-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, M3pnu8VgLw8Ctl1/lrQQC+0jtgePhDoyegGfpP0fzirD1qdqyp/w7vzzDEdJDU7r SX1Rl1z1wf+e2wRcnodv3w== 0000950135-02-005034.txt : 20021114 0000950135-02-005034.hdr.sgml : 20021114 20021114143431 ACCESSION NUMBER: 0000950135-02-005034 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: POLYMEDICA CORP CENTRAL INDEX KEY: 0000878748 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 043033368 STATE OF INCORPORATION: MA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13690 FILM NUMBER: 02824329 BUSINESS ADDRESS: STREET 1: 11 STATE ST CITY: WOBURN STATE: MA ZIP: 01801 BUSINESS PHONE: 6179332020 MAIL ADDRESS: STREET 1: 11 STATE STREET CITY: WOBURN STATE: MA ZIP: 01801 FORMER COMPANY: FORMER CONFORMED NAME: POLYMEDICA INDUSTRIES INC DATE OF NAME CHANGE: 19930328 10-Q 1 b44520pme10vq.txt POLYMEDICA CORPORATION SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File No. 0-19842 PolyMedica Corporation ----------------------------------------------------- (Exact name of registrant as specified in its charter) Massachusetts 04-3033368 - ---------------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 11 State Street, Woburn, Massachusetts 01801 - ---------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (781) 933-2020 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of November 14, 2002, there were 12,296,217 shares of the registrant's Common Stock outstanding and an additional 1,018,765 shares held in treasury. POLYMEDICA CORPORATION TABLE OF CONTENTS
PAGE ---- PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Balance Sheets as of September 30 (unaudited) and March 31, 2002 3 Unaudited Consolidated Statements of Operations for the three and six months ended September 30, 2002 and 2001 5 Unaudited Consolidated Statements of Cash Flows for the six months ended September 30, 2002 and 2001 6 Notes to Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 38 Item 4 - Controls and Procedures 39 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 40 Item 4 - Submission of Matters to a Vote of Security Holders 41 Item 6 - Exhibits and Reports on Form 8-K 42 Signatures 43 Certifications 44 Exhibit Index 47
2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS POLYMEDICA CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
SEPTEMBER 30, 2002 MARCH 31, ASSETS (UNAUDITED) 2002 ------------- -------- Current assets: Cash and cash equivalents $ 26,834 $ 27,884 Accounts receivable (net of allowances of $19,272 and $15,539 as of September 30 and March 31, 2002, respectively) 46,038 44,059 Inventories 20,644 21,663 Deferred tax asset 10,622 10,622 Prepaid expenses and other current assets 3,617 1,727 -------- -------- Total current assets 107,755 105,955 Property, plant and equipment, net 44,519 34,603 Goodwill 29,748 29,748 Intangible assets, net 330 698 Direct response advertising, net 58,251 52,112 Other assets 2,206 1,276 -------- -------- Total assets $242,809 $224,392 ======== ========
The accompanying notes are an integral part of these unaudited consolidated financial statements. 3 POLYMEDICA CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
SEPTEMBER 30, 2002 MARCH 31, (UNAUDITED) 2002 ------------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,459 $ 10,270 Amounts due to Medicare and others 2,566 4,798 Accrued expenses 14,359 12,990 Current portion, capital lease obligations 702 742 --------- --------- Total current liabilities 27,086 28,800 Long-term note payable, capital lease and other obligations 2,579 1,485 Deferred income taxes 20,524 20,524 --------- --------- Total liabilities 50,189 50,809 Commitments and contingencies (Note 12) Shareholders' equity: Preferred stock, $0.01 par value; 2,000,000 shares authorized, none issued or outstanding -- -- Common stock, $0.01 par value; 50,000,000 shares authorized; 13,314,982 and 13,300,477 shares issued as of September 30 and March 31, 2002, respectively 133 133 Treasury stock, at cost (1,103,173 and 1,143,158 shares as of September 30 and March 31, 2002, respectively) (21,574) (22,185) Additional paid-in capital 119,350 119,891 Retained earnings 94,711 75,744 --------- --------- Total shareholders' equity 192,620 173,583 --------- --------- Total liabilities and shareholders' equity $ 242,809 $ 224,392 ========= =========
The accompanying notes are an integral part of these unaudited consolidated financial statements. 4 POLYMEDICA CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, 2002 2001 2002 2001 ---- ---- ---- ---- Net revenues $ 88,012 $ 68,851 $ 169,613 $ 131,872 Cost of sales 31,208 23,555 60,065 44,820 -------- -------- --------- --------- Gross margin 56,804 45,296 109,548 87,052 Selling, general and administrative expenses 40,977 38,059 79,005 65,964 -------- -------- --------- --------- Income from operations 15,827 7,237 30,543 21,088 Other income and expense: Investment income/(loss) (12) 234 32 774 Interest expense (34) (44) (70) (87) Minority interest -- 174 -- (140) Other income and expense -- (1) (12) (1) -------- -------- --------- --------- (46) 363 (50) 546 Income before income taxes 15,781 7,600 30,493 21,634 Income tax provision 5,965 2,918 11,526 8,307 -------- -------- --------- --------- Net income $ 9,816 $ 4,682 $ 18,967 $ 13,327 ======== ======== ========= ========= Net income per weighted average share: Basic $ .81 $ .37 $ 1.56 $ 1.04 Diluted $ .79 $ .36 $ 1.52 $ 1.02 Weighted average shares, basic 12,171 12,680 12,169 12,818 Weighted average shares, diluted 12,439 12,949 12,509 13,116
The accompanying notes are an integral part of these unaudited consolidated financial statements. 5 POLYMEDICA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands)
SIX MONTHS ENDED SEPTEMBER 30, 2002 2001 -------- -------- Cash flows from operating activities: Net income $ 18,967 $ 13,327 Adjustments to reconcile net income to net cash flows: Depreciation and amortization 2,791 2,700 Amortization of direct-response advertising 17,358 13,978 Direct-response advertising (23,497) (21,090) Minority interest -- 140 Provision for bad debts 12,508 9,998 Provision for sales allowances 8,202 5,813 Provision for inventory obsolescence 539 186 Stock-based compensation 6 -- Changes in assets and liabilities: Accounts receivable (22,689) (24,932) Inventories 480 3,087 Prepaid expenses and other assets (1,716) (1,096) Accounts payable (811) (2,682) Amounts due to Medicare and others (2,232) 5,702 Accrued expenses and other liabilities 2,700 6,096 -------- -------- Total adjustments (6,361) (2,100) -------- -------- Net cash flows from operating activities 12,606 11,227 -------- -------- Cash flows from investing activities: Purchase of marketable securities -- (5,499) Proceeds from sale of marketable securities -- 5,499 Purchase of property, plant and equipment (12,077) (4,850) -------- -------- Net cash flows from investing activities (12,077) (4,850) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 724 295 Repurchase of common stock (659) (13,357) Contributions to deferred compensation plans (1,274) (1,103) Payment of obligations under capital leases and note payable (370) (315) -------- -------- Net cash flows from financing activities (1,579) (14,480) -------- -------- Net decrease in cash and cash equivalents (1,050) (8,103) Cash and cash equivalents at beginning of period 27,884 39,571 -------- -------- Cash and cash equivalents at end of period $ 26,834 $ 31,468 ======== ======== Supplemental disclosure of cash flow information: Disposal of equipment $ 77 $ -- Assets purchased under capital lease 281 323
The accompanying notes are an integral part of these unaudited consolidated financial statements. 6 POLYMEDICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. The unaudited consolidated financial statements included herein have been prepared by PolyMedica Corporation ("PolyMedica" or the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") and include, in the opinion of management, all adjustments, consisting of normal, recurring adjustments, necessary for a fair presentation of interim period results. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The results for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year. It is suggested that these interim consolidated financial statements be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2002, and our unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the period ended June 30, 2002. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Estimates and judgments are used for, including, but not limited to, determination of appropriate Medicare reimbursement rates, the allowance for doubtful accounts and sales returns, goodwill, valuation of inventory, accrued expenses, amounts due to Medicare and others, uncertainties that management determines are estimable and probable, and depreciation and amortization. Actual results could differ from those estimates. In addition, certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current period presentation. 2. We recognize revenue on product shipments to customers who have placed orders, upon shipment, provided that risk of loss has passed to the customer and that, if applicable, we have received and verified the required written Authorization of Benefits and Doctor's Order to bill Medicare, other third-party payers, and customers. We record revenue at the amounts expected to be collected from Medicare, other third-party payers, and directly from customers. Revenue recognition is delayed for product shipments for which we have not yet received a written Authorization of Benefits and Doctor's Order, if applicable, until the period in which those documents are collected and verified. Approximately $60.56 million and $44.35 million of net revenues for the three months ended September 30, 2002 and 2001, respectively, were reimbursable by Medicare for products and services provided to Medicare beneficiaries. Approximately $117.46 million and $90.60 million of net revenues for the six months ended September 30, 2002 and 2001, respectively, were reimbursable by Medicare for products and services provided to Medicare beneficiaries. 3. Sales allowances are recorded for estimated product returns using historical return trends and are recorded as a reduction of revenue. These allowances are adjusted to reflect actual returns and collection history. During the three months ended September 30, 2002 and 2001, we provided for 7 sales allowances at a rate of approximately 4.9% and 3.9% of gross revenues, respectively. During the six months ended September 30, 2002 and 2001, we provided for sales allowances at a rate of approximately 4.6% and 4.2% of gross revenues, respectively. We analyze sales allowances using historical data adjusted for significant changes in volume, customer demographics, and business conditions. At the time of revenue recognition, we follow the government-distributed list containing reimbursement prices for Medicare-covered products (the "Medicare Fee Schedule") and exclude from revenue amounts billed in excess of the Medicare (Durable Medical Equipment Prosthetics Orthotics Supplies) Fee Schedule. As a result, our contractual allowances are immaterial. The reimbursements that Medicare pays us are subject to review by appropriate government regulators. Medicare reimburses at 80% of the Medicare Fee Schedule for reimbursable supplies and we bill the remaining balance to either third-party payers or directly to customers. 4. Inventories consist of the following: (In thousands)
Sept. 30, March 31, 2002 2002 ---- ---- Raw materials $ 997 $ 616 Work in process 597 832 Finished goods 19,050 20,215 ------- ------- $20,644 $21,663 ======= =======
Due to the medical nature of the products we provide, customers sometimes request supplies before we have received the required documents, if applicable, to bill Medicare, other third-party payers and customers. Because we do not recognize revenue until we have received and verified such documents, included in inventories as of September 30 and March 31, 2002, is $3.51 million and $3.77 million, respectively, of net inventory shipped to customers for which we have received an order but have not yet received the required written documents. 5. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that ratable amortization of goodwill and certain intangible assets be replaced with periodic tests of the goodwill's impairment and that other intangible assets be amortized over their useful lives unless these lives are determined to be indefinite. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and thus was adopted by us on April 1, 2002. Effective April 1, 2002, in accordance with the provisions of SFAS No. 142, we ceased amortizing goodwill. Under SFAS No. 142, goodwill is no longer amortized but is tested for impairment under a two-step process. Under the first step, an entity's net assets are broken down into reporting units and compared to their fair value. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value, determined using a discounted cash flows approach, of a reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of a reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Upon adoption of SFAS No. 142 effective April 1, 2002, we are required to perform an initial transitional impairment test. Step one of the impairment test must be 8 completed within six months of adoption and step two must be completed within one year of adoption. Within six months of adopting the accounting standard, any impairments identified in the transitional impairment test are treated as a cumulative effect of a change in accounting principle. Additionally, new criteria have been established that determine whether an acquired intangible asset should be recognized separately from goodwill. We adopted the provisions of SFAS No. 142, as required, on April 1, 2002. As a result of adopting SFAS No. 142 effective April 1, 2002, approximately $385,000 and $770,000 of goodwill amortization was not recognized in the three and six months ended September 30, 2002, respectively. During the quarter ended September 30, 2002 we performed the first step of an impairment review of our goodwill as of April 1, 2002, under the transitional provisions of SFAS No. 142. We identified our reporting units, allocated assets and liabilities to the reporting units and compared each of the reporting unit's net book value to its estimated fair value. Assets and liabilities, including goodwill, were allocated to the reporting units based on factors such as specific identification, percentage of net revenues and square footage. The fair value of the reporting units was estimated using the discounted cash flows approach. Based on this analysis, the carrying amounts for the two reporting units included in our Pharmaceuticals segment exceeded their fair values, while carrying amounts for the reporting unit included in our Liberty Diabetes segment did not exceed fair value. During the fiscal year ended March 31, 2002, net revenues generated from the two reportable units in our Pharmaceuticals segment represented approximately 5% of our consolidated net revenues. The second step will measure the amount of goodwill impairment loss in our Pharmaceuticals segment. We will complete the second step of this transitional test in the third quarter of fiscal 2003 and expect to recognize a goodwill impairment charge related to the urological products reported in our Pharmaceuticals segment as a cumulative effect of a change in accounting principle retroactive to April 1, 2002 that will be recorded only in the year-to-date results in our Quarterly Report on Form 10-Q for the quarter ending December 31, 2002. The original goodwill related to these products was recorded in December 1992 in connection with the purchase of certain product lines. As of March 31, 2002, the net book value of the goodwill related to these products was $24.80 million. Subsequent to the transitional impairment test, we are required to perform impairment tests under SFAS No. 142 annually and whenever events or changes in circumstance suggest that the carrying value of an asset may not be recoverable. The adoption of SFAS No. 142 will have a material impact on our consolidated financial statements, as we will record an impairment charge in an amount to be determined upon the completion of the second step of the transitional impairment test which we expect to complete in the quarter ending December 31, 2002. The following is a reconciliation of reported net income to adjusted net income and reported earnings per share to adjusted earnings per share had SFAS No. 142 been in effect for the three and six months ended September 30, 2001, respectively (table in thousands, except per share amounts): 9
Three Months Six Months Ended Ended Sept. 30, 2001 Sept. 30, 2001 -------------- -------------- Net income $4,682 $13,327 Add back: Impact of goodwill amortization, net of tax benefit of $148 and $296 for the three and six months ended September 30, 2001, respectively 237 474 ------ ------- Adjusted net income $4,919 $13,801 ====== ======= Net income per share, basic $ 0.37 $ 1.04 Add back: Impact of goodwill amortization, net of taxes 0.02 0.04 ------ ------- Adjusted net income per share, basic $ 0.39 $ 1.08 ====== ======= Net income per share, diluted $ 0.36 $ 1.02 Add back: Impact of goodwill amortization, net of taxes 0.02 0.04 ------ ------- Adjusted net income per share, diluted $ 0.38 $ 1.06 ====== =======
We have three reporting units with goodwill: Liberty Medical Supply, Inc. ("Liberty"), included in the Liberty Diabetes reporting segment, and PolyMedica Pharmaceuticals (U.S.A.), Inc. and PolyMedica Healthcare, Inc., both included in the Pharmaceuticals reporting segment. The carrying amounts of goodwill and intangible assets as of September 30, 2002 and March 31, 2002, by reportable segment, are as follows (table in thousands):
Sept. 30, March 31, 2002 2002 --------- --------- LIBERTY DIABETES: Goodwill $ 4,951 $ 4,951 ======== ======== Customer list $ 1,816 $ 1,816 Accumulated amortization (1,578) (1,448) -------- -------- $ 238 $ 368 ======== ======== PHARMACEUTICALS: Goodwill $ 24,797 $ 24,797 ======== ======== Covenant not to compete $ 6,800 $ 6,800 Accumulated amortization (6,708) (6,470) -------- -------- $ 92 $ 330 ======== ======== Consolidated goodwill $ 29,748 $ 29,748 ======== ======== Amortizable intangible assets 8,616 8,616 Accumulated amortization (8,286) (7,918) -------- -------- $ 330 $ 698 ======== ========
10 Amortization expense for intangible assets was approximately $184,000 for each of the three months ended September 30, 2002 and 2001 and approximately $368,000 for each of the six months ended September 30, 2002 and 2001. As of September 30, 2002, amortization expense on existing intangibles for the remainder of fiscal 2003 and the next four fiscal years is expected to be as follows (table in thousands): Fiscal year 2003 $222 Fiscal year 2004 108 Fiscal year 2005 -- Fiscal year 2006 -- Fiscal year 2007 -- ---- Total $330 ====
6. Included in other assets are restricted investments of $1.97 million and $868,000 as of September 30 and March 31, 2002, respectively, which represent amounts we set aside under the executive deferred compensation plans (the "Plans"). The related liability is included in long-term liabilities ("long-term note payable, capital lease and other obligations" as captioned on the balance sheet). Changes in the fair value of investments held in the Plans are recorded as investment income or loss ("investment income/(loss)" as captioned on the statements of operations) with a corresponding adjustment to compensation expense, included in selling, general and administrative expenses, and to other assets and long-term liabilities ("long-term note payable, capital lease and other obligations" as captioned on the balance sheet). As of September 30, 2002, the fair value of these investments was not materially different from cost. Amounts set aside for the Plans in the six months ended September 30, 2002 and 2001 totaled $1.27 million and $1.10 million, respectively. The investments held in the Plans, which are accounted for pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," have been classified as trading, are included in other assets, and are recorded at fair value. 7. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect adoption of this statement to have a material impact on our financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of Debt," an amendment of that statement, and FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 also rescinds FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers" and FASB No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Adoption of certain provisions of this standard was required after May 15, 2002, while other provisions must be adopted with financial statements issued after May 15, 2002 or the year beginning after May 15, 11 2002. We do not expect adoption of this statement to have a material impact on our financial position or results of operations. In October 2001 the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance on the accounting for the impairment or disposal of long-lived assets. The objectives of SFAS No. 144 are to address issues relating to the implementation of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and to develop a model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. We adopted SFAS No. 144 on April 1, 2002, as required. The adoption did not have a material impact on our financial position or results of operations in the three or six months ended September 30, 2002, but could have a significant impact on our financial position or results of operations should there be future asset impairments or disposals. In August 2001, the FASB issued SFAS No. 143 "Accounting for Obligations Associated with the Retirement of Long-Lived Assets." The provisions of SFAS No. 143 apply to all entities that incur obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 and thus will be adopted, as required, on April 1, 2003. This accounting pronouncement is not expected to have a significant impact on our financial position or results of operations. 8. In accordance with Statement of Position 93-7 ("SOP 93-7"), we incurred and capitalized direct-response advertising of $11.98 million and $11.78 million in the three months ended September 30, 2002 and 2001, respectively. A total of $8.85 million and $7.40 million in direct-response advertising was amortized and charged to selling, general and administrative expenses for the three months ended September 30, 2002 and 2001, respectively. As a result, $3.13 million was added to the direct-response advertising net asset in the quarter ended September 30, 2002. A total of $23.50 million and $21.09 million of direct-response advertising was capitalized in the six months ended September 30, 2002 and 2001, respectively. A total of $17.36 million and $13.98 million was amortized and charged to selling, general and administrative expenses for the six months ended September 30, 2002 and 2001, respectively. As a result, $6.14 million was added to the direct-response advertising net asset in the six months ended September 30, 2002. Management assesses the realizability of the amounts of direct-response advertising costs reported as assets at each balance sheet date by comparing the carrying amounts of such assets to the probable remaining future net cash flows expected to result directly from such advertising. We expense in the period all other advertising that does not meet the capitalization requirements of SOP 93-7. Any business change that reduces revenues or earnings or that shortens or eliminates the expected period of benefit of our direct-response advertising costs, currently four years for our diabetes products and two years for our respiratory products, could result in accelerated charges against our earnings. 9. Amounts due to Medicare and others of $2.57 million as of September 30, 2002, represent probable amounts due to Medicare and related amounts due to insurers and Medicare beneficiaries, related to a change in interpretation of the reimbursement formula for albuterol and ipratropium combinations used in our Liberty Respiratory segment. Beginning September 6, 2001 through November 8, 2001, we received administrative overpayment notices from one Durable Medical Equipment Regional Carrier ("DMERC") relating to this reimbursement formula that has resulted in 12 $1.06 million of refunds or credits to the DMERC and others. No administrative overpayment notices have been received from November 8, 2001 to November 14, 2002. DMERCs are private insurance companies used by Medicare to administer reimbursement payments. The liability of $2.57 million is the remaining difference between reimbursement under the two interpretations of the reimbursement formula and assumes that two of the other DMERCs issue similar administrative overpayment notices. When we established the liability in the quarter ended September 30, 2001, $5.03 million was charged to selling, general and administrative expenses for billing adjustments prior to July 1, 2001 and $823,000 represented billing adjustments related to the quarter ended September 30, 2001. During the quarter ended September 30, 2002, we recorded a benefit of $2.22 million, or $0.11 per share (diluted), related to a reduction in Amounts due to Medicare and others, following a favorable determination by one of the four DMERCs that our original method of billing for albuterol and ipratropium combinations was proper. This benefit, recorded as a reduction of selling, general and administrative expenses in the quarter ended September 30, 2002, reduced the liability from $4.80 million as of March 31, 2002, to $2.57 million as of September 30, 2002. 10. Effective for the quarter ended September 30, 2002, we changed the way we segment our business for reporting purposes, in order to reflect how management currently views operations. The new segments are as follows: Liberty Diabetes - Through our Liberty Diabetes segment, we sell diabetes testing supplies and related products and services to customers suffering from diabetes and related chronic diseases. We offer a wide array of diabetes products from a broad range of manufacturers. Liberty Respiratory - Through our Liberty Respiratory segment, we sell prescription respiratory medications and supplies to customers suffering from chronic obstructive pulmonary disease ("COPD"). Pharmaceuticals - Through our Pharmaceuticals segment, we sell prescription oral medications not covered by Medicare to existing Liberty customers, over-the-counter female urinary discomfort products, home medical diagnostic kits, and prescription urology and suppository products. Depreciation and amortization expense attributable to our corporate headquarters is allocated to the operating segments according to each segment's relative percentage of total net revenues. However, segment assets belonging to our corporate headquarters are not allocated, as management evaluates these separately from the assets of the reportable segments. As a result of these allocations, the segment information may not be indicative of the financial position or results of operations that would have been achieved had these segments operated as unaffiliated entities. The depreciation and amortization amounts below include amortization of direct-response advertising. We do not organize our units geographically, as our products and services are sold throughout the United States only. There are no intersegment sales for the periods presented. Information concerning the operations in these reportable segments, restated to reflect the way we currently segment our business, is as follows: 13
Three months ended Six months ended Sept. 30, Sept. 30, Sept. 30, Sept. 30, (In thousands) 2002 2001 2002 2001 ---- ---- ---- ---- NET REVENUES: Liberty Diabetes $60,962 $ 51,765 $119,476 $ 98,459 Liberty Respiratory 18,609 12,055 35,189 24,037 Pharmaceuticals 8,441 5,031 14,948 9,376 ------- -------- -------- -------- Total $88,012 $ 68,851 $169,613 $131,872 ======= ======== ======== ======== DEPRECIATION AND AMORTIZATION: Liberty Diabetes $ 5,910 $ 4,626 $ 11,426 $ 8,940 Liberty Respiratory 4,098 3,636 8,163 6,739 Pharmaceuticals 302 500 560 999 ------- -------- -------- -------- Total $10,310 $ 8,762 $ 20,149 $ 16,678 ======= ======== ======== ======== INCOME BEFORE INCOME TAXES: Liberty Diabetes $ 7,366 $ 8,169 $ 16,632 $ 17,308 Liberty Respiratory (see Note 9) 7,528 (2,496) 12,072 693 Pharmaceuticals 887 1,927 1,789 3,633 ------- -------- -------- -------- Total $15,781 $ 7,600 $ 30,493 $ 21,634 ======= ======== ======== ========
Sept. 30, March 31, 2002 2002 ---- ---- SEGMENT ASSETS: Liberty Diabetes $144,918 $133,009 Liberty Respiratory 30,578 31,242 Pharmaceuticals 36,440 33,205 Corporate Headquarters 30,873 26,936 -------- -------- Total $242,809 $224,392 ======== ========
11. In June 2000, our Board of Directors (the "Board") authorized the repurchase of up to 1,000,000 shares of our common stock on the open market, with any shares repurchased to be held in treasury. In August 2001, our Board authorized the repurchase of an additional 1,000,000 shares. In the six months ended September 30, 2002, 25,000 shares of common stock were repurchased for $659,000 at an average repurchase price of $26.37 per share. In total, 1,271,000 shares had been repurchased for $25.30 million at an average repurchase price of $19.91 per share, as of September 30, 2002. Of the 2,000,000 shares originally authorized by the Board, 729,000 shares remained authorized for repurchase as of November 14, 2002. 12. The regulations that govern Medicare reimbursement are complex and our compliance with those regulations may be reviewed by federal agencies, including the Department of Health and Human Services, the Department of Justice ("DOJ"), and the Food and Drug Administration ("FDA"). The U.S. Attorney's Office for the Southern District of Florida, with the assistance of the Federal Bureau of Investigation ("FBI") and Department of Health & Human Services' Office of Inspector General ("OIG"), is investigating allegations of healthcare fraud, improper revenue recognition and obstruction of justice by Liberty and Liberty Home Pharmacy Corporation ("Liberty Home Pharmacy"). Both civil and criminal investigations are being 14 conducted. We are cooperating with the investigations. We cannot accurately predict the outcome of these proceedings at this time, and have therefore not recorded any charges relating to their outcome. We and three individuals who are or were officers of PolyMedica are defendants in a lawsuit alleging violations of certain sections and rules of the Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a derivative action against the directors and two individuals who are or were officers in Massachusetts state court alleging certain breaches of fiduciary duty. We, the named individuals, and the Board believe that we have meritorious defenses to the claims made against us in the actions in which we are defendants and intend to contest the claims vigorously. Although we do not consider an unfavorable outcome to the various claims probable, we cannot accurately predict their ultimate disposition, and have therefore not recorded any charges related to their outcome. Please see Item 1 of Part II, Legal Proceedings, for a more complete description of these claims. If any of these investigations or legal proceedings result in a determination that we have failed to comply with the regulations governing Medicare reimbursement or financial reporting or have otherwise committed healthcare fraud or securities law violations, we could be subject to delays or loss of reimbursement, substantial fines or penalties, and other sanctions. An adverse determination could have a material effect on our financial position and results of operations. In June 2002, Liberty received an administrative subpoena from the U.S. Attorney's Office for the Southern District of Illinois seeking documents relevant to an ongoing investigation of Medicare reimbursement of "depth shoes and inserts." Liberty has been informed that it is not a target of that investigation. We have certain contingent liabilities that arise in the ordinary course of our business activities, in addition to those described above. We accrue contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. 13. Our total net income and comprehensive income were $9.82 million and $4.68 million for the three months ended September 30, 2002 and 2001, respectively. For the six months ended September 30, 2002 and 2001, total net income and comprehensive income was $18.97 million and $13.33 million, respectively. 15 14. Calculations of earnings per share are as follows:
(In thousands, except per share data) Three Months Ended Six Months Ended Sept. 30, Sept. 30, Sept. 30, Sept. 30, 2002 2001 2002 2001 ---- ---- ---- ---- Net income $ 9,816 $ 4,682 $18,967 $13,327 BASIC: Weighted average common stock outstanding, net of treasury stock, end of period 12,171 12,680 12,169 12,818 Net income per weighted average share, basic $ .81 $ .37 $ 1.56 $ 1.04 ======= ======= ======= ======= DILUTED: Weighted average common stock outstanding, net of treasury stock, end of period 12,171 12,680 12,169 12,818 Weighted average dilutive common stock equivalents 268 269 340 298 ------- ------- ------- ------- Weighted average common stock and dilutive common stock equivalents outstanding, net of treasury stock 12,439 12,949 12,509 13,116 Net income per weighted average share, diluted $ .79 $ .36 $ 1.52 $ 1.02 ======= ======= ======= =======
Options to purchase 1,050,663 and 1,033,456 shares of common stock were outstanding during the three months ended September 30, 2002 and 2001, respectively, but were not included in the computation of diluted earnings per share, because the options' exercise prices were greater than the average market price of the common shares. During the six months ended September 30, 2002 and 2001, options to purchase 660,954 and 661,370 shares of common stock, respectively, were outstanding, but were not included in the computation of diluted earnings per share, because the options' exercise prices were greater than the average market price of the common shares. 15. On August 4, 2002, Steven J. Lee, Chief Executive Officer, Chairman and a director of PolyMedica, informed the Board of his intention to retire as Chief Executive Officer, effective as of that date. Mr. Lee has agreed to continue serving as Chairman and a director through December 31, 2002. In connection with Mr. Lee's termination of employment agreement, we incurred a one-time severance charge included in selling, general and administrative expenses of approximately $1.30 million in the quarter ended September 30, 2002. Pursuant to this agreement, this amount will be paid in cash over a twenty four-month period. Samuel L. Shanaman, a director since November 2001, has been elected to the new position of Lead Director, and will perform the functions of the chief executive officer on an interim basis until a successor is named. As compensation for his services as Interim Chief Executive Officer, we will pay Mr. Shanaman minimum wage and he will vest in eighty shares of restricted common stock, $0.01 par value, for every day he works, up to a maximum of 8,345 shares. 16. On September 12, 2002, the Board adopted a shareholder rights plan ("the Plan") declaring a dividend of one Right for each outstanding share of our common stock to stockholders of record at the close of business on September 24, 2002. The Plan provides our shareholders with the 16 opportunity to vote to either remove the Plan or keep it in place at the first annual meeting following resolution of the current ongoing investigations discussed in Note 12. The Plan is intended to protect and maximize the value of shareholders' interests in the event of an unsolicited offer. We did not adopt the Plan in response to any specific effort to acquire control of PolyMedica and are presently unaware of any takeover plans. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS We are a leading provider of direct-to-consumer medical products and services, conducting business through our Liberty Diabetes, Liberty Respiratory and Pharmaceutical segments. We sell diabetes testing supplies and related products and provide services to primarily Medicare-eligible customers suffering from diabetes and related chronic diseases through our Liberty Diabetes segment. Through our Liberty Respiratory segment we provide direct-to-consumer prescription respiratory medications, supplies and services to primarily Medicare-eligible customers suffering from chronic obstructive pulmonary disease ("COPD"). Through our Pharmaceuticals segment we sell prescription oral medications not covered by Medicare to existing Liberty customers, market, manufacture and distribute a broad line of prescription urology and suppository products, and sell over-the-counter female urinary discomfort products and home medical diagnostic kits. For selected financial information about our operating segments, see Note 10 to the consolidated financial statements. Liberty Diabetes As of September 30, 2002, we had approximately 500,000 active diabetes customers, many of whom suffer from other chronic diseases, to whom we sell name-brand products. We define a person as an active customer if that person has placed an order and we have shipped supplies to that person in the past twelve months. We deliver products to customers' homes and, as a service to our customers, bill Medicare and private insurance companies (if applicable) directly for those supplies that are reimbursable. We meet the needs of customers suffering from diabetes by: - providing mail order delivery of supplies direct to our customers' homes; - billing Medicare and/or private insurance companies directly; - providing 24-hour telephone support to customers; and - using sophisticated software and advanced order fulfillment systems to provide products and support. In the United States, there are approximately seventeen million people with diabetes, including at least seven million seniors. Of the seventeen million people with diabetes, it is estimated that approximately eleven million people are diagnosed, with the remaining six million people unaware that they have the disease. While a portion of the seven million seniors with diabetes are covered by managed care or reside in extended care facilities, we believe that the balance are potential customers of ours. Liberty Respiratory Our Liberty Respiratory segment operates similar to our Liberty Diabetes segment, as we deliver products to customers' homes and bill Medicare and private insurance companies (if applicable) directly for those prescription respiratory medications and supplies that are reimbursable. As a participating Medicare provider and third-party insurance biller, we provide a simple, reliable way for customers to obtain their supplies for respiratory disease treatment. As of September 30, 18 2002, we had approximately 55,000 active customers for our prescription respiratory medications and supplies. In the United States, there are approximately sixteen million people with COPD, including at least five million seniors. Pharmaceuticals Through our Pharmaceuticals segment we sell prescription oral medications not covered by Medicare to existing Liberty customers, market, manufacture and distribute a broad line of prescription urology and suppository products, and sell over-the-counter female urinary discomfort products and home medical diagnostic kits. We sell our female urinary discomfort products and home medical diagnostic kits under our AZO brand name through an extensive network of large drug store chains, major supermarkets, mass merchandisers and drug wholesalers in the United States. Our broad line of prescription urology products includes urinary analgesics, antispasmodics, local anesthetics and analgesic suppositories. Our primary customers for these urology products are large drug wholesalers in the United States. Business Strategies Our principal strategy is to leverage our technology-based operating platform and compliance management protocol to expand our business while maintaining strict adherence to all applicable regulations. This strategy includes the following elements: Continue growth in our Liberty Diabetes and Liberty Respiratory businesses by expanding our customer base. Since the August 1996 acquisition of Liberty Medical Supply, Inc. ("Liberty"), we have invested in an ongoing program of direct-response television advertising to reach a larger portion of the Medicare-eligible patient market. This campaign has resulted in a significant increase in sales as we have expanded our active diabetes customers from approximately 17,000 at the time of our acquisition of Liberty to approximately 500,000 active customers. In addition, we now have approximately 55,000 active customers for our prescription respiratory medications and supplies. We also use radio and print advertising to further broaden our customer base. We continue to seek opportunities to deliver new products to a broader customer base by leveraging our mail-order distribution system and software for billing and customer monitoring. To manage our growth effectively, we are continually expanding and upgrading our operations, information systems, and regulatory compliance activities. Expand non-Medicare initiatives. During fiscal year 2002 we leveraged our core business expertise and technology base with the launch of Liberty's non-Medicare operation, Liberty Medical Supply Pharmacy ("LMSP"). LMSP, which is part of our Pharmaceuticals segment, offers prescription oral medications not covered by Medicare to existing Liberty customers. Continue adding complementary products and businesses. New business initiatives, in various stages of development, include offering therapeutic footwear for diabetics deemed at risk for developing lower extremity complications, and the creation of a new clinical laboratory that offers a glycohemoglobin ("HbA1c") test, the results of which tell the patient and/or physician what the patient's blood glucose level has averaged over the previous two or three months. In order to take advantage of economies of scale in production and marketing, we continue to evaluate opportunities for the acquisition of businesses and products to complement our existing product lines or new business initiatives underway. In selecting and evaluating acquisition candidates, we examine the 19 potential market opportunities for products that can be distributed through our existing marketing infrastructure and which utilize our strengths in sales, marketing and distribution. We will also continue to consider adding businesses, manufacturing capabilities and new products that capitalize upon our established brand franchises. STATUS OF CHIEF EXECUTIVE OFFICER SEARCH Following the retirement of our former Chief Executive Officer, Steven J. Lee, effective August 4, 2002, we retained the executive recruitment firm of Heidrick & Struggles to assist our Board in its search for a new chief executive officer. We have spoken to a number of high-caliber candidates to date. OTHER Advertising rates may fluctuate during the year which may affect our acquisition of new customers. We may purchase less advertising when rates are higher. As a result, our acquisition of new customers during these periods is generally reduced and our net revenues may fluctuate accordingly. Non-direct-response advertising, promotional, and marketing costs are charged to earnings in the period in which they are incurred. We operate from manufacturing and distribution facilities located in Massachusetts and Florida. Virtually all of our product sales are denominated in U.S. dollars. Expense items include cost of sales and selling, general and administrative expenses. - Cost of sales consists primarily of purchased finished goods for sale in our markets and, to a lesser extent, materials, direct labor, and overhead costs for products that we manufacture in our facility and shipping and handling fees. - Selling, general and administrative expenses consist primarily of expenditures for personnel and benefits, as well as legal and related expenses, allowances for bad debts, rent, amortization of capitalized direct-response advertising costs and other amortization and depreciation. Period-to-period comparisons of changes in net revenues are not necessarily indicative of results to be expected for any future period. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material 20 changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate. The following summaries of our critical accounting policies should be read in conjunction with our consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2002 and our unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the period ended June 30, 2002. While all of our accounting policies impact the consolidated financial statements, certain policies may be viewed to be critical. Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and that require management's most subjective or complex judgments and estimates. Management believes the policies that fall within this category are the policies on revenue recognition and sales allowances, accounts receivable and the allowance for doubtful accounts, goodwill, inventories, direct-response advertising, amounts due to Medicare and others, and uncertainties. Revenue Recognition We recognize revenue related to product sales to customers who have placed orders upon shipment, provided that risk of loss has passed to the customer and we have received and verified the required written forms, if applicable, to bill Medicare, other third-party payers, and customers. We record revenue at the amounts expected to be collected from Medicare, other third-party payers, and directly from customers. We analyze various factors in determining revenue recognition, including a review of specific transactions, current Medicare regulations and reimbursement rates, historical experience, and the credit-worthiness of customers. The determination of appropriate Medicare rates for billing and revenue recognition are complex and sometimes subjective and therefore may require management's interpretation. Sales allowances are recorded for estimated product returns as a reduction of revenue. We analyze sales allowances using historical data adjusted for significant changes in volume, customer demographics, and business conditions. These allowances are adjusted to reflect actual returns. Changes in these factors could affect the timing and amount of revenue and costs recognized. Accounts Receivable and Allowance for Doubtful Accounts The valuation of accounts receivable is based upon the credit-worthiness of customers and third-party payers as well as our historical collection experience. Allowances for doubtful accounts are recorded as a selling, general and administrative expense for estimated amounts expected to be uncollectible from third-party payers and customers. We base our estimates on our historical collection and write-off experience, current trends, credit policy, and on our analysis of accounts receivable by aging category. Changes in judgment regarding these factors could affect the timing and amount of costs recognized. Goodwill Subsequent to the transitional impairment test, as prescribed under SFAS No. 142, we are required to perform impairment tests annually and whenever events or changes in circumstance suggest that the carrying value of an asset may not be recoverable. Step one of the impairment test is performed to determine whether an impairment exists, step two of the impairment test is performed to determine the amount of the charge to be recorded as a result of the impairment. 21 See Note 5 to the consolidated financial statements. Changes in assumptions used and forecasted results of operations of the reporting units carrying goodwill could affect the determination of whether an impairment exists as well as the quantification of the impairment value, should one exist. Inventories The carrying value of inventories represents the lower of cost or market value. Market value or the net realizable value to the Company is impacted by the types and levels of inventory held, forecasted demand, and pricing. Due to the medical nature of the products we provide, customers sometimes request supplies before we have received the required written forms, if applicable, to bill Medicare, other third-party payers, and customers. As a result, included in inventories are items shipped to customers for which we have received an order but have not yet received the required written documents and therefore have not recognized revenue. The carrying value of inventory shipped to customers is based upon historical experience of collection of documents required to bill Medicare (if applicable), other third-party payers, and customers. Changes in judgment regarding the recoverability of inventories, including the carrying value of inventory shipped to customers, could result in the recording of additional income or expense. Direct-Response Advertising In accordance with Statement of Position 93-7("SOP 93-7") we capitalize and amortize direct-response advertising and related costs when we can demonstrate that customers have directly responded to our advertisements. We assess the realizability of the amounts of direct-response advertising costs reported as assets at each balance sheet date by comparing the carrying amounts of such assets to the probable remaining future net cash flows expected to result directly from such advertising. A business change, including a change in reimbursement rates, that reduces expected net cash flows or that shortens the period over which such net cash flows are estimated to be realized could result in accelerated charges against our earnings. Amounts due to Medicare and others The government's Medicare regulations are complex and sometimes subjective and therefore may require management's interpretation. Amounts due to Medicare and others are recorded when, based upon our assessment of the facts and circumstances, we believe that the amounts due are probable and estimable. Changes in judgment regarding Amounts due to Medicare and others could result in income or expenses that are different from our estimates. Uncertainties Our compliance with Medicare regulations may be reviewed by federal or state agencies, including the Department of Health and Human Services, the DOJ, and the FDA. The U.S. Attorney's Office for the Southern District of Florida, with the assistance of the FBI and OIG, is investigating allegations of health care fraud, improper revenue recognition and obstruction of justice by Liberty and Liberty Home Pharmacy. Both civil and criminal investigations are being conducted. We are cooperating with the investigations. Since July 1, 2001 we have spent in excess of $8.00 million on legal and accounting fees primarily preparing to respond, and responding to, the investigations and the two lawsuits described below. This work has been conducted under the direction of legal counsel who report to the Oversight Committee, a special Board committee made up of three outside directors, which was established to oversee our response to the investigations and the related litigation. 22 During this period we have continued to expand the size and capabilities of our compliance and regulatory affairs department. We believe our understanding of Medicare regulations, and our ability to work within them, are important core competencies that allow us to deliver products and services to our customers in an effective and compliant manner. We also believe these capabilities represent an important barrier to entry for our core Liberty Diabetes and Liberty Respiratory segments. In December 2001 we received a formal order of investigation by the Securities and Exchange Commission ("SEC") in connection with accounting matters, financial reports, other public disclosures and sales of PolyMedica's securities. In April 2002 we received a letter from the SEC notifying us that the Commission's present staff inquiry into PolyMedica had been terminated and that no enforcement action had been recommended to the Commission. We and three individuals who are or were officers of PolyMedica are defendants in a lawsuit alleging violations of certain sections and rules of the Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a derivative action against the directors and two individuals who are or were officers in Massachusetts state court alleging certain breaches of fiduciary duty. We, the named individuals, and the Board believe that we have meritorious defenses to the claims made against us in the actions in which we are defendants and intend to contest the claims vigorously. Although we do not consider an unfavorable outcome to the various claims probable, we cannot accurately predict their ultimate disposition, and have therefore not recorded any charges related to their outcome. An unfavorable outcome could have a material effect on our financial position and results of operations. Please see Item 1 of Part II, Legal Proceedings, for a more complete description of these claims. If any of the investigations or legal proceedings referred to above results in a determination that we have failed to comply with the regulations governing Medicare reimbursement or financial reporting or have otherwise committed healthcare fraud or securities law violations, we could be subject to delays or loss of reimbursement, substantial fines or penalties, and other sanctions. An adverse determination could have a material effect on our financial position and results of operations. At this time, we cannot accurately predict the outcome of these proceedings, and have therefore not recorded any charges relating to their outcome. In June 2002, Liberty received an administrative subpoena from the U.S. Attorney's Office for the Southern District of Illinois seeking documents relevant to an ongoing investigation of Medicare reimbursement of "depth shoes and inserts." Liberty has been informed that it is not a target of that investigation. We have certain contingent liabilities that arise in the ordinary course of our business activities, in addition to those described above. 23 We accrue contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. COMPLIANCE AND REGULATORY AFFAIRS We have a Compliance and Regulatory Affairs Department that is comprised of five groups: corporate compliance, monitoring, compliance/external responses, compliance/internal reviews and contracts and licensing. Although each group is distinct, the Vice President of Regulatory Affairs coordinates activities within the department in order to promote the common goal of ensuring compliance with all federal, state and local laws and regulations applicable to the businesses of these companies. The corporate compliance group administers a formal healthcare compliance program to assist us in meeting our compliance obligations. The compliance program is designed to prevent violations of applicable fraud and abuse laws and, if such violations occur, to promote early and accurate detection and prompt resolution. This objective is achieved through education, monitoring, disciplinary action and other appropriate remedial measures. All personnel, as a condition of employment, are required to attend corporate compliance certification classes annually. In addition, each employee receives a compliance manual that has been developed to communicate standards of conduct and compliance policies and procedures. The monitoring group performs oversight functions to ensure compliance with policies and procedures and applicable laws. These functions include telephonic monitoring of contacts between employees and customers, healthcare professionals, payers and other outside contacts. The compliance/external communications group monitors communications with third parties to ensure timely responses to document and other requests and oversees the receipt and timely dissemination of supplier bulletin information. The compliance/internal reviews group is responsible for conducting a variety of internal reviews of operations to ensure compliance with healthcare program requirements and applicable laws. The contracts and licensing group monitors compliance with provider contracting and licensing requirements, which includes random, internal onsite inspections. As appropriate, we also use external audit resources to supplement our internal auditing and monitoring activities. CORPORATE GOVERNANCE In August 2001, our Board established an Oversight Committee, a special Board committee made up of three outside directors, which was established to oversee our response to the investigations and the related litigation described in Item 1 of Part II, Legal Proceedings. The Oversight Committee is advised on legal matters by our legal counsel and other appropriate independent advisors. The Oversight Committee will continue to play an active role as these investigations proceed. Its authority includes monitoring the Compliance and Regulatory Affairs Department (the "Department") and the Department's compliance program to ensure compliance with Medicare and internal Company policies. 24 Over the past year, we have expanded and strengthened our Board through the addition of four new directors. We have also recently established the position of Lead Director, to be elected annually by our outside directors. Samuel Shanaman, Interim Chief Executive Officer, currently holds that position. The role of the Lead Director is to chair regular meetings of the outside directors, providing a strong focal point for both the Board and our shareholders. In addition, we have reconstituted two important Board committees; the Corporate Governance Committee, made up of three outside directors, to coordinate our efforts in that area, and the Executive Committee, an active, decision-making sub-set of the Board. 25 RESULTS OF OPERATIONS Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001 Total net revenues increased 27.8% to $88.01 million in the three months ended September 30, 2002, as compared with $68.85 million in the three months ended September 30, 2001. This increase was primarily the result of the growth in net revenues from our Liberty Diabetes and Liberty Respiratory segments, which increased 17.8% and 54.4%, respectively, in the three months ended September 30, 2002, as compared with the three months ended September 30, 2001. Net revenues in the Liberty Diabetes segment increased 17.8% to $60.96 million in the three months ended September 30, 2002, as compared with $51.76 million in the three months ended September 30, 2001. This increase was due primarily to the growth in our customer base as a result of our direct-response advertising spending. We currently expect our promotional and direct-response advertising spending to continue in order to further the expansion of our Liberty Diabetes segment. Revenue growth was hindered, however, by an incremental 3.28% cost of living adjustment in effect for the quarter ended September 30, 2001, due to the late implementation of the January 1, 2001 cost of living adjustment which went into effect July 1, 2001, which was not in effect for the quarter ended September 30, 2002. The increase in net revenues for the fiscal 2003 second quarter as compared with the prior year second quarter, would have been greater without the incremental reimbursement which added 3.28% to the revenues of many of our Liberty Diabetes segment products in the quarter ended September 30, 2001. Net revenues in the Liberty Respiratory segment increased 54.4% to $18.61 million in the three months ended September 30, 2002, as compared with $12.06 million in the three months ended September 30, 2001. This increase was due primarily to the growth in our customer base as a result of our direct-response advertising spending. As with our Liberty Diabetes segment, we currently expect our promotional and direct-response advertising spending to continue in order to further the expansion of our Liberty Respiratory segment. Net revenues in the Pharmaceuticals segment increased 67.8% to $8.44 million in the three months ended September 30, 2002, as compared with $5.03 million in the three months ended September 30, 2001, due primarily to the growth in our LMSP reporting unit, selling oral medications not covered by Medicare to existing customers. As a percentage of total net revenues, overall gross margins were 64.5% in the three months ended September 30, 2002, down from 65.8% in the three months ended September 30, 2001. This decrease was due primarily to the late implementation of the January 1, 2001 cost of living adjustment, implemented by the government for certain durable medical equipment products and services under the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000, which went into effect July 1, 2001. The late implementation added an incremental reimbursement of 3.28% to the revenues of many of our Liberty Diabetes segment products in the quarter ended September 30, 2001. Increasing sales from new business initiatives, including LMSP in our Pharmaceuticals segment, that have lower margins than our consolidated business, contributed to the gross margin decline. Also contributing to the decline was a change in the product mix for our Liberty Diabetes and Liberty Respiratory segments. 26 As a percentage of total net revenues, selling, general and administrative expenses were 46.6% in the three months ended September 30, 2002, as compared with 55.3% in the three months ended September 30, 2001. Selling, general and administrative expenses increased 7.7% in the three months ended September 30, 2002 to $40.98 million, as compared with $38.06 million in the three months ended September 30, 2001. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily attributable to an additional $5.03 million of selling, general and administrative expenses in the quarter ended September 30, 2001 in the Liberty Respiratory segment related to the establishment of the Amounts due to Medicare and others liability, coupled with a $2.22 million decrease in selling, general and administrative expenses in the quarter ended September 30, 2002 in the Liberty Respiratory segment related to a reduction in this liability based upon a favorable determination by one of the four Medicare carriers that our original method of billing for albuterol and ipratropium combinations was proper. The $2.22 million benefit reported in the quarter ended September 30, 2002, was partially offset by a $1.30 million one-time charge to selling, general and administrative expenses related to the retirement of the Company's former Chief Executive Officer. Selling, general and administrative expenses, excluding the above items, totaled $41.90 million and $33.03 million or 47.6% and 48.0% of net revenues in the three months ended September 30, 2002 and 2001, respectively. Investment income/(loss) decreased to $(12,000) in the three months ended September 30, 2002, as compared with $234,000 in the three months ended September 30, 2001, due primarily to greater losses realized in the holdings of the executive deferred compensation plans and a lower average cash balance and lower interest rates in the quarter ended September 30, 2002, as compared with the quarter ended September 30, 2001. Interest expense decreased 24.9% to $34,000 in the three months ended September 30, 2002, as compared with $44,000 in the three months ended September 30, 2001. Net income increased 109.7% to $9.82 million for the quarter ended September 30, 2002, as compared with $4.68 million for the quarter ended September 30, 2001. The increase in net income was primarily attributable to a $3.60 million reduction in net income in the quarter ended September 30, 2001 related to the establishment of the Amounts due to Medicare and others liability (net of related taxes) coupled with a $1.38 million increase to net income in the quarter ended September 30, 2002 related to a reduction in this liability based upon a favorable determination by one of the four Medicare carriers that our original method of billing for albuterol and ipratropium combinations in our Liberty Respiratory segment was proper. The $1.38 million increase to net income in the quarter ended September 30, 2002, was partially offset by a $810,000 one-time decrease to net income in the quarter ended September 30, 2002 related to the retirement of the Company's former Chief Executive Officer (net of related taxes). Growth in our customer base as a result of our direct-response advertising also contributed to the increase in net income in the quarter ended September 30, 2002, as compared with the quarter ended September 30, 2001. Six Months Ended September 30, 2002 Compared to Six Months Ended September 30, 2001 Total net revenues increased 28.6% to $169.61 million in the six months ended September 30, 2002, as compared with $131.87 million in the six months ended September 30, 2001. This increase was primarily the result of the growth in net revenues from our Liberty Diabetes and Liberty Respiratory segments, which increased 21.3% and 46.4%, respectively, in the six months ended September 30, 2002, as compared with the six months ended September 30, 2001. 27 Net revenues in the Liberty Diabetes segment increased 21.3% to $119.48 million in the six months ended September 30, 2002, as compared with $98.46 million in the six months ended September 30, 2001. This increase was due primarily to the growth in our customer base as a result of our direct-response advertising spending. We currently expect our promotional and direct-response advertising spending to continue in order to further the expansion of our Liberty Diabetes segment. Revenue growth was hindered, however, by an incremental 3.28% cost of living adjustment in effect for the quarter ended September 30, 2001, due to the late implementation of the January 1, 2001 cost of living adjustment which went into effect July 1, 2001, which was not in effect for the quarter ended September 30, 2002. The increase in net revenues for the six months ended September 30, 2002 as compared with the six months ended September 30, 2001, would have been greater without the incremental reimbursement which added 3.28% to the revenues of many of our Liberty Diabetes segment products in the quarter ended September 30, 2001. Net revenues in the Liberty Respiratory segment increased 46.4% to $35.19 million in the six months ended September 30, 2002, as compared with $24.04 million in the six months ended September 30, 2001. This increase was due primarily to the growth in our customer base as a result of our direct-response advertising spending. As with our Liberty Diabetes segment, we currently expect our promotional and direct-response advertising spending to continue in order to further the expansion of our Liberty Respiratory segment. Net revenues in the Pharmaceuticals segment increased 59.4% to $14.95 million in the six months ended September 30, 2002, as compared with $9.38 million in the six months ended September 30, 2001, due primarily to the growth in our LMSP reporting unit, selling oral medications not covered by Medicare to existing customers. As a percentage of total net revenues, overall gross margins were 64.6% in the six months ended September 30, 2002, down from 66.0% in the six months ended September 30, 2001. This decrease was due primarily to the late implementation of the January 1, 2001 cost of living adjustment, implemented by the government for certain durable medical equipment products and services under the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000, which went into effect July 1, 2001. The late implementation added an incremental reimbursement of 3.28% to the revenues of many of our Liberty Diabetes segment products in the quarter ended September 30, 2001. Increasing sales from new business initiatives that have lower margins than our average and a change in the product mix for our Liberty Diabetes and Liberty Respiratory segments also contributed to the gross margin decline. Partially offsetting this decline was the existence of a 3.7% cost of living adjustment which added 3.7% to the revenues of many of our Liberty Diabetes segment products for the full six months ended September 30, 2002, as compared with only three months, July 2001 through September 2001, of the six months ended September 30, 2001. As a percentage of total net revenues, selling, general and administrative expenses were 46.6% in the six months ended September 30, 2002, as compared with 50.0% in the six months ended September 30, 2001. Selling, general and administrative expenses increased 19.8% in the six months ended September 30, 2002 to $79.00 million, as compared with $65.96 million in the six months ended September 30, 2001. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily attributable to an additional $5.03 million of selling, general and administrative expenses in the six months ended September 30, 2001 in the Liberty Respiratory 28 segment related to the establishment of the Amounts due to Medicare and others liability, coupled with a $2.22 million decrease in selling, general and administrative expenses in the quarter ended September 30, 2002 in the Liberty Respiratory segment related to a reduction in this liability based upon a favorable determination by one of the four Medicare carriers that our original method of billing for albuterol and ipratropium combinations was proper. The $2.22 million benefit reported in the quarter ended September 30, 2002, was offset by a $1.30 million one-time charge to selling, general and administrative expenses related to the retirement of the Company's former Chief Executive Officer. Selling, general and administrative expenses, excluding the above items, totaled $79.93 million and $60.94 million or 47.1% and 46.2% of net revenues in the six months ended September 30, 2002 and 2001, respectively. Investment income/(loss) decreased 95.9% to $32,000 in the six months ended September 30, 2002, as compared with $774,000 in the six months ended September 30, 2001, due primarily to greater losses realized in the holdings of the executive deferred compensation plans and a lower average cash balance and lower interest rates in the six months ended September 30, 2002, as compared with the six months ended September 30, 2001. Interest expense decreased 19.5% to $70,000 in the six months ended September 30, 2002, as compared with $87,000 in the six months ended September 30, 2001. Net income increased 42.3% to $18.97 million for the six months ended September 30, 2002, as compared with $13.33 million for the six months ended September 30, 2001. The increase in net income was primarily attributable to $3.60 million reduction in net income in the six months ended September 30, 2001 related to the establishment of the Amounts due to Medicare and others liability (net of related taxes) coupled with a $1.38 million increase to net income in the six months ended September 30, 2002 related to a reduction in this liability based upon a favorable determination by one of the four Medicare carriers that our original method of billing for albuterol and ipratropium combinations in our Liberty Respiratory segment was proper. The $1.38 million increase to net income in the quarter ended September 30, 2002, was offset by a $810,000 one-time decrease to net income in the six months ended September 30, 2002 related to the retirement of the Company's former Chief Executive Officer (net of related taxes). Growth in our customer base as a result of our direct-response advertising also contributed to the increase in net income in the six months ended September 30, 2002, as compared with the six months ended September 30, 2001. Liquidity and Capital Resources Our business and its sustained growth is currently funded through cash flow from operations. We have generated positive cash flow from operations in each of the last fifteen quarters and have reported positive annual cash flows from operations in each of the last 4 fiscal years, with $22.90 million, $14.62 million, $10.08 million, and $539,000 generated in the fiscal years ended March 31, 2002, 2001, 2000, and 1999, respectively. Our cash and cash equivalents balance decreased $1.05 million to $26.83 million as of September 30, 2002, as compared with $27.88 million as of March 31, 2002, due primarily to cash used for capital expenditures, offset by cash flows generated from operations. Cash flows from operations of $12.61 million for the six months ended September 30, 2002 were generated by net income of $18.97 million, offset by cash used to fund certain areas of our operations, such as increased spending for direct-response advertising of $2.41 million to $23.50 million in the six months ended September 30, 2002, as compared with $21.09 million in the six months ended September 30, 2001, to further expand our customer base, both for our Liberty Diabetes and Liberty Respiratory segments. 29 Our contractual obligations for future annual minimum lease and rental commitments as of September 30, 2002, were not materially different from those as of March 31, 2002, disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2002. In the six months ended September 30, 2002 and 2001, we used $12.08 million and $4.85 million of cash for investing activities, respectively. The $7.23 million increase in total cash used for investing activities was due to an increase in capital expenditures of $7.23 million in the six months ended September 30, 2002, as compared with the six months ended September 30, 2001. Property, plant and equipment purchases totaled $12.08 million and $4.85 million for the six months ended September 30, 2002 and 2001, respectively. Higher spending in the current fiscal year for capital expenditures is related to the recently completed construction of two new facilities in Port St. Lucie, Florida to meet our expansion needs. The cumulative amount spent through September 30, 2002 related to this construction was $13.37 million, which we will begin depreciating in the quarter ending December 31, 2002. In the quarter ending December 31, 2002, we estimate that we will spend an additional $1.00 million on the construction of these two new facilities, for which no liability has been recorded as of September 30, 2002, because we have no contractual obligation to complete the construction. In the six months ended September 30, 2002, we used $1.58 million of cash for financing activities, $1.27 million of which we set aside for executive deferred compensation plans with an additional $659,000 used to repurchase 25,000 shares of our common stock at an average repurchase price of $26.37 per share. In June 2000, the Board authorized the repurchase of up to 1,000,000 shares of our common stock on the open market, with any shares repurchased to be held in treasury. In August 2001, the Board authorized the repurchase of an additional 1,000,000 shares. As of November 14, 2002, 1,271,000 shares had been repurchased in total for $25.30 million at an average repurchase price of $19.91 per share. Of the 2,000,000 shares originally authorized by the Board, 729,000 shares remained authorized for repurchase as of November 14, 2002. Other financing activities included the receipt of proceeds from the issuance of common stock and repayments of capital lease obligations. In November 2000, we filed an amendment to a shelf registration statement we originally filed in April 2000, to enable us to offer from time to time, shares of our common stock having an aggregate value of up to $100 million. The SEC declared the shelf registration statement effective during the quarter ended December 31, 2000. No shares of common stock had been sold under this shelf registration statement as of September 30, 2002. We believe that our cash and cash equivalents balance as of September 30, 2002 of $26.83 million and cash flows generated from operations, will be sufficient to meet working capital, capital expenditure and financing needs for future business operations for the foreseeable future. In the event that we undertake to make acquisitions of complementary businesses, products or technologies, we may require substantial additional funding beyond currently available working capital and funds generated from operations. Other factors which could negatively impact our liquidity include a reduction in the demand for our products, an unfavorable outcome of pending litigation and investigations, or a reduction in Medicare reimbursement for our products. We hold certain investments related to executive deferred compensation plans, see Note 6 to the consolidated financial statements, which are accounted for pursuant to SFAS No. 115, 30 "Accounting for Certain Investments in Debt and Equity Securities." Investments related to the executive deferred compensation plans, which have been classified as trading, are included in other assets and are recorded at fair value. As of September 30, 2002, the fair value of these investments was not materially different from cost. Accounting Pronouncements In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect adoption of this statement to have a material impact on our financial position or results of operations. In October 2001 the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance on the accounting for the impairment or disposal of long-lived assets. The objectives of SFAS No. 144 are to address issues relating to the implementation of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and to develop a model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. We adopted SFAS No. 144 on April 1, 2002, as required. The adoption did not have a material impact on our financial position or results of operations in the three or six months ended September 30, 2002, but could have a significant impact on our financial position or results of operations should there be future asset impairments or disposals. In August 2001, the FASB issued SFAS No. 143 "Accounting for Obligations Associated with the Retirement of Long-Lived Assets." The provisions of SFAS No. 143 apply to all entities that incur obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 and thus will be adopted, as required, on April 1, 2003. This accounting pronouncement is not expected to have a significant impact on our financial position or results of operations. 31 FACTORS AFFECTING FUTURE OPERATING RESULTS The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are 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, including, but not limited to, statements regarding our expectations, hopes, intentions or strategies regarding the future. Forward-looking statements include, among others: statements regarding future benefits from our advertising and promotional expenditures; statements regarding future net revenue levels; statements regarding product development, introduction and marketing; and statements regarding future acquisitions. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual results could differ materially from those in such forward-looking statements. Our future operating results remain difficult to predict. We continue to face many risks and uncertainties which could affect our operating results, including without limitation, those described below. We could experience significantly reduced profits if Medicare changes, delays or denies reimbursement Sales of a significant portion of our Liberty Diabetes and Liberty Respiratory medications and supplies depend on the continued availability of reimbursement of our customers by government and private insurance plans. Any reduction in Medicare reimbursement currently available for our products would reduce our revenues. Without a corresponding reduction in the cost of such products, the result would be a reduction in our overall profit margin. Similarly, any increase in the cost of such products would reduce our overall profit margin unless there was a corresponding increase in Medicare reimbursement. Our profits could also be affected by the imposition of more stringent regulatory requirements for Medicare reimbursement or adjustments to previously reimbursed amounts. Federal governmental authorities are continually considering changes to laws and regulations applicable to us as they relate to billing requirements and reimbursement levels of our products. Legislation and regulations are pending relating to: Competitive Bidding There is pending legislation that requires certain Medicare Part B items and services to be competitively bid in certain areas of the country. The United States House of Representatives (the "House") has passed a bill (HR4954) that requires durable medical equipment and inhalation drugs to be competitively bid unless such bidding would not be competitive because of low population in a particular geographic region or because it would not result in significant savings when compared to the current fee schedule reimbursement. The House bill requires multiple winners in each area of the country. It further requires that the plan be implemented over a three-year period beginning in 2004. The United States Senate may consider legislation (S 3018) that mandates similar competitive bidding except in areas where there are fewer than 500,000 individuals. The proposed Senate bill would begin in 2003 and be phased-in over a four-year period. 32 If enacted, these proposals could apply to us; if so, we would begin the process of understanding the bidding requirements and working with appropriate officials in preparing bids for products that are covered. These proposals are part of a larger Medicare bill that increases reimbursement for certain providers and authorizes certain regulatory relief in the administrative processes of the Medicare claims and payment rules. It is uncertain at this time whether this legislation will be enacted and become law. Inherent reasonableness Final regulations may be implemented by the Centers for Medicare and Medicaid Services ("CMS") that reduce the payment for certain Medicare Part B items and services by as much as fifteen percent (CMS-1908F Application of Inherent Reasonableness to All Medicare Part B Services (Other than Physician Services)). CMS has the authority to determine whether the reimbursement for certain fee schedule items and services is reasonable when compared to other payers' prices for similar services and to make reductions or increases up to 15 percent. This proposal could apply to the items and services that we provide. Litigation may materially adversely affect us We and three individuals who are or were officers of PolyMedica are defendants in a lawsuit alleging violations of certain sections and rules of the Securities Exchange Act of 1934 (the "Exchange Act"). In addition, there is a derivative action against the directors and two individuals who are or were officers in Massachusetts state court alleging certain breaches of fiduciary duty. We, the named individuals, and the Board believe that we have meritorious defenses to the claims made against us in the actions in which we are defendants and intend to contest the claims vigorously. Although we do not consider an unfavorable outcome to the various claims probable, we cannot accurately predict their ultimate disposition, and have therefore not recorded any charges related to their outcome. An unfavorable outcome could have a material effect on our financial position and results of operations. Please see Item 1 of Part II, Legal Proceedings, for a more complete description of these claims. We could experience significantly reduced profits as the result of an unfavorable outcome to current governmental investigations The regulations that govern Medicare reimbursement are complex and our compliance with those regulations may be reviewed by federal agencies, including the Department of Health and Human Services, the DOJ, and the FDA. The U.S. Attorney's Office for the Southern District of Florida, with the assistance of the FBI and OIG, is investigating allegations of healthcare fraud, improper revenue recognition and obstruction of justice by Liberty and Liberty Home Pharmacy. Both civil and criminal investigations are being conducted. We are cooperating with the investigations. We cannot accurately predict the outcome of these proceedings at this time, and have therefore not recorded any charges relating to their outcome. If any of these investigations results in a determination that we have failed to comply with the regulations governing Medicare reimbursement or financial reporting or have otherwise committed healthcare fraud or securities law violations, we could be subject to delays or loss of reimbursement, substantial fines or penalties, and other sanctions. An adverse determination could have a material 33 effect on our financial position and results of operations. In June 2002, Liberty received an administrative subpoena from the U.S. Attorney's Office for the Southern District of Illinois seeking documents relevant to an ongoing investigation of Medicare reimbursement of "depth shoes and inserts." Liberty has been informed that it is not a target of that investigation. Our stock price could be volatile The trading price of our common stock has been volatile and is likely to continue to be volatile. The stock market in general, and the market for healthcare-related companies in particular, has experienced extreme volatility. This volatility has often been unrelated to the operating performance of particular companies. Investors may not be able to sell their common stock at or above the price at which they purchased the stock. Prices for the common stock will be determined in the marketplace and may be influenced by many factors, including variations in our financial results, changes in earnings estimates by industry research analysts, investors' perceptions of us and general economic, industry and market conditions. We plan to continue our rapid expansion; if we do not manage our growth successfully, our growth and profitability may slow or stop We have expanded our operations rapidly and plan to continue to expand. This expansion has created significant demand on our administrative, operational and financial personnel and other resources. Additional expansion in existing or new markets could strain these resources and increase our need for capital. Our personnel, systems, procedures, controls and existing space may not be adequate to support further expansion. The profitability of our Liberty Diabetes and Liberty Respiratory segments will decrease if we do not receive recurring orders from customers We generally incur losses and negative cash flow with respect to the first order from a new customer for Liberty Diabetes and Liberty Respiratory products, due primarily to the marketing and regulatory compliance costs associated with initial customer qualification. Accordingly, the profitability of these segments depends in large part, on recurring and sustained reorders. Reorder rates are inherently uncertain due to several factors, many of which are outside our control, including changing customer preferences, competitive price pressures, customer transition to extended care facilities, customer mortality and general economic conditions. We could experience significantly reduced profits from our Liberty Diabetes segment if improved technologies that eliminate the need for consumable testing supplies are developed for glucose monitoring The majority of our Liberty Diabetes net revenues are from consumable testing supplies, used to draw and test small quantities of blood for the purpose of measuring and monitoring glucose levels. Numerous research efforts are underway to develop more convenient and less intrusive glucose measurement techniques. The commercialization and widespread acceptance of new technologies that eliminate or reduce the need for consumable testing supplies could negatively affect our Liberty Diabetes segment. 34 We could experience a charge to earnings as a result of an impairment of our goodwill We are required to perform impairment tests under SFAS No. 142 annually and whenever events or changes in circumstance suggest that the carrying value of an asset may not be recoverable. The valuation of our goodwill is based upon the results of these impairment tests. Changes in assumptions used and forecasted results of operations of the reporting units carrying goodwill, could affect the quantification of an impairment value, should one exist. We could be liable for harm caused by products that we sell The sale of medical products entails the risk that users will make product liability claims. A product liability claim could be expensive. While management believes that our insurance provides adequate coverage, no assurance can be made that adequate coverage will exist for these claims. We could lose customers and revenues to new or existing competitors who have greater financial or operating resources Competition from other sellers of products offered through our Liberty Diabetes, Liberty Respiratory, and Pharmaceuticals segments, manufacturers of healthcare products, pharmaceutical companies and other competitors is intense and expected to increase. Many of our competitors and potential competitors are large companies with well-known names and substantial resources. These companies may develop products and services that are more effective or less expensive than any that we are developing or selling. They may also promote and market these products more successfully than we promote and market our products. Loss of use of manufacturing or data storage facilities would significantly reduce revenues and profits from our businesses We manufacture substantially all of our prescription urology and suppository products and many of our AZO brand name products at our facility in Woburn, Massachusetts. In addition, we process and store most of our customer data in our facility in Port St. Lucie, Florida. If we cannot use any of these facilities as a result of the FDA, Occupational Safety and Health Administration or other regulatory action, fire, natural disaster or other event, our revenues and profits would decrease significantly. We might also incur significant expense in remedying the problem or securing alternative manufacturing or data storage sources. If we or our suppliers do not comply with applicable government regulations, we may be prohibited from selling our products The majority of the products that we sell are regulated by the FDA and other regulatory agencies. If any of these agencies mandate a suspension of production or sales of our products or mandate a recall, we may lose sales and incur expenses until we are in compliance with the regulations or change to another acceptable supplier. We could have difficulty selling our pharmaceutical products if we cannot maintain and expand our sales to distributors We rely on third party distributors to market and sell our over-the-counter female urinary 35 discomfort products and prescription urology and suppository products. Our sales of these products will therefore depend in part on our maintaining and expanding marketing and distribution relationships with pharmaceutical, medical device, personal care and other distributors and on the success of those distributors in marketing and selling our products. Shortening or eliminating the amortization period of our direct-response advertising costs could adversely affect our operating results Any change in existing accounting rules or a business change that impacts expected net cash flows or that shortens the period over which such net cash flows are estimated to be realized, currently four years for our diabetes products and two years for our prescription respiratory medications and supplies, could result in accelerated charges against our earnings. Our quarterly revenues or operating results could vary, which may cause the market price of our securities to decline We have experienced fluctuations in our quarterly operating results and anticipate that such fluctuations could continue. Results may vary significantly depending on a number of factors, including: - changes in reimbursement guidelines and amounts; - changes in regulations affecting the healthcare industry; - the timing of customer orders; - the timing and cost of our advertising campaigns; and - the timing of the introduction or acceptance of new products and services offered by us or our competitors. - changes in the mix and costs of our products. Product mix and costs are significantly influenced by the product brand chosen by the customers of our mail-order diabetes supply business. We provide a wide range of product brand choices to our customers, purchased at varying costs from suppliers. Our ability to sustain current gross margin levels is dependent both on our ability to continue securing favorable pricing from suppliers and on the brand choices of our customers. We may make acquisitions that will strain our financial and operational resources We regularly review potential acquisitions of businesses and products. Acquisitions involve a number of risks that might adversely affect our financial and operational resources, including: - diversion of the attention of senior management from important business matters; - amortization of substantial intangible assets; - difficulty in retaining key personnel of an acquired business; - failure to assimilate operations of an acquired business; - failure to retain the customers of an acquired business; - possible operating losses and expenses of an acquired business; - exposure to legal claims for activities of an acquired business prior to acquisition; and - incurrence of debt and related interest expense. 36 We may issue preferred stock with rights senior to the common stock Our articles of organization authorize the issuance of up to 2,000,000 shares of preferred stock without stockholder approval. The shares may have dividend, voting, liquidation and other rights and preferences that are senior to the rights of the common stock. The rights and preferences of any such class or series of preferred stock would be established by our Board in its sole discretion. 37 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We own certain money market funds and mutual funds that are sensitive to market risks as part of our investment portfolio. The investment portfolio is used to preserve our capital until it is required to fund operations. None of the market-risk sensitive instruments held in our investment portfolio are held for trading purposes. We do, however, hold some market-risk sensitive instruments in our executive deferred compensation plans, for trading purposes. These investments are accounted for under SFAS No. 115, "Accounting for certain investments in Debt and Equity Securities." The investments are recorded at fair value, and changes in fair value are recorded as compensation expense and investment income/(loss) for the period. We do not own derivative financial instruments in our investment portfolio. We do not believe that the exposure to market risks in our investment portfolio is material. 38 ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Based on their evaluation of PolyMedica's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, PolyMedica's Principal Executive Officer and Principal Financial Officer have concluded that PolyMedica's disclosure controls and procedures are designed to ensure that information required to be disclosed by PolyMedica in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and are operating in an effective manner. (b) Changes in internal controls. There were no significant changes in PolyMedica's internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation. 39 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The U.S. Attorney's Office for the Southern District of Florida, with the assistance of the FBI and Department of Health & Human Services' OIG, is investigating allegations of health care fraud, improper revenue recognition and obstruction of justice by Liberty Medical Supply, Inc. ("Liberty") and Liberty Home Pharmacy Corporation ("Liberty Home Pharmacy"). Both civil and criminal investigations are being conducted. We are cooperating with the investigations. We cannot accurately predict the outcome of these proceedings at this time, and have therefore not recorded any charges relating to their outcome. On November 27, 2000, Richard Bowe SEP-IRA filed a purported class action lawsuit in the United States District Court for the District of Massachusetts (the "Bowe Complaint") against us and one of our then officers. The Bowe Complaint claims violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 promulgated thereunder and seeks unspecified damages, attorneys' fees and costs. On December 19, 2000, Trust Advisors Equity Plus LLC filed a purported class action lawsuit in the United States District Court for the District of Massachusetts (the "Trust Advisors Complaint") against us and one of our then officers. The Trust Advisors Complaint asserts the same claims, makes the same allegations and seeks the same relief as the Bowe Complaint. On January 26, 2001, the plaintiffs in the Bowe and Trust Advisors Complaints moved to consolidate the Bowe and Trust Advisors Complaints and to be appointed as lead plaintiffs in the consolidated action pursuant to Section 21D(a)(3)(B) of the Exchange Act. On July 30, 2001 the Court granted these motions and consolidated the Bowe and Trust Advisor Complaints under the caption In re: PolyMedica Corp. Securities Litigation, Civ. Act. No. 00-12426-REK. Plaintiffs filed a consolidated amended complaint on October 9, 2001. The consolidated amended complaint extended the class period (the amended class period is October 26, 1998 through August 21, 2001), and named an additional two officers and Liberty as defendants. We and the named defendants moved to dismiss the consolidated amended complaint on December 10, 2001. The plaintiffs filed their opposition to this motion on February 11, 2002 and defendants filed a reply memorandum on March 11, 2002. The Court denied the motion without a hearing on May 10, 2002. We and the named defendants filed answers to the consolidated amended complaint on June 20, 2002. We and the named defendants believe that we have meritorious defenses to the claims made in the consolidated amended complaint and intend to contest the claims vigorously. We are unable to express an opinion as to the likely outcome of this litigation. Between August 9, 2001 to August 24, 2001, four derivative actions were filed in Massachusetts Superior Court for Middlesex County against our Board of Directors: Casden v. Bernstein et al., Civ. Act. No. 01-3446; Vezmar v. LoGerfo et al., Civ. Act. No. 01-3612; Sullivan v. Bernstein et al., Civ. Act. No. 01-3656; and Messner v. Lee et al., Civ. Act. No. 01-3697. On August 31, 2001, plaintiffs filed a motion to consolidate the first three actions and to file an amended consolidated complaint within 60 days. The fourth derivative action was added to the motion to consolidate on October 3, 2001. On October 11, 2001, the Court granted plaintiffs' motion to consolidate all four derivative actions under the caption In re: PolyMedica Corp. Shareholder Derivative Litigation, Civ. Act. No. 01-3446. On December 17, 2001, plaintiffs filed a consolidated derivative complaint. The consolidated 40 complaint named two additional officer defendants. The Complaint alleges that the directors and officers breached their fiduciary duties by, among other things, failing to exercise reasonable care in the oversight of corporate affairs and management with respect to the operations of Liberty and by acquiescing in alleged misconduct by Liberty . The Complaint seeks unspecified damages, the return of compensation, and other relief, including injunctive relief. The defendants filed a motion to dismiss the consolidated complaint on January 31, 2002. Plaintiffs filed an opposition to the motion on March 22, 2002 and defendants filed a reply memorandum on April 19, 2002. The Court heard arguments on the motion to dismiss on April 30, 2002 and entered an order denying the motion to dismiss on July 16, 2002. On August 8, 2002, defendants filed a motion for reconsideration of the order denying defendants' motion to dismiss, or, in the alternative, to report the case to the Appeals Court and stay the proceeding. After hearing oral argument, the Court issued an order on September 16, 2002 in which it refused to reconsider its decision, but reported the case to the Appeals Court and granted defendants' motion to stay the action. The directors and defendants believe they have meritorious defenses to the claims made in the consolidated complaint and intend to contest the claims vigorously. We are unable to express an opinion as to the likely outcome of this litigation. A shareholder derivative complaint, Minasian v. Bernstein et. al., Civ. Act. No. 01-11485REK, was filed against our Board of Directors in United States District Court for the District of Massachusetts on August 17, 2001. The Complaint alleged that the directors breached their fiduciary duties by, among other things, failing to exercise reasonable care in the oversight of corporate affairs and management with respect to the operations of Liberty and by acquiescing in alleged misconduct by Liberty , and sought unspecified damages, the return of director compensation, and other injunctive relief. On November 16, 2001, plaintiff filed an assented-to motion to dismiss the complaint without prejudice, and the case was closed on November 21, 2001. In June 2002, Liberty received an administrative subpoena from the U.S. Attorney's Office for the Southern District of Illinois seeking documents relevant to an ongoing investigation of Medicare reimbursement of "depth shoes and inserts." Liberty has been informed that it is not a target of that investigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At our Annual Meeting of Stockholders held on September 12, 2002, the following proposals were submitted to a vote of our stockholders:
For Against Abstain --- ------- ------- Election of Directors: Steven J. Lee 10,657,496 443,440(1) Samuel L. Shanaman 10,695,065 405,871(1) Thomas S. Soltys 10,694,102 406,834(1) John K. P. Stone, III 10,692,631 408,305(1)
41
For Against Abstain --- ------- ------- To approve an amendment to PolyMedica's 2000 Stock Incentive Plan ("the Plan") increasing from 1,800,000 to 2,300,000 the number of authorized shares of common stock available for issuance under the Plan 9,065,535 2,013,769 21,632 To ratify the selection by the Board of PricewaterhouseCoopers LLP as PolyMedica's independent public accountants for the fiscal year ending March 31, 2003 10,149,394 937,200 14,342
- ---------- (1) Represents votes "withheld" from each respective director. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) See Exhibit Index immediately following this report, which is incorporated herein by reference. (b) Current Report on Form 8-K, dated September 12, 2002, reporting the declaration of a dividend of one Right for each outstanding share of PolyMedica's common stock. 42 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PolyMedica Corporation (registrant) /s/ Samuel L. Shanaman ---------------------- Samuel L. Shanaman Lead Director and Interim Chief Executive Officer (Principal Executive Officer) /s/ Eric G. Walters ------------------- Eric G. Walters Executive Vice President and Clerk (Principal Financial Officer) /s/ Stephen C. Farrell ---------------------- Stephen C. Farrell Chief Financial Officer (Principal Accounting Officer) Dated: November 14, 2002 43 CERTIFICATIONS I, Samuel L. Shanaman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PolyMedica Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 44 /s/ Samuel L. Shanaman ---------------------- Dated: November 14, 2002 Samuel L. Shanaman Lead Director and Interim Chief Executive Officer (Principal Executive Officer) I, Eric G. Walters, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PolyMedica Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that 45 could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Eric G. Walters ------------------- Dated: November 14, 2002 Eric G. Walters Executive Vice President and Clerk (Principal Financial Officer) 46 Exhibit Index
Exhibit Description - ------- ----------- 10.59 - Employment Agreement by and between the Registrant and Samuel L. Shanaman dated October 7, 2002. 10.60 - Restricted Stock Agreement by and between the Registrant and Samuel L. Shanaman dated October 7, 2002. 99.1 - Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
47 EX-10.59 3 b44520pmexv10w59.txt EMPLOYMENT AGREEMENT - SAMUEL SHANAMAN EXHIBIT 10.59 THIS EMPLOYMENT AGREEMENT (the "Agreement"), made this 7th day of October, 2002, is entered into by PolyMedica Corporation, a Massachusetts corporation with its principal place of business at 11 State Street, Woburn, Massachusetts 01801 (the "Company"), and Samuel L. Shanaman, residing at Five Millstone Circle, Andover, Massachusetts 01810 (the "Employee"). INTRODUCTION The Employee is a member of the Board of Directors of the Company (the "Board"). At the request of the other members of the Board, in light of the recent retirement of the Chief Executive Officer of the Company, the Employee has been serving as Interim Chief Executive Officer of the Company and has agreed to continue to do so while the Board conducts a search for a new Chief Executive Officer. The Company and the Employee have each acknowledged that the Employee will not provide his services on a full-time basis. Both parties currently contemplate that the time commitment of the Employee will be approximately 70% of a full-time commitment, or three to four days a week. This acknowledgement shall not, however, be interpreted as a limit on the time that the Employee may work. In consideration of the mutual covenants and promises contained herein and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the parties hereto, the parties agree as follows: 1. Services. The Employee agrees to perform such management, advisory and related services to and for the Company as may be reasonably requested from time to time by the Board of Directors of the Company or its designees (the "Board"), including, but not limited to, acting as Interim Chief Executive Officer of the Company. During the Employment Period (as defined below), the Employee shall not engage in any activity that has a conflict of interest with the Company, including any competitive employment, business, or other activity, and he shall not assist any other person or organization that competes, or intends to compete, with the Company. 2. Term. This Agreement shall commence on the date hereof and shall continue until terminated by vote of the Board (such period, as it may be extended, being referred to as the "Employment Period"). 3. Compensation. 3.1. Restricted Stock and Salary. The Employee's sole compensation for the services provided hereunder shall be (a) to enter into a Restricted Stock Agreement with the Company on the date hereof in the form attached hereto as Exhibit A and (b) to be paid $600 for each of the Company's bi-weekly pay periods that occurs during the Employment Period. 3.2. Reimbursement of Expenses. The Company shall reimburse the Employee for all reasonable and necessary expenses incurred or paid by the Employee in connection with, or related to, the performance of his services under this Agreement. The Employee shall submit to the Company itemized monthly statements, in a form satisfactory to the Company, of such expenses incurred in the previous month. The Company shall pay to the Employee amounts shown on each such statement within 30 days after receipt thereof. 3.3. Benefits. Notwithstanding his employment by the Company, the Employee acknowledges and agrees that he shall not be entitled to any benefits, coverages or privileges, including, without limitation, social security, unemployment, medical or pension payments, made available to employees of the Company. 4. Cooperation. The Employee shall use his best efforts in the performance of his obligations under this Agreement. The Company shall provide such access to its information and property as may be reasonably required in order to permit the Employee to perform his obligations hereunder. The Employee shall cooperate with the Company's personnel, shall not interfere with the conduct of the Company's business and shall observe all rules, regulations and security requirements of the Company concerning the safety of persons and property. 5. Proprietary Information. 5.1. The Employee acknowledges that his relationship with the Company is one of high trust and confidence and that in the course of his service to the Company he will have access to and contact with Proprietary Information. The Employee agrees that he will not, during the Employment Period or at any time thereafter, disclose to others, or use for his benefit or the benefit of others, any Proprietary Information or Invention. 5.2. For purposes of this Agreement, Proprietary Information shall mean, by way of illustration and not limitation, all information (whether or not patentable and whether or not copyrightable) owned, possessed or used by the Company, including, without limitation, any Invention, formula, vendor information, customer information, apparatus, equipment, trade secret, process, research, report, technical data, know-how, computer program, software, software documentation, hardware design, technology, marketing or business plan, forecast, unpublished financial statement, budget, license, price, cost and employee list that is communicated to, learned of, developed or otherwise acquired by the Employee in the course of his service as a Employee to the Company. 5.3. The Employee's obligations under this Section 5 shall not apply to any information that (i) is or becomes known to the general public under circumstances involving no breach by the Employee or others of the terms of this Section 5, (ii) is generally disclosed to third parties by the Company without restriction on such third parties, or (iii) is approved for release by written authorization of the Board of Directors of the Company. 5.4. Upon termination of this Agreement or at any other time upon request by the Company, the Employee shall promptly deliver to the Company all records, files, memoranda, notes, designs, data, reports, price lists, customer lists, drawings, plans, computer programs, software, software documentation, sketches, laboratory and research notebooks and other documents (and all copies or reproductions of such materials) relating to the business of the Company. 5.5. The Employee acknowledges that any breach of the provisions of this Section 6 shall result in serious and irreparable injury to the Company for which the Company cannot be adequately compensated by monetary damages alone. The Employee agrees, therefore, that, in addition to any other remedy it may have, the Company shall be entitled to enforce the specific performance of this Agreement by the Employee and to seek both temporary and permanent injunctive relief (to the extent permitted by law) without the necessity of proving actual damages. 6. Notices. All notices required or permitted under this Agreement shall be in writing and shall be deemed effective upon personal delivery or upon deposit in the United States Post Office, by registered or certified mail, postage prepaid, addressed to the other party at the address shown above, or at such other address or addresses as either party shall designate to the other in accordance with this Section 6. 7. Pronouns. Whenever the context may require, any pronouns used in this Agreement shall include the corresponding masculine, feminine or neuter forms, and the singular forms of nouns and pronouns shall include the plural, and vice versa. 8. Entire Agreement. This Agreement constitutes the entire agreement between the parties and supersedes all prior agreements and understandings, whether written or oral, relating to the subject matter of this Agreement. 9. Amendment. This Agreement may be amended or modified only by a written instrument executed by both the Company and the Employee. 10. Governing Law. This Agreement shall be construed, interpreted and enforced in accordance with the laws of the Commonwealth of Massachusetts. 11. Successors and Assigns. This Agreement shall be binding upon, and inure to the benefit of, both parties and their respective successors and assigns, including any corporation with which, or into which, the Company may be merged or which may succeed to its assets or business, provided, however, that the obligations of the Employee are personal and shall not be assigned by him. 12. Indemnification. The Employee, as an officer and director of the Company, shall have the full benefit of all indemnification and similar protections provided by the Company to its officers and directors, including without limitation pursuant to the indemnification provisions set forth in the Company's Articles of Organization and any liability insurance maintained by the Company for the benefit of its officers, directors, or both, each as in effect from time to time. Without limitation of the foregoing, the Company acknowledges and agrees that the Employee, as Interim Chief Executive Officer of the Company, is an officer for all purposes of any indemnification or insurance protection provided by the Company to its officers. 13. Miscellaneous. 13.1. No delay or omission by the Company in exercising any right under this Agreement shall operate as a waiver of that or any other right. A waiver or consent given by the Company on any one occasion shall be effective only in that instance and shall not be construed as a bar or waiver of any right on any other occasion. 13.2. The captions of the sections of this Agreement are for convenience of reference only and in no way define, limit or affect the scope or substance of any section of this Agreement. 13.3. In the event that any provision of this Agreement shall be invalid, illegal or otherwise unenforceable, the validity, legality and enforceability of the remaining provisions shall in no way be affected or impaired thereby. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year set forth above. POLYMEDICA CORPORATION: /s/ Stephen C. Farrell ---------------------- Stephen C. Farrell Chief Financial Officer EMPLOYEE: /s/ Samuel L. Shanaman ---------------------- Samuel L. Shanaman Lead Director and Interim Chief Executive Officer EX-10.60 4 b44520pmexv10w60.txt RESTRICTED STOCK AGREEMENT EXHIBIT 10.60 AGREEMENT made this 7th day of October, 2002, between PolyMedica Corporation, a Massachusetts corporation (the "Company"), and Samuel L. Shanaman (the "Participant"). For valuable consideration, receipt of which is acknowledged, the parties hereto agree as follows: 1. Purchase of Shares. The Company shall issue and sell to the Participant, and the Participant shall purchase from the Company, subject to the terms and conditions set forth in this Agreement and in the Company's 2000 Stock Incentive Plan (the "Plan"), 8,345 shares (the "Shares") of common stock, $0.01 par value, of the Company ("Common Stock"), at a purchase price of $0.01 per share. The aggregate purchase price for the Shares shall be paid by the Participant by check payable to the order of the Company or such other method as may be acceptable to the Company. Upon receipt by the Company of payment for the Shares, the Company shall issue to the Participant one or more certificates in the name of the Participant for that number of Shares purchased by the Participant. The Participant agrees that certain of the Shares shall be subject to the purchase options set forth in Section 2 of this Agreement and the restrictions on transfer set forth in Section 4 of this Agreement. 2. Purchase Option. Upon the termination of the employment agreement dated as of the date hereof by and between the Company and the Participant (the "Employment Agreement"), for any reason or no reason, with or without cause, prior to January 30, 2003, the Company shall have the right and option (the "Purchase Option") to purchase from the Participant, for a sum of $0.01 per share (the "Option Price"), some or all of the Unvested Shares (as defined below). "Unvested Shares" means the total number of Shares less the total number of Vested Shares (as defined herein) at the time the Purchase Option becomes exercisable by the Company. Of the Shares, 2,345 shall be "Vested Shares" on the date hereof and the remaining 6,000 Shares shall vest on the 30th day of each month that the Employment Agreement is in effect, beginning October 30, 2002, in an amount determined by multiplying 80 Shares by the number of days actually worked by the Participant during the period from the last vesting date to and including the current vesting date. The calculation of Vested Shares to be made on October 30, 2002 shall be made for the period beginning October 8, 2002. 3. Exercise of Purchase Option and Closing. The Company may exercise the Purchase Option by delivering or mailing to the Participant (or his estate), within 60 days after the termination of the Employment Agreement, a written notice of exercise of the Purchase Option. Such notice shall specify the number of Shares to be purchased. If and to the extent the Purchase Option is not so exercised by the giving of such a notice within such 60-day period, the Purchase Option shall automatically expire and terminate effective upon the expiration of such 60-day period. 3.1. Within 10 days after delivery to the Participant of the Company's notice of the exercise of the Purchase Option pursuant to subsection (a) above, the Participant (or his estate) shall, pursuant to the provisions of the Joint Escrow Instructions referred to in Section 5 below, tender to the Company at its principal offices the certificate or certificates representing the Shares which the Company has elected to purchase in accordance with the terms of this Agreement, duly endorsed in blank or with duly endorsed stock powers attached thereto, all in form suitable for the transfer of such Shares to the Company. Promptly following its receipt of such certificate or certificates, the Company shall pay to the Participant the aggregate Option Price for such Shares (provided that any delay in making such payment shall not invalidate the Company's exercise of the Purchase Option with respect to such Shares). 3.2. After the time at which any Shares are required to be delivered to the Company for transfer to the Company pursuant to subsection (b) above, the Company shall not pay any dividend to the Participant on account of such Shares or permit the Participant to exercise any of the privileges or rights of a stockholder with respect to such Shares, but shall, in so far as permitted by law, treat the Company as the owner of such Shares. 3.3. The Option Price may be payable, at the option of the Company, in cancellation of all or a portion of any outstanding indebtedness of the Participant to the Company or in cash (by check) or both. 3.4. The Company shall not purchase any fraction of a Share upon exercise of the Purchase Option, and any fraction of a Share resulting from a computation made pursuant to Section 2 of this Agreement shall be rounded to the nearest whole Share (with any one-half Share being rounded upward). 3.5. The Company may assign its Purchase Option to one or more persons or entities. 4. Restrictions on Transfer. 4.1. The Participant shall not sell, assign, transfer, pledge, hypothecate or otherwise dispose of, by operation of law or otherwise (collectively "transfer") any Shares, or any interest therein, that are subject to the Purchase Option, except that the Participant may transfer such Shares (i) to or for the benefit of any spouse, children, parents, uncles, aunts, siblings, grandchildren and any other relatives approved by the Board of Directors (collectively, "Approved Relatives") or to a trust established solely for the benefit of the Participant and/or Approved Relatives, provided that such Shares shall remain subject to this Agreement (including without limitation the restrictions on transfer set forth in this Section 4 and the Purchase Option) and such permitted transferee shall, as a condition to such transfer, deliver to the Company a written instrument confirming that such transferee shall be bound by all of the terms and conditions of this Agreement or (ii) as part of the sale of all or substantially all of the shares of capital stock of the Company (including pursuant to a merger or consolidation), provided that, in accordance with the Plan, the securities or other property received by the Participant in connection with such transaction shall remain subject to this Agreement. 4.2. The Participant shall have the right, at any time and from time to time, to pledge or hypothecate the Shares to a commercial bank or financial institution (the "Bank") as security for a loan from such Bank. During the term of the pledge or hypothecation agreement, the Company may not exercise the Purchase Option with respect to the Shares that are subject to the pledge (the "Pledged Shares"), and if the Participant defaults on such loan, then the Bank may take possession of the Pledged Shares provided that such Pledged Shares shall remain subject to this Agreement, other than the Purchase Option which shall terminate with respect to the Pledged Shares and such permitted transferee shall, as a condition to such transfer, deliver to the Company a written instrument confirming that such transferee shall be bound by all of the other terms and conditions of this Agreement. 5. Escrow. The Participant shall, upon the execution of this Agreement, execute Joint Escrow Instructions in the form attached to this Agreement as Exhibit A. The Joint Escrow Instructions shall be delivered to the Secretary of the Company, as escrow agent thereunder. The Participant shall deliver to such escrow agent a stock assignment duly endorsed in blank and hereby instructs the Company to deliver to such escrow agent, on behalf of the Participant, the certificate(s) evidencing the Shares issued hereunder. Such materials shall be held by such escrow agent pursuant to the terms of such Joint Escrow Instructions. 6. Restrictive Legends. All certificates representing Shares shall have affixed thereto legends in substantially the following form, in addition to any other legends that may be required under federal or state securities laws: 6.1. "The shares of stock represented by this certificate are subject to restrictions on transfer and an option to purchase set forth in a certain Restricted Stock Agreement between the corporation and the registered owner of these shares (or his predecessor in interest), and such Agreement is available for inspection without charge at the office of the Secretary of the corporation." 7. Provisions of the Plan. This Agreement is subject to the provisions of the Plan, a copy of which is furnished to the Participant with this Agreement. 7.1. As provided in the Plan, upon the occurrence of an Acquisition Event (as defined in the Plan), the repurchase and other rights of the Company hereunder shall inure to the benefit of the Company's successor and shall apply to the cash, securities or other property which the Shares were converted into or exchanged for pursuant to such Acquisition Event in the same manner and to the same extent as they applied to the Shares under this Agreement. If, in connection with an Acquisition Event, a portion of the cash, securities and/or other property received upon the conversion or exchange of the Shares is to be placed into escrow to secure indemnification or similar obligations, the mix between the vested and unvested portion of such cash, securities and/or other property that is placed into escrow shall be the same as the mix between the vested and unvested portion of such cash, securities and/or other property that is not subject to escrow. 8. Withholding Taxes; Section 83(b) Election. 8.1. The Participant acknowledges and agrees that the Company has the right to deduct from payments of any kind otherwise due to the Participant any federal, state or local taxes of any kind required by law to be withheld with respect to the purchase of the Shares by the Participant or the lapse of the Purchase Option. 8.2. The Participant has reviewed with the Participant's own tax advisors the federal, state, local and foreign tax consequences of this investment and the transactions contemplated by this Agreement. The Participant is relying solely on such advisors and not on any statements or representations of the Company or any of its agents. The Participant understands that the Participant (and not the Company) shall be responsible for the Participant's own tax liability that may arise as a result of this investment or the transactions contemplated by this Agreement. The Participant understands that it may be beneficial in many circumstances to elect to be taxed at the time the Shares are purchased rather than when and as the Company's Purchase Option expires by filing an election under Section 83(b) of the Code with the I.R.S. within 30 days from the date of purchase. 8.3. THE PARTICIPANT ACKNOWLEDGES THAT IT IS THE PARTICIPANT'S SOLE RESPONSIBILITY AND NOT THE COMPANY'S TO FILE TIMELY THE ELECTION UNDER SECTION 83(b), EVEN IF THE PARTICIPANT REQUESTS THE COMPANY OR ITS REPRESENTATIVES TO MAKE THIS FILING ON THE PARTICIPANT'S BEHALF. 9. Miscellaneous. 9.1. No Rights to Employment. The Participant acknowledges and agrees that the vesting of the Shares pursuant to Section 2 hereof is earned only by continuing service pursuant to the Employment Agreement (not through the act of being hired or purchasing shares hereunder). The Participant further acknowledges and agrees that the transactions contemplated hereunder and the vesting schedule set forth herein do not constitute an express or implied promise of continued engagement as an employee or consultant for the vesting period, for any period, or at all. 9.2. Severability. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, and each other provision of this Agreement shall be severable and enforceable to the extent permitted by law. 9.3. Waiver. Any provision for the benefit of the Company contained in this Agreement may be waived, either generally or in any particular instance, by the Board of Directors of the Company. 9.4. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Company and the Participant and their respective heirs, executors, administrators, legal representatives, successors and assigns, subject to the restrictions on transfer set forth in Section 4 of this Agreement. 9.5. Notice. All notices required or permitted hereunder shall be in writing and deemed effectively given upon personal delivery or five days after deposit in the United States Post Office, by registered or certified mail, postage prepaid, addressed to the other party hereto at the address shown beneath his or its respective signature to this Agreement, or at such other address or addresses as either party shall designate to the other in accordance with this Section 9(e). 9.6. Pronouns. Whenever the context may require, any pronouns used in this Agreement shall include the corresponding masculine, feminine or neuter forms, and the singular form of nouns and pronouns shall include the plural, and vice versa. 9.7. Entire Agreement. This Agreement and the Plan constitute the entire agreement between the parties, and supersede all prior agreements and understandings, relating to the subject matter of this Agreement. 9.8. Amendment. This Agreement may be amended or modified only by a written instrument executed by both the Company and the Participant. 9.9. Governing Law. This Agreement shall be construed, interpreted and enforced in accordance with the internal laws of the Commonwealth of Massachusetts without regard to any applicable conflicts of laws. 9.10. Participant's Acknowledgments. The Participant acknowledges that he or she: (i) has read this Agreement; (ii) has been represented in the preparation, negotiation, and execution of this Agreement by legal counsel of the Participant's own choice or has voluntarily declined to seek such counsel; (iii) understands the terms and consequences of this Agreement; (iv) is fully aware of the legal and binding effect of this Agreement; and (v) understands that the law firm of Hale and Dorr LLP, is acting as counsel to the Company in connection with the transactions contemplated by the Agreement, and is not acting as counsel for the Participant. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. POLYMEDICA CORPORATION: /s/ Stephen C. Farrell ---------------------- Stephen C. Farrell Chief Financial Officer HOLDER: /s/ Samuel L. Shanaman ---------------------- Samuel L. Shanaman Lead Director and Interim Chief Executive Officer Exhibit A - Joint Escrow Instructions Dear Mr. Walters: As Escrow Agent for PolyMedica Corporation, a Massachusetts corporation, and its successors in interest under the Restricted Stock Agreement (the "Agreement") of even date herewith, to which a copy of these Joint Escrow Instructions is attached (the "Company"), and the undersigned person ("Holder"), you are hereby authorized and directed to hold the documents delivered to you pursuant to the terms of the Agreement in accordance with the following instructions: 1. Appointment. Holder irrevocably authorizes the Company to deposit with you any certificates evidencing Shares (as defined in the Agreement) to be held by you hereunder and any additions and substitutions to said Shares. For purposes of these Joint Escrow Instructions, "Shares" shall be deemed to include any additional or substitute property. Holder does hereby irrevocably constitute and appoint you as his attorney-in-fact and agent for the term of this escrow to execute with respect to such Shares all documents necessary or appropriate to make such Shares negotiable and to complete any transaction herein contemplated. Subject to the provisions of this paragraph 1 and the terms of the Agreement, Holder shall exercise all rights and privileges of a stockholder of the Company while the Shares are held by you. 2. Closing of Purchase. 2.1. Upon any purchase by the Company of the Shares pursuant to the Agreement, the Company shall give to Holder and you a written notice specifying the purchase price for the Shares, as determined pursuant to the Agreement, and the time for a closing hereunder (the "Closing") at the principal office of the Company. Holder and the Company hereby irrevocably authorize and direct you to close the transaction contemplated by such notice in accordance with the terms of said notice. 2.2. At the Closing, you are directed (i) to date the stock assignment form or forms necessary for the transfer of the Shares, (ii) to fill in on such form or forms the number of Shares being transferred, and (iii) to deliver same, together with the certificate or certificates evidencing the Shares to be transferred, to the Company against the simultaneous delivery to you of the purchase price for the Shares being purchased pursuant to the Agreement. 3. Withdrawal. The Holder shall have the right to withdraw from this escrow any Shares as to which the Purchase Option (as defined in the Agreement) has terminated or expired. 4. Duties of Escrow Agent. 4.1. Your duties hereunder may be altered, amended, modified or revoked only by a writing signed by all of the parties hereto. 4.2. You shall be obligated only for the performance of such duties as are specifically set forth herein and may rely and shall be protected in relying or refraining from acting on any instrument reasonably believed by you to be genuine and to have been signed or presented by the proper party or parties. You shall not be personally liable for any act you may do or omit to do hereunder as Escrow Agent or as attorney-in-fact of Holder while acting in good faith and in the exercise of your own good judgment, and any act done or omitted by you pursuant to the advice of your own attorneys shall be conclusive evidence of such good faith. 4.3. You are hereby expressly authorized to disregard any and all warnings given by any of the parties hereto or by any other person or Company, excepting only orders or process of courts of law, and are hereby expressly authorized to comply with and obey orders, judgments or decrees of any court. In case you obey or comply with any such order, judgment or decree of any court, you shall not be liable to any of the parties hereto or to any other person, firm or Company by reason of such compliance, notwithstanding any such order, judgment or decree being subsequently reversed, modified, annulled, set aside, vacated or found to have been entered without jurisdiction. 4.4. You shall not be liable in any respect on account of the identity, authority or rights of the parties executing or delivering or purporting to execute or deliver the Agreement or any documents or papers deposited or called for hereunder. 4.5. You shall be entitled to employ such legal counsel and other experts as you may deem necessary properly to advise you in connection with your obligations hereunder and may rely upon the advice of such counsel. 4.6. Your rights and responsibilities as Escrow Agent hereunder shall terminate if (i) you cease to be Secretary of the Company or (ii) you resign by written notice to each party. In the event of a termination under clause (i), your successor as Secretary shall become Escrow Agent hereunder; in the event of a termination under clause (ii), the Company shall appoint a successor Escrow Agent hereunder. 4.7. If you reasonably require other or further instruments in connection with these Joint Escrow Instructions or obligations in respect hereto, the necessary parties hereto shall join in furnishing such instruments. 4.8. It is understood and agreed that should any dispute arise with respect to the delivery and/or ownership or right of possession of the securities held by you hereunder, you are authorized and directed to retain in your possession without liability to anyone all or any part of said securities until such dispute shall have been settled either by mutual written agreement of the parties concerned or by a final order, decree or judgment of a court of competent jurisdiction after the time for appeal has expired and no appeal has been perfected, but you shall be under no duty whatsoever to institute or defend any such proceedings. 4.9. These Joint Escrow Instructions set forth your sole duties with respect to any and all matters pertinent hereto and no implied duties or obligations shall be read into these Joint Escrow Instructions against you. 4.10. The Company shall indemnify you and hold you harmless against any and all damages, losses, liabilities, costs, and expenses, including attorneys' fees and disbursements, for anything done or omitted to be done by you as Escrow Agent in connection with this Agreement or the performance of your duties hereunder, except such as shall result from your gross negligence or willful misconduct. 5. Notice. Any notice required or permitted hereunder shall be given in writing and shall be deemed effectively given upon personal delivery or upon deposit in the United States Post Office, by registered or certified mail with postage and fees prepaid, addressed to each of the other parties thereunto entitled at the following addresses, or at such other addresses as a party may designate by ten days' advance written notice to each of the other parties hereto. COMPANY: Notices to the Company shall be sent to the address set forth in the salutation hereto, Attn: President HOLDER: Notices to Holder shall be sent to the address set forth below Holder's signature below. ESCROW AGENT: Notices to the Escrow Agent shall be sent to the address set forth in the salutation hereto. 6. Miscellaneous. 6.1. By signing these Joint Escrow Instructions, you become a party hereto only for the purpose of said Joint Escrow Instructions, and you do not become a party to the Agreement. 6.2. This instrument shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. Very truly yours, POLYMEDICA CORPORATION: /s/ Stephen C. Farrell ---------------------- Stephen C. Farrell Chief Financial Officer HOLDER: /s/ Samuel L. Shanaman ---------------------- Samuel L. Shanaman Lead Director and Interim Chief Executive Officer ESCROW AGENT: /s/ Eric G. Walters - ------------------- Eric G. Walters Executive Vice President and Clerk EX-99.1 5 b44520pmexv99w1.txt CERTIFICATION OF OFFICERS EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report on Form 10-Q of PolyMedica Corporation (the "Company") for the period ended September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, Samuel L. Shanaman, Lead Director and Interim Chief Executive Officer, and Stephen C. Farrell, Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Samuel L. Shanaman ---------------------- Dated: November 14, 2002 Samuel L. Shanaman Lead Director and Interim Chief Executive Officer /s/ Stephen C. Farrell ---------------------- Dated: November 14, 2002 Stephen C. Farrell Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----