not anticipate any additional expense related to this
audit. In July 2004, the Company was granted a license to bill New Jersey
Medicaid from New York, as a result the Company will no longer serve New Jersey
Medicaid patients from Texas.
  New
York Medicaid Audit. In May
2004, the Company was notified that MOMS Pharmacy, Inc., the Company’s New York
wholly owned subsidiary, is the subject of an audit and review being conducted
by the New York State Department of Health. As part of the audit, the Department
of Health withheld payment of Medicaid claims to us but ceased withholding
payments in December 2004. The Department returned $800,000 of the total
$920,000 it withheld from us. The Department may conclude that MOMS is subject
to certain financial penalties and fines, in which case some or all of the
payments withheld will not be paid to the Company. At this time, management
believes the outcome will not have a material adverse effect on the Company’s
financial position and financial resources. The Company accrued the full amount
of the monies still withheld as expenses in 2004.
  52
 **NOTE
15. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS**
  The
Company provides prescription medications to its customers in the United States
through its four wholly owned subsidiaries. Credit losses relating to customers
historically have been minimal and within management’s
expectations.
  At
December 31, 2004, the Company maintained 98% of its cash and cash equivalents
with two financial institutions.
  Under
certain federal and state third-party reimbursement programs, the Company
received net sales of approximately $58,710,000, $42,739,000 and $23,081,000 for
the years ended December 31, 2004, 2003 and 2002 respectively. At December 31,
2004 and 2003, the Company had an aggregate outstanding receivable from federal
and state agencies of approximately $4,186,000 and $3,012,000,
respectively.
  **NOTE
16. CAPITAL LEASE OBLIGATIONS**
  Future
minimum commitments under non-cancelable capital leases are as
follows:
  CapitalLeases2005
    
    $
    153,8572006
    
    
    116,2742007
    
    
    49,6202008
    
    
    49,620Total
      minimum lease payments
    
    
    369,371Amounts
      representing interest
    
    
    (45,425
    )Present
      value of net minimum lease payments (including current portion of
      $130,640)
    
    $
    323,946
  **NOTE
17. OTHER LONG-TERM DEBT**
  The
Company owes the Internal Revenue Service (“IRS”) $100,000 as of December 31,
2004 which is recorded in other current liabilities. The United States
Bankruptcy Court entered an order confirming the settlement of the I.R.S. claim
against the Company on September 29, 1999. The Company had agreed to pay
$130,000 over six years to satisfy the I.R.S. claim. The Company will not carry
forward any net operating losses or credit available from pre-1999 periods, into
post-1998 years. The Company will have no federal income tax liability from any
periods prior to January 1, 1999. In addition, the IRS will not conduct any
further audits of the Company for periods prior to January 1, 1999, provided
that the Company complies with the terms of the Bankruptcy Court’s confirmation
order of February 1, 1999.
  **NOTE
18. MAJOR SUPPLIERS**
  During
the year ended December 31, 2004, the Company purchased approximately
$55,707,000 of inventory from its major supplier, $40,268,000 from three major
suppliers in fiscal 2003 and approximately $22,459,000 from two major suppliers
in fiscal 2002.
  53
 In
September 2003, the Company signed a five-year agreement with a drug wholesaler
that requires certain minimum purchases per the agreement. If the Company has
not met the minimum purchase commitments as set forth in the agreement, the
Company will be charged a prorated amount of 0.20% of the projected volume
remaining on the term of the agreement. The agreement also states that the
Company’s minimum purchases during the term of the agreement will be no less
than $400,000,000.
  **NOTE
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**
  Quarterly
financial information for the years ended December 31, 2004 and 2003, is
summarized below (in thousands, except share data):
  (in
      thousands, except per share)2004FirstQuarter
    
    SecondQuarter
    
    ThirdQuarter
    
    FourthQuarter
    
    TotalNet
      Sales
    
    $
    14,447
    
    $
    15,671
    
    $
    17,016
    
    $
    17,472
    
    $
    64,606Operating
      Loss
    
    $
    (586
    )
    $
    (1,004
    )
    $
    (330
    )
    $
    (457
    )
    $
    (2,377
    )Net
      Loss
    
    $
    (677
    )
    $
    (1,103
    )
    $
    (370
    )
    $
    (530
    )
    $
    (2,680
    )Basic
      and Diluted Lossper
      Common Share
    
    $
    (0.22
    )
    $
    (0.36
    )
    $
    (0.12
    )
    $
    (0.16
    )
    $
    (0.86
    )
  2003FirstQuarter
    
    
    SecondQuarter
    
    
    ThirdQuarter
    
    
    FourthQuarter
    
    
    TotalNet
      Sales
    
    $
    8,302
    
    $
    12,132
    
    $
    13,818
    
    $
    13,911
    
    $
    48,223Operating
      Loss
    
    $
    (152
    )
    $
    (890
    )
    $
    (987
    )
    $
    (462
    )
    $
    (2,491
    )Net
      Loss
    
    $
    (202
    )
    $
    (955
    )
    $
    (1,066
    )
    $
    (731
    )
    $
    (2,954
    )Basic
      and Diluted Lossper
      Common Share
    
    $
    (0.07
    )
    $
    (0.31
    )
    $
    (0.34
    )
    $
    (0.23
    )
    $
    (0.95
    )
  54
 **NOTE
20. SUBSEQUENT EVENTS**
  On
January 4, 2005, the Company purchased 100% of the stock of North American Home
Health Supply, Inc. (“NAHH”), a California corporation. NAHH is engaged
primarily in the retail HIV/AIDS pharmacy and prescription nutritional supply
business in California. The Company intends to incorporate the Home Health
Supply business into its existing operations in California. The Company paid
total consideration of $7,067,178.
  **Purchase
      Price Paid**Cash
      paid at closing
    
    $
    5,000,000Cash
      Payment for Working Capital
    
    
    311,981Notes
      Payable
    
    
    1,375,000Fair
      value of warrants issued
    
    
    241,760Direct
      acquisition costs
    
    
    500,000Total
      Purchase Price
    
    
    7,428,741less:
      net tangible assets
    
    
    (361,563
    )$
    7,067,178**Allocation
      of Purchase Price**Covenant
      Not to Compete (five year life)
    
    
    50,000Referral
      Lists (fifteen year life)
    
    
    4,514,331Goodwill
    
    
    2,502,847$
    7,067,178
  The
following pro forma results were developed assuming the acquisition of NAHH
occurred January 1, 2003. In addition, we have assumed that the sale of the
Company’s Series D and E convertible preferred stock occurred on January 1,
2003.
  Year
      Ended
      December
      31, 2004
      (Unaudited)Revenue
    
    $
    80,006,659Net
      loss
    
    $
    (1,538,104
    )Basic
      and diluted loss per share
    
    $
    (0.50
    )
 
 On
February 28, 2005 the Company purchased 100% of the stock of Specialty
Pharmacies, Inc. (“SPI”) for aggregate consideration of approximately $7.9
million. SPI is engaged primarily in the business of providing HIV/AIDS pharmacy
services in Washington and California. In the transaction, the sellers received
cash, promissory notes of MOMS Pharmacy and warrants to purchase 351,438 shares
of common stock of Allion. The purchase price consisted of a combination of cash
and securities, which included $5,000,000 of cash paid prior to and at closing,
promissory notes due February 28, 2006, in the aggregate principal amount of
$2,500,000 and warrants issued by the Company to purchase an aggregate
of 351,438 shares of  Company common stock, at an exercise price of
$6.26 per share. The purchase price is subject to a post-closing adjustment
based on the amount of SPI’s working capital as of the closing. The Company will
reimburse Sellers up to a maximum of $200,000, for any amounts received by the
Company as a result of SPI’s qualifying for the California HIV Pilot
Program.
  On March
3, 2005, the Company entered into a letter of intent with Oris Medical Systems,
Inc., a California corporation based in San Diego. The letter contemplates a
potential software licensing agreement under which the Company would secure an
exclusive license from Oris Medical to use an electronic prescription writing
system (Ground Zero Software’s LabTrackerTM software) that is tailored to address
the needs of physicians who treat HIV and AIDS patients. Under such a license,
the Company would pay Oris Medical a per patient royalty fee (for patients using
the software) that would be capped at $40 million. The Company is not obligated
to enter into this software license or to complete any other transaction with
Oris Medical. However, to secure the exclusive right to negotiate a software
license with Oris Medical, or to negotiate an acquisition of Oris Medical, the
Company is making certain payments to Oris Medical. These payments are $50,000
per month in each of February, March, April, May and June 2005 to cover Oris
Medical’s monthly operating expenses. In addition, if the Company completes an
initial public offering of its common stock, the Company has agreed to pay Oris
Medical an additional $1 million within three days of completion of that
offering. In exchange for these payments, Oris Medical granted the Company an
exclusivity right to negotiate a definitive agreement through August 31, 2005.
The Company has the right, at its sole option, to extend this exclusivity period
for up to four successive one-month periods if the Company pays Oris Medical’s
monthly operating expenses for July-October 2005, up to $50,000 per month. The
Company may not reach a definitive agreement on either a licensing or
acquisition transaction with Oris Medical.
  55
 In March
2005, the Company decided to cease its operations in Texas and will complete
closing its facilities by June 30, 2005. For the year ended December 31, 2004,
Texas represented $4.5 million of the Company’s net sales. The Company’s lease
in Austin, Texas expires on June 30, 2005.
  In March
2005, the Company decided to cease serving transplant and oncology patients,
which are not areas where the Company plans to specialize going forward. Most of
these patients receive reimbursement from Medicare. Currently these patients are
served from the Company’s locations in Texas, Florida and New York and are
approximately $1.5 million of net sales. The Company may sell a portion of this
business to another pharmacy in return for a nominal amount.
   **ITEM
9.** **CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE**
  None.
  **ITEM
9A.**  **CONTROLS
AND PROCEDURES**
  EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES
  Under the
supervision and with the participation of our management, we evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures, as such term is defined in Rule 13a-15(e) promulgated under the
Securities Exchange Act of 1934, as amended as of the end of the period covered
by this annual report. Based on this evaluation management concluded that our
disclosure controls and procedures were effective in ensuring that all material
information required to be filed in this report has been made known to him in a
timely manner.
  CHANGES
IN INTERNAL CONTROLS OVER FINANCIAL REPORTING.
  There
have been no significant changes in our internal controls over financial
reporting that occurred during our last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.
  **ITEM
9B.**  **OTHER
INFORMATION**
  None.
  **PART
III**
  **ITEM
10.**  **DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT**
  The
following table sets forth the names, ages and principal positions of our
directors and executive officers as of March 25, 2005:
  **Name**
    **Age**
    **Position**Michael
      P. Moran
    44
    Chairman,
      President and Chief Executive OfficerJohn
      W. Colloton (2)(4)
    74
    DirectorJames
      B. Hoover (1)(2)(3)(4)
    50
    DirectorJohn
      Pappajohn (1)(2)(4)
    76
    DirectorDerace
      Schaffer, M.D (1)(4)
    56
    DirectorHarvey
      Z. Werblowsky, Esq.
    57
    DirectorRobert
      E. Fleckenstein, RPh
    51
    Vice
      President, Pharmacy OperationsMikeLynn
      Salthouse
    49
    Vice
      President, HIV SalesJames
      G. Spencer
    36
    Chief
      Financial Officer, Secretary and Treasurer
 
 
  
 (1)
    Member
      of the Compensation Committee
 (2)
    Member
      of the Audit Committee
 (3)
    Audit
      Committee Financial Expert
 (4)
    Member
      of Corporate Governance/Nominating
Committee
  *John
W. Colloton,* has
served as a director of Allion Healthcare since May 18, 2004. He is currently
Director Emeritus of the University of Iowa Hospitals and Clinics. Mr. Colloton
previously served as a director of Baxter International Inc. from 1989-2003 and
of Radiologix, Inc. from 1997-2002. From 1971 to 1993, Mr. Colloton served as a
director of the University of Iowa Hospitals and Clinics, and from 1993 through
the year 2000 he was vice president of the University of Iowa for Statewide
Health Services. Mr. Colloton also serves as a Lead Director of Wellmark, Inc.
(Iowa-South Dakota Blue Cross & Blue Shield).
  56
 *James
B. Hoover,* has
served as a director of Allion Healthcare since September 2003. Mr. Hoover has
served as the Managing Partner of Dauphin Capital Partners since 1998. Prior to
founding Dauphin Capital in 1998, Mr. Hoover was a General Partner of Welsh,
Carson, Anderson and Stowe, a management buy-out firm specializing in health
care and information services. Prior to joining WCAS, Mr. Hoover was a General
Partner of Robertson, Stephens & Co., an investment banking firm
specializing in the financing of emerging growth companies with a particular
emphasis on the health care industry. Mr. Hoover joined Robertson, Stephens in
1984. Mr. Hoover is a director of Quovadx Inc., and U.S. Physical Therapy, Inc.
two publicly traded companies, as well as a director of several private health
care companies. He is a member of the Special Projects Committee of Memorial
Sloan-Kettering Cancer Center. He received his MBA from the Graduate School of
Business at Indiana University. He holds a BS degree from Elizabethtown College
(Pennsylvania) where he presently serves as a member of the Board of Trustees
and Chairman of its Investment Committee. Our Board of Directors has determined
that Mr. Hoover is "independent" as such term is defined in Rule 4200 of the
National Association of Securities Dealers, Inc. listing standards. Our Board of
Directors has also determined that James B. Hoover, Chairman of our Audit
Committee, meets the SEC definition of an “audit committee financial expert” and
the additional “independence” requirements of NASD’s listing standards for audit
committee members.
  *Michael
P. Moran* , has
served as Chairman, President and Chief Executive Officer and as a member of our
Board of Directors since September 1997. From 1997 to 2002, Mr. Moran also
served as our Chief Financial Officer. From 1996 to September of 1997 Mr. Moran
was a Regional Vice President at Coram Healthcare, Inc. From 1990 to 1996 Mr.
Moran was a Regional Vice President for Chartwell Home Therapies, Inc. Prior to
1990, Mr. Moran held various sales and management positions at Critical Care
America, Inc. Mr. Moran received a B.A. in management from Assumption
College.
  *John
Pappajohn* , has
served as a director of Allion Healthcare since 1996. Since 1969, Mr. Pappajohn
has been the President and principal stockholder of Equity Dynamics, Inc., a
financial consulting firm, and the sole owner of Pappajohn Capital Resources, a
venture capital firm. Mr. Pappajohn has served on the Boards of over 40 public
companies and currently serves as a director of the following public companies;
MC Informatics, Inc., PACE Health Management Systems, Inc. and Patient
Infosystems, Inc. Mr. Pappajohn received his B.A. in Business from the
University of Iowa.
  *Derace
Schaffer, M.D.* , has
served as a director of Allion Healthcare since 1996. Dr. Schaffer is a founder
of Radiologix, Inc., a public company. Dr. Schaffer is the Chairman and CEO of
the IDE Group, P.C., one of the radiology practices with which Radiologix has a
contractual relationship. Dr. Schaffer was also CEO and President of the Lan
Group, a venture capital firm. Dr. Schaffer is a founder of Patient Infosystems,
Inc., a public company. Dr. Schaffer is a founder and director of Cardsystems,
Inc. Dr. Schaffer is a board certified radiologist. He received his postgraduate
radiology training at the Harvard Medical School and Massachusetts General
Hospital, where he served as Chief Resident. Dr. Schaffer is a member of Alpha
Omega Alpha, the national medical honor society, and until 2004 he was Clinical
Professor of Radiology at the University of Rochester School of Medicine. In
2004, Dr. Schaffer accepted a position as a professor at the Weill Medical
College of Cornell University.
  *Harvey
Z. Werblowsky, Esq.* , has
served as a director of Allion Healthcare since May 18, 2004. Since December
2003, he has been the general counsel of Kushner Companies, a real estate
organization. From December 1990 until December 2003, Mr. Werblowsky was a
partner at the law firm of McDermott Will & Emery LLP. Mr. Werblowsky
received a BA degree from Yeshiva University and a JD degree from New York
University School of Law.
  *Robert
E. Fleckenstein, RPh,* has
served as Vice President of Pharmacy Operations since January 2004 and is
responsible for national pharmacy operations. Mr. Fleckenstein has held
positions in pharmacy management for 20 years, with over 10 of those years in
specialty pharmacy. From 2000 to 2002, Bob served as Vice President of
Operations for CVS ProCare at its Pittsburgh distribution center. From 1997 to
2000 he served as Director of Pharmacy Services for Stadtlanders Drug Company.
Bob received his B.S. in Pharmacy from the University of Pittsburgh and his MBA
from the Katz Graduate School of Business at the University of
Pittsburgh.
  *James
G. Spencer,* has
served as our Chief Financial Officer, Secretary and Treasurer since May 18,
2004 and served as a consultant to us from October 2003 until becoming Chief
Financial Officer. Prior to joining Allion Healthcare, Mr. Spencer served as a
Vice President in the Health Care Investment Banking Group for Thomas Weisel
Partners starting in February 2002. Prior to that time, he served as Vice
President in the Health Care Investment Banking Group for Credit Suisse First
Boston from 1999 to 2002. Prior to 1999, Mr. Spencer worked at Alex. Brown and
Sons in Health Care Investment Banking. Mr. Spencer has a MBA from The Wharton
School of the University of Pennsylvania and a B. S. in Economics and Management
Statistics from the University of Maryland.
  57
 *MikeLynn
Salthouse, RN,* has
served a Vice President, HIV Sales since October 2002. Ms. Salthouse has worked
in the pharmaceutical industry for 20 years, including 9 years with Stadtlanders
and CVS ProCare. Ms. Salthouse served as Vice President, Sales and Vice
President, Business Development while with Stadtlanders and CVS ProCare. For the
years prior to 1993, Ms. Salthouse held sales management positions with both
Ivonyx and Clinical Homecare, infusion service companies, as well as various
sales and management positions at McNeil Consumer Products, a division of
Johnson & Johnson. Ms. Salthouse attended Loma Linda University and
graduated from Riverside College, both in Southern California.
  BOARD
COMMITTEES
  The
standing committees of our Board of Directors include the Audit Committee, the
Compensation Committee and the Corporate Governance/Nominating
Committee.
  The
members of the Audit Committee are John Colloton, James Hoover and John
Pappajohn. In 2005, Derace Shaffer will replace John Pappajohn as a member of
our Audit Committee. The Audit Committee provides assistance to the Board of
Directors in fulfilling their responsibility to the stockholders, potential
stockholders and the investment community relating to corporate accounting,
reporting practices of the corporation, and the quality and integrity
of our financial reports. In so doing, the Audit Committee is responsible
for maintaining free and open means of communication between the directors, the
independent auditors, the internal auditors and the financial management of the
corporation. Our Board of Directors has determined that James B. Hoover,
Chairman of the our Audit Committee, meets the SEC's definition of "audit
committee financial expert." The Audit Committee operates under a written
charter adopted by the Board of Directors. A copy of the Audit Committee Charter
is available on our website at www.allionhealthcare.com.
  The
members of the Compensation Committee are James Hoover, John Pappajohn, and
Derace Schaffer. The Chairman of the Compensation Committee is John Pappajohn.
The Compensation Committee is appointed by the Board of Directors to discharge
the Board of Directors' responsibilities relating to compensation of our
directors, officers and executives. The Compensation Committee has overall
responsibility for approving and evaluating the director, officer and executive
compensation, plans, policies and programs. The Compensation Committee operates
under a written charter adopted by the Board of Directors. A copy of the
Compensation Committee Charter is available on our website at
www.allionhealthcare.com.
  The
members of the Corporate Governance/Nominating Committee are John Colloton,
James Hoover, John Pappajohn, and Derace Schaffer. Mr. Hoover has been appointed
as Chairman of the Corporate Governance/Nominating Committee. The Corporate
Governance/Nominating Committee: (i) assists the Board of Directors by
identifying individuals qualified to become Board members and recommends to the
Board the director nominees for the next annual meeting of stockholders, (ii)
recommends to the Board the corporate governance guidelines and (iii) takes a
leadership role in shaping our corporate governance. The Corporate
Governance/Nominating Committee evaluates the current Board members at the time
they are considered for nomination. The Corporate Governance/Nominating
Committee also considers whether any new members should be added to the Board.
The Corporate Governance/Nominating Committee operates under a written charter
adopted by the Board of Directors. A copy of the Corporate Governance/Nominating
Committee charter is available on our website at
www.allionhealthcare.com.
  As
provided in its charter, the Corporate Governance/Nominating Committee seeks to
select individuals as director nominees who shall have the highest personal and
professional ethics integrity and values, who are committed to representing the
long-term interests of the stockholders and capable of an objective perspective,
who have mature judgment and experience at policy-making levels, who are willing
to devote sufficient time to carrying out their duties and responsibilities
effectively, and who are committed to serve on the Board of Directors for an
extended period of time. The Corporate Governance/Nominating Committee will also
consider the current composition of the Board of Directors and select nominees
that fit the perceived needs of the Board of Directors in terms of independence,
background and experience with public company governance, finance, marketing and
the healthcare industry, as they are relevant to our then-current activities.
  58
 The
Corporate Governance/Nominating Committee determines the current needs of the
Board and screens candidates to determine whether a nominee meets the general
requirements. The Corporate Governance/Nominating Committee will consider
recommendations from our stockholders of potential candidates for nomination as
director. In the case of a stockholder nominee, before the Corporate
Governance/Nominating Committee will screen the candidate the following
information must be supplied: a current and complete resume, a statement of the
candidate's share ownership and ten (10) references, including both professional
and personal references. If this information is supplied, the Corporate
Governance/Nominating Committee will subject the candidate to a similar
screening process as is used for an internal nomination.
  CODE OF
ETHICS
  We have
adopted a Code of Ethics that applies to all of our executive officers and
directors, including the chief executive officer, chief financial financer,
chief accounting officer, and controller, a copy of which was filed as Exhibit
14.1 to 2003 Form 10-KSB. The Audit Committee of our Board of Directors is
responsible for reviewing and authorizing any waivers from the Code of Ethics,
and we will file any waivers from, or amendments to, this code with the
Securities and Exchange Commission. The Code of Ethics and the charters for our
audit committee, nominating and corporate governance committee and compensation
committee, are available on our website, www.allionhealthcare.com . This
information is also available in print, at no cost, upon written request to
our Secretary at the address set forth above.
  COMPENSATION
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
  None of
the members of the Compensation Committee of our Board of Directors is or has
ever been an officer or employee of Allion Healthcare, Inc. or any of its
subsidiaries. None of our executive officers serves as a member of the Board of
Directors or compensation committee of any entity that has one or more executive
officers serving on our Board of Directors or our Compensation Committee.
  59
 **ITEM
11.**  **EXECUTIVE
COMPENSATION AND OTHER INFORMATION**
  The
following table sets forth all compensation received for services rendered to us
in all capacities for the years ended December 31, 2004, 2003 and 2002, by (i)
each person who served as our Chief Executive Officer during the year ended
December 31, 2004 and (ii) each of our other executive officers who were serving
as executive officers as of December 31, 2004:
  **Summary
Compensation Table**
 Annual
      Compensation
    
    Long-Term
      CompensationAwards
    
    PayoutsName
      and Principal
      Position
    
    Year
    
    Salary
      ($)
    
    Bonus
      ($)
      (1)
    
    Other
      Annual Compensation ($)(2)
    
    Restricted
      Stock
      Award(s)
      ($)
    
    Securities
      Underlying Options/
      (#)
    
    LTIP
      Payouts
      ($)
    
    All
      Other Compensation ($)Michael
      P. Moran,
    
    
    2004
    
    $
    251,924
    
    $
    100,000
    
    $
    0
    
    $
    0
    
    
    0
    
    $
    0
    
    $
    0Chairman,
    
    
    2003
    
    $
    247,483
    
    $
    100,000
    
    $
    0
    
    $
    0
    
    
    0
    
    $
    0
    
    $
    0President,
      Chief
    
    
    2002
    
    $
    247,569
    
    $
    0
    
    $
    0
    
    $
    0
    
    
    50,000
    
    $
    0
    
    $
    0Executive
      OfficerJames
      G. Spencer,
    
    
    2004
    
    $
    151,538
    (3)
    $
    20,000
    
    $
    0
    
    $
    0
    
    
    125,000
    
    $
    0
    
    $
    0Chief
      FinancialOfficer,
      Secretaryand
      TreasurerMikelynn
      Salthouse,
    
    
    2004
    
    $
    169,204
    
    $
    10,000
    
    $
    7,200
      (4
    )
    $
    0
    
    
    40,000
    
    $
    0
    
    $
    0Vice
      President,
    
    
    2003
    
    $
    150,000
    
    $
    0
    
    $
    7,200
      (4
    )
    $
    0
    
    
    0
    
    $
    0
    
    $
    0HIV
      Sales
    
    
    2002
    
    $
    40,385
    
    $
    0
    
    $
    1,650
      (4
    )
    $
    0
    
    
    75,000
    
    $
    0
    
    $
    0Robert
      E. Fleckenstein, RPh,
    
    
    2004
    
    $
    131,000
    
    $
    18,750
    
    $
    0
    
    $
    0
    
    
    50,000
    
    $
    0
    
    $
    0Vice
      President ofPharmacy
      Operations
  (1)
    Bonuses
      were paid at the discretion of the Compensation Committee from time to
      time during 2004 based on merit-based performance. We do not have a
      written bonus plan.
  (2)
    For
      the years presented perquisites and other personal benefits did not exceed
      the lesser of $50,000 or 10% of total annual salary and bonus for the
      named executive officer.
  (3)
    Mr.
      Spencer became our Chief Financial Officer on May 18, 2004. The amount
      shown in the table above represents the amount we paid Mr. Spencer from
      May 20 through December 31, 2004. In addition to the amount shown above,
      Mr. Spencer served as a consultant to us from January 1 until May 17, 2004
      during which time he was paid a fee of
$23,681.
  (4)
    This
      reflects amounts paid to Ms. Salthouse for an annual automobile
      allowance.
  **Options
Grants in Last Fiscal Year (Individual Grants)**
  Name
    Securities
      Underlying
      Options(1)
    Percentage
      of
      Total
      Options
      Granted
    Exercise
      Price
    Expiration
    Grant
      Date
      Present
      Value
      (2)Michael
      P. Moran
    0
    0%
    —
    —
    —James
      G. Spencer
    125,000
    21%
    $6.00
    5/18/2014
    $235,938Mikelynn
      Salthouse
    40,000
    7%
    $6.00
    5/18/2014
    $66,300Robert
      E. Fleckenstein
    50,000
    9%
    $6.00
    5/18/2014
    $82,875
 (1)
    The
      options granted in 2004 were issued on May 18 and vest ratably over a
      four-year period on the date of grant, except that the options issued to
      Mr. Spencer were vested 25% on the date of grant and vest 33-1/3% on each
      of the first three anniversaries of the date of
grant.
 (2)
    Calculated
      using the same methodology as used in Black-Scholes option valuation model
      as used in Note 2 to our consolidated financial statements set forth in
      Item 8 of this Report.
  60
 **Aggregated
Stock Option Exercises in Last Fiscal Year and Fiscal Year-end Option
Values**
  The
following table sets forth the number of exercisable and unexercisable options
held by our named executive officers at December 31, 2004. The option value of
$6.26 per share was determined by comparison to the offering price of our Series
E Preferred Stock.
  Name
    Shares
      acquired on exercise (#)
    Value
      Realized
      ($)
    Number
      of SecuritiesUnderlying UnexercisedOptions atFiscal
      Year-EndExercisable/Unexercisable (#)
    Value
      of Unexercised
      In-the-MoneyOptions
      atFiscal Year End
      Exercisable/Unexercisable
      ($)Michael
      P. Moran
    —
    —
    648,611
      / 1,389
    3,696,181
      / 3,819James
      G. Spencer
    —
    —
    31,250
      / 93,750
    15,625
      / 15,625Mikelynn
      Salthouse
    —
    —
    72,917
      / 42,083
    203,021
      / 13,229Robert
      E. Fleckenstein
    —
    —
    0 /
      50,000
    3,125
      / 9,375
 
 DIRECTOR
COMPENSATION
  Our
directors do not receive cash compensation for serving on our board, but the
non-employee directors are eligible to receive stock options for our common
stock. We do not have a formal policy regarding the granting of stock options to
our directors. In 2004, each of our non-employee directors received 20,000
options for their service as board members. These options have an exercise price
of $6.00 and vest over a period of one year. In 2004, John Colloton and
Harvey Werblowsky received 50,000 options for joining the Board of Directors.
These options have an exercise price of $6.00 and vest over a period of three
years. In 2004, Mr. Moran did not receive compensation for his services as a
director.
  EMPLOYMENT
AGREEMENTS
  Currently,
we do not have any written employment agreements with any of our executive
officers. The risks associated with not having employment agreements with our
executive officers is discussed at Item 7 of this Report under the heading “Risk
Factors—Risks Related to Our Company.”
  COMPENSATION
COMMITTEE REPORT ON EXECUTIVE COMPENSATION
  The
Compensation Committee of the Board of Directors is responsible for determining
the Company’s executive compensation policies, developing compensation incentive
plans and programs, reviewing and approving the compensation of the Company's
chief executive officer and making grants of stock options.
  *Philosophy* . The
compensation philosophy of the Company is to develop and implement policies that
will encourage and reward outstanding financial performance and increase the
profitability of the Company, thereby increasing stockholder value. Maintaining
competitive compensation levels in order to attract, retain and reward
executives who bring valuable experience and skills to the Company is also an
important consideration.
  As of the
end of December, 2004, the Compensation Committee was composed of James Hoover,
John Pappajohn and Derace Schaffer, M.D. with Mr. Pappajohn serving as the
Committee Chairperson. Working with the Company, the Compensation Committee
develops and implements compensation arrangements for the Company’s executive
officers.
  *Compensation
Structure* . There
are three primary components of executive compensation for the Company’s
executive officers: base salary, bonus and stock option grants. While the
elements of compensation are considered separately, the Compensation Committee
takes into account the total compensation package afforded by the Company to the
individual executive.
  61
 *Base
Salary.* Base
salaries for the Company’s executive officers are determined initially by
evaluating the responsibilities of the position held and the experience of the
individual in light of the Company’s compensation philosophy described above. No
specific formula is applied in setting an executive officer’s base salary,
either with respect to the total amount of such base salary or the relative
value such base salary should bear to the executive officer’s total compensation
package. Salaries paid to executive officers (including the Chief Executive
Officer) are reviewed annually by the Compensation Committee and proposed
adjustments are based upon an assessment of the nature of the position and the
individual’s contribution to the Company’s corporate goals, experience and
tenure of the executive officer, comparable market salary data, growth in the
Company’s size and complexity and changes in the executive’s responsibilities.
The Compensation Committee approves all changes to executive officers’
salaries.
  *Bonus* . The
Compensation Committee, in its discretion, may award bonuses to executive
officers. Such bonuses are based upon: an executive officer’s performance as
well as the performance of the Company, such as the consummation of an important
acquisition or financing, meeting or exceeding sales targets or recognition of
superior performance. In 2004, the Compensation Committee approved all bonuses
paid to the named executive officers.
  *Stock
Options.* Stock
options are designed to align the interests of executives with those of the
Company’s stockholders. At this time, stock options are the only form of equity
that an executive officer of the Company is entitled to receive. Stock option
grants may be made to executive officers when one of the following events
occurs: (i) upon initial employment, (ii) upon promotion to a new, higher
position that entails increased responsibilities and accountability, (iii) for
recognition of superior performance or (iv) as an incentive for continued
service with the Company as well as continued superior performance.
  *Chief
Executive Officer Compensation.* Mr.
Moran does not have an employment agreement with the Company. The Compensation
Committee determined that Mr. Moran was entitled to a bonus of $100,000 based
upon, among other things, the pursuit of several strategic acquisitions for the
company. Mr. Moran did not receive an increase in salary nor did he receive any
stock options during the year ended December 31, 2004.
  *Executive
Officer Compensation* . In
addition to the factors mentioned above, the Compensation Committee’s general
approach in setting executive officer compensation is to seek to be competitive
with other companies in the Company’s industry and to get the best talent for
the applicable management position. In determining bonuses, the Compensation
Committee reviews the Company’s performance as a whole as well as all of the
executive officer’s achievements. Other than the Company’s former chief
financial officer, no executive officers of the Company were employed by
employment agreement during the year ended December 31, 2003. None of our
executive officers, outside the Chief Executive Officer, were given cash bonuses
during 2003. Stock options are awarded to executive officers by the Compensation
Committee according to the factors mentioned above. None of our executive
officers were granted stock options during 2003. The Compensation Committee
feels that actions taken regarding executive compensation are appropriate in
view of the individual and corporate performance.
  *Policy
Regarding Section 162(m) of the Internal Revenue Code* . In the
event total compensation for any named executive officer exceeds the $1 million
threshold at which tax deductions are limited under Internal Revenue Code
Section 162(m), the Compensation Committee intends to balance tax deductibility
of executive compensation with its responsibility to retain and motivate
executives with competitive compensation programs. As a result, the Compensation
Committee may take such actions as it deems to be in the best interests of the
stockholders, including (i) provide non-deductible compensation above the $1
million threshold; (ii) require deferral of a portion of the bonus or other
compensation to a time when payment may be deductible by the Company; and/or
(iii) modify existing programs to qualify bonuses and other performance-based
compensation to be exempt from the deduction limit.
  This
report by the Compensation Committee shall not be deemed to be incorporated by
reference by any general statement incorporating by reference this Proxy
Statement into any filing under the Securities Act or the Exchange Act and shall
not otherwise be deemed filed under such Acts.
  Submitted
by the Compensation Committee of the Company’s board of directors
  James B.
Hoover
 John
Pappajohn
 Derace
Schaffer, M.D.
  62
 **ITEM
      12.**
    **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS**
  The
following table sets forth certain information as of March 25, 2005 regarding
the beneficial ownership of our capital stock by (i) each person known by us to
own more than five percent of the our outstanding capital stock;(ii) each of our
directors and named executive officers and (iii) all of our directors and named
executive officers as a group. Except as indicated in the footnotes to this
table and under applicable community property laws, to our knowledge, the
persons named in the table have sole voting and investment power with respect to
all shares of common stock. Options exercisable on or before May 25, 2005, are
included as shares beneficially owned. For the purposes of calculating percent
ownership as of March 25, 2005, we had issued and outstanding: 3,100,000
shares of our common stock; 512,500 shares of our Series A Preferred Stock;
666,668 shares of our Series B Preferred Stock; 1,235,000 shares of our
Series C Preferred Stock; 1,491,828 shares of our Series D Preferred
Stock; 664,013 shares of our Series E Preferred Stock; and, for any
individual who beneficially owns shares represented by options exercisable on or
before May 25, 2005 or shares of preferred stock convertible on or before May
25, 2005. These shares are treated as if outstanding for purposes of determining
ownership of a particular class of our securities for that person, but not for
any other person. The heading Fully Diluted is intended to reflect ownership of
our common stock assuming holders of our outstanding preferred stock converted
their shares on March 25, 2005, and for any particular person, shares issuable
upon exercise of options on or before May 25, 2005. Unless otherwise indicated,
the address of each of the individuals and entities named below is: c/o Allion
Healthcare, Inc., 1660 Walt Whitman Road, Suite 105, Melville, New York
11747.
  **Security
Ownership Table**
 
 **Shares
      of****Preferred
      Stock, Series:****Name**
    
    **CommonStock**
    
    **%
      ofCommonStock**
    
    **A**
    
    **%
      of A**
    
    **B**
    
    **%
      of B**
    
    **C**
    
    **%
      of C**
    
    **D**
    
    **%
      of D**
    
    **E**
    
    **%
      of E**
    
    **%
      of All**John
      Pappajohn (1)
    
    
    1,657,500
    
    
    44.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    100,000
    
    
    8.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    20.1
    %2116
      Financial Ctr.Des
      Moines, IA 50309Principal
      Life Insurance Company (2)
    
    
    733,334
    
    
    19.1
    %
    
    —
    
    
    —
    
    
    333,334
    
    
    50.0
    %
    
    400,000
    
    
    32.4
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    9.6
    %711
      High StreetDes
      Moines, IA 50392Edgewater
      Private Equity Fund II, L.P. (3)
    
    
    637,373
    
    
    20.2
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    50,000
    
    
    4.0
    %
    
    —
    
    
    —
    
    
    7,137
    
    
    1.1
    %
    
    8.3
    %900
      N. Michigan Ave., 14th FlChicago,
      IL 60611Michael
      P. Moran (4)
    
    
    648,611
    
    
    17.3
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    7.8
    %1660
      Walt Whitman Road, Suite 105Mellville,
      NY 11747Gary
      Kirke (5)
    
    
    500,000
    
    
    13.9
    %
    
    500,000
    
    
    97.6
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    6.5
    %417
      Locust StreetDes
      Moines, IA 50309Derace
      Schaffer, MD (6)
    
    
    418,611
    
    
    13.0
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    5.4
    %3489
      Elmwood Ave.Rochester,
      NY 14610Gainesborough
      Investments, L.L.C. (7)
    
    
    333,334
    
    
    9.7
    %
    
    —
    
    
    —
    
    
    333,334
    
    
    50.0
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    4.3
    %420
      Bedford St., Ste. 110Lexington,
      MA 02420James
      B. Hoover (8)
    
    
    371,944
    
    
    11.8
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    320,000
    
    
    25.9
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    4.8
    %1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747Crestview
      Capital Master L.L.C. (9)
    
    
    326,500
    
    
    9.5
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    166,500
    
    
    11.2
    %
    
    160,000
    
    
    24.1
    %
    
    4.3
    %95
      Revore Drive, Ste. ANorthbrook,
      IL 60062Dauphin
      Capital Partners, LP (10)
    
    
    300,000
    
    
    8.8
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    300,000
    
    
    24.3
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    3.9
    %108
      Forest Ave., Locust Valley, NY 11560Northwest
      Holdings, Ltd.
    
    
    250,000
    
    
    8.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    3.3
    %4th
      Floor, Bank of Nova Scotia Bldg., PO Box 1068Georgetown,
      Grand Cayman,Cayman
      IslandsSands
      Brothers Venture Capital LLC (11)
    
    
    200,000
    
    
    6.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    200,000
    
    
    16.2
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    2.6
    %90
      Park Ave.,New
      York, NY 10016Presidio
      Partners LP (12)
    
    
    166,668
    
    
    5.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    166,668
    
    
    11.2
    %
    
    —
    
    
    —
    
    
    2.2
    %44
      Montgomery Street, Suite 2110San
      Francisco, CA 94104Joseph
      Giamanco (13)
    
    
    215,000
    
    
    6.5
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    40,000
    
    
    3.2
    %
    
    —
    
    
    —
    
    
    50,000
    
    
    7.5
    %
    
    2.8
    %Four
      Whiterock TerraceHolmodel,
      NJ 07733Peter
      Nordin APS (14)
    
    
    125,000
    
    
    3.9
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    125,000
    
    
    8.4
    %
    
    —
    
    
    —
    
    
    1.6
    %Bakkeuej
      2ADU-3070
      SuekkerstenPhillip
      Roy Fund LLP (15)
    
    
    100,000
    
    
    3.1
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    100,000
    
    
    15.1
    %
    
    1.3
    %28463
      US 19 North, Suite 102Clearwater,
      FL 33761Thominvest
      OY (16)
    
    
    83,333
    
    
    2.6
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    83,333
    
    
    5.6
    %
    
    —
    
    
    —
    
    
    *Italahdenkatu
      15-17Helsinki,
      FinlandJohn
      Colloton (17)
    
    
    16,667
    
    
    0.5
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    *1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747Harvey
      Werblowsky (18)
    
    
    16,667
    
    
    0.5
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    *1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747Mikelynn
      Salthouse (19)
    
    
    82,917
    
    
    2.6
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    *1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747James
      G. Spencer (20)
    
    
    62,500
    
    
    *
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    *1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747Robert
      Fleckenstein (21)
    
    
    12,500
    
    
    *
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    *1660
      Walt Whitman Road, Suite 105Melville,
      NY 11747All
      officers and directors as a group
    
    
    3,287,917
    
    
    70.4
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    420,000
    
    
    34.0
    %
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    35.6
    %(9
      persons)
 63
 
  Security Ownership Table
(continued)
  (1)
    Includes
      375,000 shares held by Halkis, Ltd., a sole proprietorship owned by Mr.
      Pappajohn and 250,000 shares held by Thebes, Ltd., a sole proprietorship
      owned by Mr. Pappajohn’s spouse. Includes 70,000 shares of Common Stock
      issuable upon exercise of options, 487,500 shares of Common Stock issuable
      upon exercise of warrants and 100,000 shares of Common Stock issuable upon
      conversion of Series C Preferred.(2)
    Includes
      333,334 shares of Common Stock issuable upon conversion of shares of
      Series B Preferred and 400,000 shares of Common Stock issuable upon
      conversion of shares of Series C Preferred.(3)
    Includes
      50,000 shares of Common Stock issuable upon conversion of shares of Series
      C Preferred.(4)
    Represents
      648,611 shares of Common Stock issuable upon exercise of
      options.(5)
    Includes
      500,000 shares of Common Stock issuable upon conversion of shares of
      Series A Preferred.(6)
    Includes
      118,611 shares of Common Stock issuable upon exercise of
      options.(7)
    Includes
      333,334 shares of Common Stock usable upon conversion of shares of Series
      C Preferred.(8)
    Represents
      51,944 shares of Common Stock issuable upon exercise of options and 15,000
      shares issuable upon conversion of shares of the Series C. Includes
      Dauphin Capital Partners, LP ownership and 5,000 shares owned by TriSons
      (controlled by Mr. Hoover and his spouse).(9)
    Represents
      166,500 shares of Common Stock issuable upon conversion of shares of the
      Series D Preferred and 160,000 shares of Common Stock issuable upon
      conversion of shares of the Series E Preferred.(10)
    Includes
      300,000 shares of Common Stock issuable upon conversion of shares of
      Series C Preferred.(11)
    Includes
      30,000 shares of Common Stock held by Sands Brother Venture Capital II LLC
      issuable upon conversion of shares of Series C Preferred, 100,000 shares
      of Common Stock held by Sands Brothers Venture Capital III LLC issuable
      upon conversion of shares of Series C Preferred, and 40,000 shares of
      Common Stock held by Sands Brothers Venture Capital IV LLC issuable upon
      conversion of shares of Series C Preferred. Sands Brothers Venture Capital
      LLC disclaims beneficial ownership of the shares held by Sands Brothers
      Venture Capital II LLC, Sands Brothers Venture Capital III LLC and Sands
      Brothers Venture Capital IV LLC.(12)
    Represents
      166,668 shares of Common Stock issuable upon conversion of shares of the
      Series D Preferred owned by Presidio Partners LP, Geary Partners L.P.,
      Brady Retirement Fund LP and Presidio Offshore
    International.(13)
    Represents
      40,000 shares of Common Stock issuable upon conversion of shares of the
      Series C Preferred and 50,000 shares of Common Stock issuable upon
      conversion of shares of the Series E Preferred.(14)
    Represents
      125,000 shares of Common Stock issuable upon conversion of shares of the
      Series D Preferred.(15)
    Represents
      100,000 shares of Common Stock issuable upon conversion of shares of the
      Series E Preferred.(16)
    Represents
      83,333 shares of Common Stock issuable upon conversion of shares of the
      Series D Preferred.(17)
    Represents
      16,667 shares of Common Stock issuable upon exercise of
      options.(18)
    Represents
      16,667 shares of Common Stock issuable upon exercise of
      options.(19)
    Represents
      82,917 shares of Common Stock issuable upon exercise of
      options.(20)
    Represents
      62,500 shares of Common Stock issuable upon exercise of
      options.(21)
    Represents
      12,500 shares of Common Stock issuable upon exercise of
      options.
 
 64
 
  **ITEM
13.**  **CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS**
  In
January 2000, 375,000 common stock warrants with an exercise price of $1.00
were issued to John Pappajohn, a director as consideration for his guarantee of
a $1,500,000 credit facility with West Bank. As
consideration for the renewal of his guarantee, we issued warrants to
purchase 125,000 shares of common stock to Mr. Pappajohn in July 2003,
exercisable at a price per share of $5.00. The warrants expire ten years from
the date of grant, if not exercised. The terms of the credit line with West Bank
are discussed above in Item 7 under the heading "Liquidation and Capital
Resources."
  **ITEM
14.**  **PRINCIPAL
ACCOUNTANT FEES AND SERVICES**
  The
aggregate fees billed by BDO Seidman, LLP for professional services rendered for
the years ended December 31, 2004 and December 31, 2003 were
  2004
    
    2003Audit
      Fees
    
    $
    99,000
    
    $
    97,239Audit-Related
      Fees
    
    
    11,292
    
    
    111,432Tax
      Related Fees
    
    
    12,500
    
    
    13,250Total
      Fees
    
    $
    122,792
    
    $
    221,921
 
 Audit
fees consist of professional services rendered for the annual audit for our
financial statements and the quarterly reviews of the financial
statements.
  The
aggregate fees billed for all audit-related services rendered by BDO for the
years ended December 31, 2004 and 2003 principally covered due diligence in
connection with acquisitions, accounting consultations, audits and consultations
in connection with dispositions.
  The
aggregate amount billed for all tax fees for the years ended December 31, 2004
and 2003 , principally covered preparing and filing our federal consolidated and
state tax returns.
  No other
professional services were rendered or fees were billed by BDO for the most
recent fiscal year or for the year ending December 31, 2003.
  The Audit
Committee has adopted policies and procedures for the pre-approval of the above
fees. All requests for services to be provided by BDO are submitted to the Audit
Committee. Requests for all non-audit related services require pre-approval from
the entire Audit Committee. A schedule of approved services is then reviewed and
approved by the entire Audit Committee at each Audit Committee
meeting.
  **PART
IV**
 ****
 **ITEM
15.**  **EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES**
  The
following documents are filed as part of this report.
 
 (1)
    Financial Statements. The financial statements are set
      forth under Item 8 of this report on Form 10-K.
 
 (2)
    Schedules.
      An index of Exhibits and Schedules is on page 68 of this Report.
      Schedules other than those listed below have been omitted from this Report
      because they are not required, are not applicable or the required
      information is included in the financial statements or the notes
      thereon.
  INDEX TO
FINANCIAL STATEMENTS, SUPPLEMENTARY DATA AND FINANCIAL STATEMENT
SCHEDULES
  Page
      Numbering
      Form
      10-KSchedules:Valuation
      and Qualifying Accounts
    
    
    71
 (3)
    Exhibits.
      The exhibits listed in the accompanying Exhibit Index are filed or
      incorporated by reference as part of this
Report.
   FINANCIAL
STATEMENTS AND SCHEDULES
  All other
schedules are omitted because they are not applicable or the required
information is shown in the Audited Consolidated Financial Statements or the
notes thereto.
  65
 
   **SIGNATURES**
 In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
  ALLION HEALTHCARE,
      INC.Date: March  29,
      2005
    By:
    /s/ James SpencerJames
      Spencer
      Secretary,
      Treasurer and Chief Financial Officer
 
 In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
  
 /s/
      Michael P. Moran
      Michael P. Moran, Chairman,
      President
      and Chief Executive Officer
      Date:
      March 29, 2005/s/
      John Pappajohn
      
      John
      Pappajohn, Director
      Date:
      March 29, 2005/s/
      Derace Schaffer
      Derace Schaffer, M.D., Director
      Date: March 29, 2005/s/
      James Hoover
      James Hoover, Director
      Date: March 29, 2005/s/
      Harvey Werblowsky
      Harvey
      Werblowsky, Director
      Date:
      March 29, 2005/s/
      John Colloton
      John Colloton, Director
      Date: March 29,
2005
 
 
 66
  **Supplemental Information to be Furnished With Reports
Filed**
 **Pursuant
to Section 15(d) of the Act by Registrants Which Have Not
Registered**
 **Securities
Pursuant to Section 12 of the Act**
  Allion Healthcare,
Inc. has not furnished, and does not intend to furnish, an annual report to
its stockholders covering the 2004 fiscal year nor does it intend to
furnish a proxy statement or other soliciting materials to its stockholders in
2005.
  67
 EXHIBIT
INDEX
  2.1
    Confirmation
      Order dated February 1, 1999. (Incorporated by reference to Exhibit 2.1 to
      the Registrant's Current Report on Form 8-K filed on October 10,
      1999.)
  2.2
    First
      Amended Plan of Reorganization of The Care Group, Inc., et al dated
      January 2, 1998. (Incorporated by reference to Exhibit 2.2 to the
      Registrant's Current Report on Form 8-K filed on October 10,
      1999.)
  2.3
    Stock
      Purchase Agreement, dated as of May 1, 2003, among MOMs Pharmacy, Inc., as
      buyer, Allion Healthcare, Inc. as parent, and Darin A Peterson and Allan
      H. Peterson collectively as sellers. (Incorporated by reference to Exhibit
      2.1 to the Registrant’s Current Report on Form 8-K filed on May 16,
      2003.)
  2.4
    Stock
      Purchase Agreement by and among MOMS Pharmacy, Inc. and Michael Stone and
      Jonathan Spanier dated as of January 4, 2005 (Incorporated by reference to
      Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on
      January 10, 2005.)
  2.5
    Stock
      Purchase Agreement by and among MOMS Pharmacy, Inc. and Pat Iantorno, Eric
      Iantorno, Jordan Iantorno, Jordan Iantorno A/C/F Max Iantorno, Michael
      Winters and George Moncada dated as of February 28, 2005.(Incorporated by
      reference to Exhibit 10.1 to the Registrant’s Current Report of Form 8-K
      filed on March 4, 2005.)
 
 3.2
    Amended and Restated Certificate of Incorporation of the
      Registrant (Incorporated
      by reference to Exhibit A to the Registrant’s proxy statement filed on
      June 4, 2003.)
 
 3.3
    Certificate
      of Designation of Rights and Preferences of Series A Preferred Stock of
      Allion Healthcare, Inc. *
 
 3.4
    Amended
      and Restated Certificate of Designation of Rights and Preferences of
      Series B Preferred Stock of Allion Healthcare, Inc.
*
 
 3.5
    Certificate
      of Designation of Rights and Preferences of Series C Preferred Stock of
      Allion Healthcare, Inc. (Incorporated by reference to Exhibit 3.1 to the
      Registrant’s Annual Report on Form 10-KSB filed on April 16,
    2003.)
 
 3.6
    Certificate
      of Designation of Rights and Preferences of Series D Preferred Stock of
      Allion Healthcare, Inc. *
 
 3.8
    Certificate
      of Designation of Rights and Preferences of Series E Preferred Stock of
      Allion Healthcare, Inc. (Incorporated by reference to Exhibit 3.1 to the
      Registrant’s Current Report on Form 8-K filed on December 20,
    2004.)
 
 3.2
    Second
      Amended and Restated By-laws of the Registrant. (Incorporated by reference
      to Exhibit 3.2 to the Registrant’s Annual Report on Form 10-KSB filed on
      April 15, 2003.)
  4.1
    Warrant
      to Purchase Common Stock of Allion Healthcare, Inc. issued to Darin A.
      Peterson, as of May 1, 2003 (Incorporated by reference to Exhibit 4.1 to
      the Registrant’s Current Report on Form 8-K filed on May 16,
      2003.)
  4.2
    Warrant
      to Purchase Common Stock of Allion Healthcare, Inc. issued to Allan H.
      Peterson, as of May 1, 2003 (Incorporated by reference to Exhibit 4.2 to
      the Registrant’s Current Report of Form 8-K filed on May 16,
      2003.)
  68
 4.3
    Warrants
      to Purchase Common Stock of Allion Healthcare, Inc. issued to the former
      owners of North American Home Health Supply, Inc., as of January 4, 2005
      (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current
      Report of Form 8-K filed on January 10,
2005.)
  4.4
    Warrant
      to Purchase Common Stock of Allion Healthcare, Inc. issued to the former
      owners of Specialty Pharmacies Inc., as of February 28, 2005 (Incorporated
      by reference to Exhibit 3.1 to the Registrant’s Current Report of Form 8-K
      filed on March 4, 2005.)
  4.5
    Subordinated
      Secured Promissory Note of Allion Healthcare, Inc. dated as of May 1,
      2003, in the principal amount of $1,187,500, issued to Darin A. Peterson
      (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current
      Report on Form 8-K filed on May 16, 2003.)
  4.6
    Subordinated
      Secured Promissory Note of Allion Healthcare, Inc., dated as of May 1,
      2003, in the principal amount of $62,500, issued to Allan H. Peterson
      (Incorporated by reference to Exhibit 10.3 to the Registrant’s Current
      Report on Form 8-K filed on May 16, 2003.)
  4.7
    Subordinated
      Secured Promissory Notes of Allion Healthcare, Inc., dated as of January
      4, 2005, in the aggregate amount of $1,375,000, issued to the former
      owners of North American Home Health Supply, Inc. (Incorporated by
      reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K
      filed on January 10, 2005.)
  4.8
    Subordinated
      Secured Promissory Notes of Allion Healthcare, Inc., dated as of February
      28, 2005, in the aggregate amount of $1,900,000, issued to the former
      owners of Specialty Pharmacies, Inc. (Incorporated by reference to Exhibit
      10.4 to the Registrant’s Current Report on Form 8-K filed on March 4,
      2005.)
  4.9
    Continuing
      Guaranty of Allion Healthcare, Inc. Indebtedness to West Des Moines State
      Bank by Guarantor John Pappajohn dated as of December 16, 1999.
      (Incorporated by reference to Exhibit 4.7 to the Registrant’s Annual
      Report on Form 10-KSB filed on April 14,
2004)
  4.10
    Guaranty
      given by Allion Healthcare, Inc. to and for the benefit of Michael Stone
      and Jonathan Spanier dated as of January 4, 2005 (Incorporated by
      reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K
      filed on January 10, 2005.)
  10.1
    Registration
      Rights Agreement, dated as of October 30, 2001, by and between Allion
      Healthcare, Inc. and Gainesborough, L.L.C (Incorporated by reference to
      Exhibit 3.1 to the Registrant’s Annual Report on 10-KSB/A filed in May
      2004).
  10.2
    Registration
      Rights Agreement, dated as of December 17, 2004 (Incorporated by reference
      to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on
      December 20, 2004)
  10.3
    1998
      Stock Option Plan*
  10.4
    2002
      Stock Incentive Plan (Incorporated by reference to Exhibit 10.4 to the
      Registrant’s Annual Report on Form 10-KSB filed on April 15,
      2003.)
  69
 10.5
    Subordinated
      Security Agreement, dated as of May 1, 2003, among Allion Healthcare,
      Inc., as borrower, Darin A. Peterson and Allan H. Peterson, collectively,
      as lenders, and Darin A. Peterson, as collateral agent (Incorporated by
      reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
      filed on May 16, 2003.)
  10.6
    Loan
      and Security Agreement, dated as of April 21, 1999, by and among the
      Registrant, The Care Group of Texas Inc., Care Line of Houston, Inc., Mail
      Order Meds, Inc., Care Line of New York, Inc., Commonwealth Certified Home
      Care, Inc. and HCFP Funding, Inc. (Incorporated by reference to Exhibit
      10.6 to the Registrant’s Annual Report on Form 10-KSB filed on April 14,
      2004.)
  10.7
    Amendment
      No. 1 to Loan and Security Agreement, executed as of July 27, 2001 and
      effective as of April 21, 2001, by and among the Registrant, The Care
      Group of Texas Inc., Care Line of Houston, Inc., Mail Order Meds, Inc.,
      Care Line of New York, Inc., Commonwealth Certified Home Care, Inc. and
      Heller Healthcare Finance, Inc. (f/k/a HCFP Funding, Inc.)(Incorporated by
      reference to Exhibit 10.7 to the Registrant’s Annual Report on Form 10-KSB
      filed on April 14, 2004.)
  10.8
    Amendment
      No. 2 to Loan and Security Agreement, dated as of April 2002, by and among
      the Registrant, The Care Group of Texas, Inc., Care Line of Houston, Inc.,
      Mail Order Meds, Inc., Care Line of New York, Inc., Commonwealth Certified
      Home Care, Inc. and Heller Healthcare Finance, Inc. (f/k/a HCFP Funding,
      Inc.)(Incorporated by reference to Exhibit 10.8 to the Registrant’s Annual
      Report on Form 10-KSB filed on April 14,
2004.)
  10.9
    Amendment
      No. 3 and Consent to Loan and Security Agreement, dated as of May 28,
      2003, by and among the Registrant, The Care Group of Texas, Inc., Care
      Line of Houston, Inc., Mail Order Meds, Inc., Care Line of New York, Inc.,
      Commonwealth Certified Home Care, Inc. and Heller Healthcare Finance, Inc.
      (f/k/a HCFP Funding, Inc.)(Incorporated by reference to Exhibit 10.9 to
      the Registrant’s Annual Report on Form 10-KSB filed on April 14,
      2004.)
  10.10
    Amendment
      No. 4 to Loan and Security Agreement, dated as of September 2003, by and
      among the Registrant, The Care Group of Texas, Inc., Care Line of Houston,
      Inc., Mail Order Meds, Inc., Care Line of New York, Inc., Commonwealth
      Certified Home Care, Inc. and Heller Healthcare Finance, Inc. (f/k/a HCFP
      Funding, Inc.)(Incorporated by reference to Exhibit 10.10 to the
      Registrant’s Annual Report on Form 10-KSB filed on April 14,
      2004.)
  10.11
    Agreement
      of Lease Between Reckson Operating Partnership, L.P and Allion Healthcare,
      Inc. (Filed as an Exhibit to the Registrant’s Annual Report on Form 10-KSB
      filed on April 14, 2004)
  10.12
    Amendment
      No. 5 to Loan and Security Agreement, dated as of January 2005, by and
      among the Registrant, The Care Group of Texas, Inc., Care Line of Houston,
      Inc., Mail Order Meds, Inc., Care Line of New York, Inc., Commonwealth
      Certified Home Care, Inc. and Heller Healthcare Finance, Inc. (f/k/a HCFP
      Funding, Inc.)*
  10.13
    Amendment
      No. 6 to Loan and Security Agreement, dated as of February 2005, by and
      among the Registrant, The Care Group of Texas, Inc., Care Line of Houston,
      Inc., Mail Order Meds, Inc., Care Line of New York, Inc., Commonwealth
      Certified Home Care, Inc. and Heller Healthcare Finance, Inc. (f/k/a HCFP
      Funding, Inc.)*
  10.14
    AmerisourceBergen
      Prime Vendor Agreement dated September 15,
2003**
  10.15
    Letter
      Agreement with Oris Medical Systems, Inc. dated March 3, 2005 relating to
      potential software licensing arrangement under which we would secure an
      exclusive license from Oris Medical to use an electronic prescription
      writing system (Ground Zero Software’s LabTrackerTM software).
      (Incorporated by reference to Exhibit 10.1 to the Registrant's Current
      Report on Form 8K filed on March 7, 2005.)
  10.16
    Registration
      Rights Agreement, dated as of January 4, 2005, by and between Allion
      Healthcare, Inc. and Michael Stone and Jonathan
Spanier.*
 
 70
 14.1
    Code
      of Ethics. (Filed as an exhibit to the Registrant’s Annual Report on Form
      10-KSB filed on April 14, 2004.)
  21.1
    Subsidiaries
      of the Registrant. *
  31.1
    Certification
      of the Chief Executive Officer pursuant to Rule 13a-14(a) Section 302 of
      the Sarbanes-Oxley Act of 2002. *
  31.2
    Certification
      of the Chief Financial Officer pursuant to Rule 13a-14(a) Section 302 of
      the Sarbanes-Oxley Act of 2002. *
  31.3
    Certification
      by the Chief Executive Officer and Acting Chief Financial Officer pursuant
      to 18 U.S.C. § 1350 Section 906 of the Sarbanes-Oxley Act of 2002.
      ***
  * - Filed
herewith
  **
-Certain portions of this document have been omitted pursuant to a request for
confidential treatment. We have filed non-redacted copies of this agreement with
the Securities and Exchange Commission.
  *** -
These certifications are being furnished solely pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and are not being filed as part this Annual Report on
Form 10-K or as a separate disclosure document.
  71
 SCHEDULE
II — VALUATION AND QUALIFYING ACCOUNTS
 (in
thousands)
  **Description**
    
    **Balance
      atBeginning of Period**
    
    **Charged
      to Costs and Expenses**
    
    **Deductions****(1)**
    
    **Balance
      at End of Period**Year
      ended December 31, 2002:
      Allowance
      for doubtful accounts
    
    $
    281,799
    
    $
    105,652
    
    $
    110,845
    
    $
    276,606Year
      ended December 31, 2003:
      Allowance
      for doubtful accounts
    
    $
    276,606
    
    $
    236,558
    
    $
    76,132
    
    $
    437,032Year
      ended December 31, 2004:
      Allowance
      for doubtful accounts
    
    $
    437,032
    
    $
    80,200
    
    $
    220,912
    
    $
    296,320
 
 (1)
Consists primarily of recoveries of accounts previously deemed
uncollectable.
 
 
 72