SECURITIES AND EXCHANGE COMMISSION

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 March 31, 2004

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 number 000-25769

ACCREDO HEALTH, INCORPORATED

(Exact name of registrant as specified in its charter)

1640 CENTURY CENTER PKWY, SUITE 101, MEMPHIS, TN 38134

(901) 385-3688

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year,
if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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ACCREDO HEALTH, INCORPORATED
INDEX

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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ACCREDO HEALTH, INCORPORATED

See accompanying notes to condensed consolidated financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2004

1.

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the condensed consolidated financial position, results of operations and cash flows of Accredo Health, Incorporated (the “Company” or “Accredo”) have been included. Operating results for the three and nine-month periods ended March 31, 2004, are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2004.

Certain amounts for the three and nine-month periods ended March 31, 2003 have been reclassified to conform to the presentation for the three and nine-month periods ended March 31, 2004. These reclassifications had no effect on net income or total revenues.

The balance sheet at June 30, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

2.

RESTATEMENT

Subsequent to the issuance of the Company’s fiscal year 2003 quarterly financial statements, the Company’s management determined that previously issued interim financial statements should be restated due to a change in the timing and recognition of revenue. For revenue recognition purposes, prior to April 1, 2003, the Company considered the delivery criteria to have been met when product was shipped to its patients, and the Company had no further obligation related to such product. The Company has now determined that the delivery criteria are met when the product has been delivered to the patient (which typically occurs one day after shipment), and the Company has no further obligation related to such product. The restatement (in thousands, except per share data) resulted in a decrease in net patient revenue of $8,456 for the three months and nine months ended March 31, 2003. The previously reported net loss for the three months ended March 31, 2003 increased from $17,769 to $18,723 and the previously reported net income for the nine months ended March 31, 2003 decreased from $13,250 to $12,296. The previously reported basic and diluted loss per common share was increased by $.02 for the three months ended March 31, 2003 and the previously reported basic and diluted earnings per common share was decreased by $.02 for the nine months ended March 31, 2003.

A summary of the significant effects of the restatement is as follows (in thousands, except per share data):

     Condensed Consolidated Statement of Operations Data:

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3.

STOCKHOLDERS’ EQUITY

     During the quarter and nine months ended March 31, 2004, employees and directors exercised stock options to acquire 311,924 and 601,460 shares of Accredo common stock, respectively. The weighted average option exercise price was $13.27 per share for the quarter and $8.88 per share for the nine-month period.

4.

PRO FORMA NET INCOME EFFECT OF COMPANY STOCK OPTION PLANS

The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Pro forma information regarding net income is required by Statement of Financial Accounting Standards No. 123 (“Statement 123”) and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. Significant assumptions used by the Company in the Black-Scholes option-pricing model computations are as follows for the three-month and nine-month periods ended March 31:

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

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the three-month and nine-month periods ended March 31 is as follows (in thousands, except share data):

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5.

COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) includes changes in the fair value of certain derivative financial instruments that qualify for hedge accounting. Comprehensive income (loss) for all periods presented is as follows:

The adjustments made in computing comprehensive income (loss) are reflected as a component of stockholders’ equity under the heading “accumulated other comprehensive loss”.

6.

CONTINGENCIES

Commencing April 8, 2003, the Company and certain officers and directors were named as defendants in several substantially similar putative class action lawsuits filed in the United States District Court for the Western District of Tennessee, Memphis Division. The various complaints have been consolidated into a single action, but the Court has not appointed a Lead Plaintiff. Once the Lead Plaintiff is appointed, a Consolidated Complaint will be filed to which the Defendants will respond. The lawsuits filed to date name the Company, David D. Stevens, Joel Kimbrough, John R. Grow and Thomas W. Bell, Jr. as Defendants. One of the lawsuits also named the Company’s former independent auditor, Ernst & Young LLP, as a defendant. The lawsuits allege violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)(5) promulgated thereunder, and Section 20 of the Securities Exchange Act of 1934. The putative class representatives seek to represent a class of individuals and entities that purchased Company stock during the period June 16, 2002 through April 7, 2003 and who supposedly suffered damages from the alleged violations of the securities laws. The Company believes that the claims asserted in the putative class action lawsuits are without merit.

In addition, two purported derivative lawsuits were filed in the Circuit Court of Shelby County, Tennessee for the Thirtieth Judicial District at Memphis. These actions were consolidated and a Consolidated Derivative Complaint was filed on July 28, 2003. The derivative action names Company officers, directors and a former director; David D. Stevens, John R. Grow, Kyle J. Callahan, Kevin L. Roberg, Kenneth R. Masterson, Kenneth J. Melkus, Dick R. Gourley, Nancy Ann DeParle, Joel R. Kimbrough, Thomas W. Bell, Jr., and Patrick J. Welsh; as defendants. The derivative lawsuit alleges that the defendants breached fiduciary duties owed to the Company by engaging in the same alleged conduct that is the basis of the putative class action lawsuits. On behalf of the Company, the derivative complaint seeks compensatory damages from the defendants and the disgorgement of profits, benefits and other compensation received by the defendants. The Company believes that the claims asserted in the derivative lawsuit are without merit and has filed a Motion to Dismiss the Consolidated Derivative Complaint.

Also, from time to time, the Company is involved in lawsuits, claims, audits and investigations arising in the normal course of its business. In the Company’s opinion, in the aggregate these lawsuits, claims, audits and investigations should not have a material adverse effect on the Company’s business, financial condition, or results of operations. In addition, the business that the Company acquired from Gentiva Health Services, Inc. has several lawsuits and claims related to its historic operation by Gentiva, which are being controlled by Gentiva and for which the Company is entitled to indemnification from liability by Gentiva.

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7.

ACQUISITION

On October 17, 2003, the Company acquired certain assets, including inventory and accounts receivable, of Alpha Therapeutic Services, Inc. (“ATS”) from Baxter Healthcare Corporation. ATS, located in the City of Industry, California, provides pharmaceutical care for certain chronic, long-term patient populations including those requiring IVIG and blood related disorders such as hemophilia. As a result of the acquisition, we have increased our market share in these products. The aggregate purchase price paid was $35.7 million. Total assets acquired were $4.2 million. The excess of the total purchase price over the fair value of the assets acquired was allocated as follows: $30.8 million to goodwill and $0.7 million to acquired patient relationships. The acquired patient relationship intangible is being amortized over five years. The results of the ATS operations have been included in the consolidated financial statements since October 18, 2003.

8.

EARNINGS PER SHARE

The Company presents earnings per share in accordance with SFAS No. 128, Earnings Per Share. All per share amounts have been calculated using the weighted average number of shares outstanding during each period. Diluted earnings per share are adjusted for the impact of common stock equivalents using the treasury stock method when the effect is dilutive. Options to purchase approximately 26,000 and 2.5 million shares of common stock were outstanding at March 31, 2004 and March 31, 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of common shares and, therefore, the effect would be antidilutive. A reconciliation of the basic and diluted weighted average shares outstanding is as follows at March 31:

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

Some of the information in this quarterly report contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “intend,” “estimate” and “continue” or similar words. You should read statements that contain these words carefully for the following reasons:

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the statements discuss our future expectations;

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the statements contain projections of our future earnings or of our financial condition; and

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the statements state other “forward-looking” information.

     Specifically, this report contains, among others, forward-looking statements about:

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our expectations regarding our product mix for periods following March 31, 2004;

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our expectations regarding our payor mix for periods following March 31, 2004;

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our expectations regarding the transfer of patients pursuant to our strategic alliance with Medco Health Solutions, Inc. following March 31, 2004;

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our expectations regarding the scope and cost of our capital expenditures following March 31, 2004;

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our sources and availability of funds to satisfy our working capital needs;

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our critical accounting policies; and

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our expectations regarding the percentage of our revenues attributable to federal and state programs.

The forward-looking statements contained in this report reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties. Many important factors could cause our actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict. Important factors that could cause actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements include, among other things, the factors discussed in Part I, Item 2 of this report under the sub-heading “Risk Factors.”

You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we currently expect or anticipate. You should be aware that the occurrence of any of the events described in the risk factors discussed elsewhere in this quarterly report and other events that we have not predicted or assessed could have a material adverse effect on our earnings, financial condition and business. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.

We qualify all of our forward-looking statements by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

OVERVIEW

For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this report. This management’s discussion and analysis should also be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Form 10-K for the fiscal year ended June 30, 2003.

We provide specialty retail pharmacy services for the treatment of patients with costly, chronic diseases. We derive revenues primarily from the retail sale of drugs to patients. We focus almost exclusively on a limited number of complex and expensive drugs that serve small patient populations. The following table presents the percentage of our total revenues generated from sales with respect to the diseases that we primarily serve:

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In the June 2004 quarter, we anticipate that revenues for the treatment of RSV will represent a much smaller percentage of our overall revenues with an offsetting increase in the percentage of our revenues from the other diseases listed above. Synagis®, for the treatment of RSV, is primarily dispensed in the December and March quarters.

Reimbursement for the products we sell comes from governmental payors, Medicare and Medicaid, and from non-governmental payors. The following table presents the percentage of our total revenues reimbursed by these payors:

The increase in Medicare reimbursement and the related decrease in non-governmental reimbursement from fiscal year 2002 to fiscal year 2003 is due to the increase in revenues from hemophilia factor and the PAH products, Flolan® and Remodulin®, as a result of the acquisition of the SPS division. These are the only products we distributed in fiscal years 2002 and 2003 for which we are reimbursed directly by Medicare. We anticipate that our payor mix for the remainder of our fiscal year 2004 will be similar to the payor mix achieved in fiscal 2003 and the nine months ended March 31, 2004.

STRATEGIC ALLIANCE

On February 9, 2004, we signed a long-term agreement with Medco Health Solutions, Inc. (“Medco”) to become the preferred retail and home delivery pharmacy provider to Medco members for our specialty product lines that we currently dispense to treat patients with long-term, chronic diseases. The agreement includes drugs to treat hemophilia, pulmonary arterial hypertension, RSV, multiple sclerosis, growth hormone deficiency and Gaucher’s disease. We have historically provided our drugs to some Medco members, however, we expect an increase in the number of prescriptions for Medco members resulting from the agreement.

ACQUISITION

On October 17, 2003, we acquired certain assets, including inventory and accounts receivable, of Alpha Therapeutic Services, Inc. (“ATS”) from Baxter Healthcare Corporation. ATS provides pharmaceutical care for certain chronic, long-term patient populations including those requiring IVIG and blood related disorders such as hemophilia. As a result of the acquisition, we have increased our market share in these products. The aggregate purchase price paid was $35.7 million. The results of the ATS operations have been included in the consolidated financial statements since October 18, 2003. During the March 2004 quarter, we completed the transition of the ATS patients into our existing IVIG and hemophilia operations eliminating the facility and related costs previously associated with ATS.

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RESULTS OF OPERATIONS

As discussed in Note 2 to the condensed consolidated financial statements included under Item 1, we have restated our condensed consolidated financial statements for the three and nine-month periods ended March 31, 2003. The following management’s discussion and analysis gives effect to the restatement.

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Revenues. Total revenues increased 14% from $358.1 million to $409.3 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. Net patient revenue increased 14% from $349.4 million to $398.9 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. During fiscal 2003, we began distributing certain wholesale products on a consignment basis for the manufacturer and sold our infertility business thus eliminating revenues from the sale of these products from our business. Revenues from these products amounted to approximately $23.0 million for the three months ended March 2003. Excluding the $23.0 million from the three months ended March 31, 2003 results, our revenues increased 22% from the March 2003 quarter to the March 2004 quarter. The increase is primarily due to volume growth in our products for the treatments of RSV, PAH, growth hormone disorders, hemophilia, autoimmune disorders and PID as a result of the addition of new patients and additional sales of product to existing patients. While we benefited from prior payor agreements with Medco in the March quarter, we did not experience a transfer of new patients pursuant to the new strategic alliance discussed above. However, we do expect the transfer of patients to begin by the end of our fourth quarter. We also benefited from the addition of new and expanded contracts with managed care organizations.

Cost of Sales. Cost of sales increased 15% from $283.5 million to $325.5 million from the three months ended March 31, 2003 to the three months ended March 31, 2004, which is commensurate with the increase in our revenues discussed above. As a percentage of revenues, cost of sales increased from 79.2% to 79.5% from the three months ended March 31, 2003 to the three months ended March 31, 2004, resulting in gross margins of 20.8% and 20.5% for the three months ended March 31, 2003 and 2004, respectively. Gross margins for the individual products have remained relatively stable. However, a change in product mix resulted in a decrease in the composite gross margin in the three months ended March 31, 2004. The primary change in product mix was an increase in the percentage of total revenues of Synagis® for the treatment of RSV from 11% in the three months ended March 31, 2003 to 14% in the three months ended March 31, 2004. Synagis® has a lower gross margin than the composite gross margin.

General and Administrative. General and administrative expense increased from $33.8 million to $34.2 million, or 1%, from the three months ended March 31, 2003 to the three months ended March 31, 2004. As a percentage of revenues, general and administrative expense decreased from 9.4% to 8.4% from the three months ended March 31, 2003 to the three months ended March 31, 2004. Although there has been a slight increase in general and administrative expense, the expense as a percentage of revenues has decreased one percent due to the 14% increase in total revenues from the three months ended March 31, 2003 to the three months ended March 31, 2004, which has resulted in a leveraging of some of our general and administrative expenses.

Bad Debts. Bad debts decreased from $66.1 million to $9.3 million from the three months ended March 31, 2003 to the three months ended March 31, 2004. As a percentage of revenues, bad debt expense was 2.3% for the three months ended March 31, 2004, which is in line with our historical trends. During the March 2003 quarter, we analyzed historical collection rates and other data used in estimating the allowance for doubtful accounts. Our calculations indicated that the accounts receivable reserve needed to be increased. As a result of the new information obtained through the analysis, we recorded a charge to bad debt expense and increased the allowance for doubtful accounts resulting in total bad debt expense of $66.1 million for the three months ended March 31, 2003.

Depreciation and Amortization. Depreciation expense increased from $1.6 million to $2.1 million from the three months ended March 31, 2003 to the three months ended March 31, 2004, as a result of purchases of property and equipment associated with our revenue growth including additional computer hardware and enhancements to our fully integrated pharmacy and reimbursement software system. Amortization expense increased from $1.1 million to $1.2 million from the three months ended March 31, 2003 to the three months ended March 31, 2004 due to additional amortization related to the purchase of the ATS assets.

Interest Income/Expense, Net. Interest expense, net decreased from $2.4 million to $2.0 million from the three months ended March 31, 2003 to the three months ended March 31, 2004 due to a decrease in the amount of debt outstanding and lower interest rates.

Income Tax Expense. Our effective tax rate decreased from 39.3% to 38.6% from the three months ended March 31, 2003 to the three months ended March 31, 2004. The decrease in the effective tax rate for the period is primarily due to a larger

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percentage of our profits being derived from locations that are not taxable in certain states. The difference between the recognized effective tax rate and the statutory rate is primari