The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of BioScrip as a whole. This discussion should be read in conjunction with our Consolidated Financial Statements, including the Notes thereto, and the information discussed in Part I, Item 1A - Risk Factors.
Co-Payments; Co-Insurance. When prescriptions are filled by our own pharmacies (that is, where we are acting as a participating pharmacy in another PBM’s or payor’s pharmacy network), we collect and retain co-payments or co-insurance from Plan Sponsors’ members and record these receipts as revenue when the amounts are collected or deemed collectible and reasonably estimable. Conversely, when prescriptions are filled through pharmacies participating in our retail pharmacy networks, we are not entitled to retain co-payments or co-insurance and accordingly do not recognize revenue with respect to or account for retail pharmacy co-payments or co-insurance in our financial statements. In our capacity as a PBM, pharmacy network co-payments and co-insurance are never billed or collected by us and we have no legal right or obligation to receive them as they are collected by our network pharmacies.
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB 25, and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach to estimating the fair value of options in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as a current period expense in the income statement based on their fair values. Pro forma disclosure is no longer an alternative and SFAS No. 123(R) must be adopted no later than January 1, 2006.
The excess of the purchase price over the fair value of the identifiable net assets and the fair value of the identifiable intangible assets acquired was allocated to goodwill and was assigned to the Specialty Services segment.
On October 7, 2005 the Company acquired all of the issued and outstanding stock of JPD, Inc. d/b/a Northland Medical Pharmacy (“Northland”), a community-based specialty pharmacy located in Columbus, Ohio for $12 million in cash, plus a potential earn-out payment contingent on Northland achieving certain performance benchmarks in 2006. Northland complements the Company’s expanding community pharmacy model.
The Company recorded a $4.3 million charge, net of tax, in the fourth quarter of 2005 to reflect an increase in the allowance for doubtful accounts receivable created by lower than expected collections during the Chronimed integration of the Company’s accounting and IT functions.
In the area of accounts receivable, we identified the following ineffective controls which we believe constitute a material weakness in the aggregate:
This material weakness affects the ability to monitor collections of accounts receivable, develop appropriate estimates of uncollectible amounts, and to report accounts receivable in the financial statements at net realizable value and resulted in a material adjustment in the fourth quarter.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 financial statements, and this report does not affect our report dated March 27, 2006 on those financial statements.
Lease between Alchemie Properties, LLC and Pro-Mark Holdings, Inc., dated as of December 1, 1994
Receivables Purchase and Transfer Agreement, dated as of November 1, 2000, among MIM Health Plans, Inc., Continental Pharmacy, Inc., American Disease Management Associates LLC and MIM Funding LLC
Lease Agreement by and between Alchemie Properties, LLC and Scrip Solutions, LLC
The Company accounts for employee stock and stock-based compensation plans using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) as permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and as such, generally recognizes no compensation cost for employee stock options.
The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions:
the opportunity to create corporate function and other cost synergies, which will enable the combined entity to grow and improve margins.
In connection with the consolidation of the finance and IT departments as described above, on March 4, 2005 the Company notified 67 associates that their employment with the Company would be involuntarily terminated. All of these terminations were the result of the purchase of Chronimed and were expensed in the Specialty Services segment. All associates were terminated by December 31, 2005. Estimated severance costs in connection with this restructuring were recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”), with the expense being allocated over the estimated retention period of employees. Severance costs of $2.3 million were recorded in SG&A expenses for associate separation costs in 2005, in connection with the termination of these associates. In September and December of 2005 the two Rhode Island offices were closed, resulting in $0.4 million of expense recorded in SG&A. All of these costs have been recorded in the Specialty Services segment.
Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $3.5 million, $2.0 million and $2.0 million, respectively.
As of December 31, 2005, the NOLs described above are subject to limitation and may be utilized in a future year upon release of the limitation. If the NOLs are not utilized in the year they are available they may be utilized in a future year to the extent they have not expired.
As of December 31, 2005 and 2004, the exercisable portion of outstanding options was 4,669,207 shares and 2,365,492 shares, respectively. Stock option activity under the Plans through December 31, 2005 is as follows: