| MEDCO HEALTH SOLUTIONS INC Item 1A Risk Factors |
| This Annual Report on Form 10-K contains “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 |
| These statements involve risks and uncertainties that may cause results to differ materially from those set forth in the statements |
| No forward-looking statement can be guaranteed, and actual results may differ materially from those projected |
| We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise |
| Forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about the business and future financial results of the PBM and specialty pharmacy industries, and other legal, regulatory and economic developments |
| We use words such as “anticipates,” “believes,” “plans,” “expects,” “future,” “intends,” “may,” “will,” “should,” “could,” “estimates,” “predicts,” “potential,” “continue” and similar expressions to identify these forward-looking statements |
| Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in this Item 1A, “Risk Factors,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of this Annual Report on Form 10-K Risks Relating to Our Business We may fail to realize the anticipated synergies, cost savings and other benefits expected from our 2005 acquisition of Accredo |
| Our acquisition of Accredo requires the integration of two companies that had previously operated independently |
| Achieving the benefits of the merger will depend in part upon meeting the challenges inherent in the successful combination of two business enterprises of the size and scope of Medco and Accredo and the possible resulting diversion of management attention for an extended period of time |
| There can be no assurance that such challenges will be met and that such diversion will not negatively impact our long-term operations |
| Any delays encountered in the transition process could have a material adverse effect upon our revenues, level of expenses, operating results and financial condition |
| Although we expect significant benefits to result from the acquisition, such as increased cost savings and incremental sales opportunities, there can be no assurance that we will realize the full value of these anticipated benefits |
| We may incur substantial expenses in connection with the integration of the business, policies, procedures, operations, technologies and systems of Accredo with those of Medco |
| There are a large number of systems that we continue to integrate, including information management, purchasing, operations, accounting and finance, sales, billing, fixed asset and lease administration systems and regulatory compliance |
| While we have assumed that a certain amount of expenses would be incurred, factors beyond our control could affect the total amount or the timing of all of the expected integration expenses |
| These expenses could, particularly in the near term, exceed the savings that we expect to achieve from the elimination of duplicative expenses and the realization of economies of scale and cost and revenue synergies related to the integration of the businesses |
| Medco is a defendant in two qui tam cases in which the federal government has intervened, and a separate qui tam case that remains under seal, as well as antitrust and other suits, any of which could limit its business practices and have a material adverse effect on its business, financial condition, liquidity and operating results |
| Medco is a defendant in a lawsuit filed by the US Attorney’s Office for the Eastern District of Pennsylvania, alleging violations of the federal False Claims Act and asserting other legal claims, including a claim against Medco under the Anti-Kickback Law for allegedly making improper payments to health plans to induce such plans to select Medco as a PBM for government contracts |
| The lawsuit originated as two qui tam, or whistleblower, complaints, which are currently pending with the government’s complaint-in-intervention |
| The government has alleged, among other things, that Medco canceled and later re-entered prescriptions in order to avoid violating contractual guarantees regarding prescription dispensing turnaround times in its mail order pharmacies; dispensed fewer pills than reported to the patient and charged clients based on the reported number of units dispensed; favored the products of certain manufacturers, including Merck, over less expensive products; and engaged in improper pharmacy practices |
| Sanctions for violating the False Claims Act include liability for treble damages, as well as mandatory civil penalties for each separate claim |
| Sanctions for violating the Anti-Kickback Law may include criminal and civil sanctions, substantial monetary fines and exclusion from participation in 21 ______________________________________________________________________ [49]Table of Contents federal health care programs |
| Although the government’s lawsuit has been settled with respect to injunctive, or non-monetary, relief, the US Attorney’s Office for the Eastern District of Pennsylvania is seeking to impose monetary damages and fines that could have a material adverse effect on Medco’s business, financial condition, liquidity and operating results |
| At the request of the court, the parties are currently engaged in mediation process with a federal judge |
| Medco has been informed that it is named as one of various defendants in another qui tam complaint alleging that Medco conspired to defraud the Medicare and Medicaid programs in violation of the False Claims Act, as well as various state laws relating to false claims |
| This complaint remains under seal |
| Medco has not seen and does not know the identity of the relator or the other defendants or the time period at issue |
| On January 21, 2005, Medco received a subpoena from the OIG requesting certain documents that may relate to this qui tam complaint |
| After discussions with the government, Medco has agreed to turn over documents subject to negotiated protections |
| Medco does not know when the government will decide whether to intervene in support of any or all of the allegations |
| In January 2005, Medco also received a letter from the US Attorney’s Office for the Eastern District of Pennsylvania requesting information about Medco’s Medicare Coordination of Benefits “COB” recovery program |
| Medco has also received a letter from the Texas Attorney General’s office requesting information on how Medco processes Medicaid subrogation requests on behalf of its clients |
| Medco has complied with the request |
| In addition to the government lawsuit and the qui tam complaint that remains under seal, Medco has been sued by several private plaintiffs, challenging its business practices and seeking various types of relief |
| These suits have been instituted based on various legal theories, including antitrust law and breach of contract |
| Medco and Merck are also defendants in four antitrust lawsuits |
| Two of these lawsuits are purported class actions brought in federal court and assert claims for violation of the Sherman Act |
| The plaintiffs in one case seek to represent a national class of retail pharmacies that have contracted with Medco, and the plaintiffs in the other case seek to represent a class of independent retail pharmacies that have contracted with Medco |
| One of these actions alleges that Medco has conspired with plan sponsors to restrain competition in the market for the dispensing and sale of prescription drugs |
| The other alleges that Medco and Merck have engaged in price fixing and other unlawful concerted actions with others to restrain trade in the dispensing and sale of prescription drugs and have conspired with plan sponsors to restrain competition in the market for the dispensing and sale of prescription drugs |
| The plaintiffs in each action allege that, through the alleged concerted action or conspiracy, as the case may be, Medco and Merck have engaged in various forms of anticompetitive conduct, including, among other things, setting reimbursement rates to such pharmacies at unreasonably low levels |
| The plaintiffs seek treble damages and injunctive relief |
| The third antitrust suit was brought against Medco and Merck in a California state court and asserts claims for violations of California antitrust law and California law prohibiting unfair business practices |
| The plaintiffs seek to represent a class of all California pharmacies and pharmacists that have contracted with Medco and indirectly purchased prescription drugs from Merck |
| The complaint copies verbatim many of the allegations that the US Attorney’s Office for the Eastern District of Pennsylvania has made, as described above |
| The plaintiffs also allege, among other things, that Medco has failed to maintain an open formulary, and that Medco and Merck failed to prevent nonpublic information received from competitors of Medco and Merck from being disclosed to each other |
| As a result, the plaintiffs allege, Medco has been able to increase its market share and artificially reduce the level of reimbursement to the class members, and, in addition, the prices of prescription drugs from Merck and other pharmaceutical manufacturers that do business with Medco have been fixed and raised above competitive levels |
| The fourth antitrust suit which was filed in California federal court, relies upon factual allegations substantially similar to the California state court action discussed above |
| In this action, the plaintiff retail pharmacies seek to represent a national class of pharmacies that have contracted with Medco, and assert claims, under the Sherman Act and a California law prohibiting unfair business practices |
| Medco also is the defendant in a breach of contract suit brought in New Jersey state court by one of its former clients |
| In another breach of contract suit brought in Alabama state court, the plaintiff which seeks to represent a national class of independent retail pharmacies that have contracted with Medco under a formula that included the AWP as a method of reimbursement |
| Medco entered into an indemnification and insurance matters agreement with Merck in connection with the spin-off |
| To the extent that Medco is required to indemnify Merck for liabilities arising out of a lawsuit pursuant to the terms of that 22 ______________________________________________________________________ [50]Table of Contents agreement, if Merck is required to make any payments in connection with such a lawsuit, Medco would need to make indemnification payments to Merck in amounts that could be material to Medco, in addition to any amounts that Medco may be required to pay directly as a result of such a lawsuit |
| The various lawsuits and inquiries described above arise in an environment of rising costs for prescription drugs and heightened public scrutiny of the pharmaceutical industry, including the PBM industry and its practices |
| This public scrutiny is characterized by extensive press coverage, ongoing attention in Congress and in state legislatures, and investigations and public statements by law enforcement officials |
| These factors contribute to the uncertainty regarding the possible course and outcome of the proceedings discussed above |
| While Medco believes it has acted appropriately in its business practices, an adverse outcome in any one of the lawsuits described above could result in material fines and damages; material changes to Medco’s business practices; loss of (or litigation with) clients; and other penalties |
| An adverse outcome in any one of these lawsuits or as a result of any of these inquiries could have a material adverse effect on Medco’s business, financial condition, liquidity and operating results |
| Pending and threatened litigation challenging some of Medco’s important business practices could significantly affect Medco’s ability to obtain rebates and could materially limit Medco’s business practices |
| Medco and Merck are defendants in six federal lawsuits filed in the US District Court for the Southern District of New York, alleging, among other things, that Medco should be treated as a “fiduciary” under the provisions of ERISA (the Employee Retirement Income Security Act of 1974) and that Medco has breached fiduciary obligations under ERISA in connection with Medco’s development and implementation of formularies, preferred drug listings and intervention programs |
| Medco and Merck agreed to settle these lawsuits on a class action basis to avoid the significant cost and distraction of protracted litigation |
| Under a settlement among Medco, Merck and the plaintiffs in five of these six cases, to which the trial court has granted final approval, Medco and Merck have agreed to pay dlra42dtta5 million, and Medco has agreed to change or to continue certain specified business practices for a period of five years |
| The settlement does not involve the release of any potential antitrust claims |
| The Court of Appeals has sent the settlement back to the District Court for additional findings |
| Medco and Merck are defendants in other lawsuits asserting claims under ERISA For example, in one, the plaintiff seeks to represent a class of all participants and beneficiaries of ERISA plans that required participants to pay a percentage co-payment on prescription drugs |
| The effect of the release under the settlement discussed above on this action has not yet been determined |
| In addition, Medco and Merck are defendants in two proposed class actions brought by trustees of two other benefit plans, which have elected to opt out of the settlement |
| The allegations in these actions are similar to those in the cases discussed above |
| Another lawsuit, commenced by a former client of Medco’s, relies on allegations similar to those in the ERISA cases discussed above, as well as allegations specific to the plaintiff, which has elected to opt out of the settlement referred to above |
| The action includes claims under ERISA, New Jersey consumer protection law and contract claims |
| The plaintiff seeks compensatory, punitive and treble damages, as well as rescission and restitution of revenues that were allegedly improperly received by Medco |
| The plaintiff in this lawsuit has also filed an action against Merck, which relies on allegations similar to those in the ERISA cases discussed above and in the case filed by this plaintiff against Medco |
| The complaint asserts claims that Merck violated federal and state racketeering laws, tortiously interfered with the plaintiff’s contract with Medco, and was unjustly enriched |
| The plaintiff seeks, among other things, compensatory damages of approximately dlra35 million, treble damages, and restitution of revenues that were allegedly improperly received by Merck |
| All of the ERISA actions discussed above have been consolidated in the US District Court for the Southern District of New York |
| Medco and Merck are defendants in another proceeding, initially filed in California state court, which is also based on allegations similar to those in the ERISA cases discussed above and which also relies on a California law prohibiting unfair business practices |
| The plaintiff, who purports to sue on behalf of the general public of California, seeks injunctive relief and disgorgement of the revenues that were allegedly improperly received by Medco and Merck |
| This case was removed to the US District Court for the Southern District of California and later transferred to the US District Court for the Southern District of New York and consolidated with the ERISA cases pending there |
| 23 ______________________________________________________________________ [51]Table of Contents Medco and Merck are involved in litigation in West Virginia state court with the West Virginia Public Employees Insurance Agency, or PEIA, and the State of West Virginia |
| Initially, Medco filed a declaratory judgment action asserting Medco’s right to retain certain cost savings under its agreement with PEIA Shortly thereafter, the State of West Virginia and PEIA filed a separate lawsuit against Medco and Merck, premised on several state law theories, including violations of the West Virginia Consumer Credit and Protection Act, conspiracy, tortious interference, unjust enrichment, accounting fraud and breach of contract |
| The State of West Virginia and PEIA sought civil penalties, compensatory and punitive damages and injunctive relief |
| Thereafter, in the declaratory judgment action, PEIA filed a counterclaim, and the State of West Virginia, which was joined as a party, filed a third-party complaint against Medco and Merck, raising the same allegations asserted by PEIA and the State of West Virginia in their separate lawsuit |
| Medco and Merck filed a motion to dismiss the separate lawsuit against them, and also filed a motion to dismiss the counterclaim and third-party complaint filed in the declaratory judgment action |
| These motions were granted in part, and PEIA has filed an amended counterclaim and third-party complaint, seeking to reassert its fraud claims and restate certain of its other claims |
| Medco is the defendant in a lawsuit in New Jersey state court filed by a former client, which asserts claims for violation of fiduciary duty under state law; breach of contract; negligent misrepresentation; unjust enrichment; violations of certain District of Columbia laws regarding consumer protection and restraint of trade; and violation of a New Jersey law prohibiting racketeering |
| The plaintiff demands compensatory damages, punitive damages, treble damages for certain claims, and restitution |
| Accredo and an 80prca-owned subsidiary of Accredo sold clotting factor to a third-party pharmacy that is the subject of a state agency audit |
| On January 20, 2006, the agency issued a preliminary assessment of its findings, which included allegations of overbilling and false claims |
| Since that time, Accredo has been involved in a dialogue with the agency and is in the process of providing additional information and documents for the agency to consider in connection with its ultimate findings |
| Accredo and two of its officers are defendants in a class action lawsuit filed in the United States District Court for the Western District of Tennessee |
| Certain Accredo officers and former directors are defendants in a related stockholders derivative suit filed in the Circuit Court of Shelby County, Tennessee |
| Plaintiffs in the class action lawsuit allege that the officer’s actions and omissions constitute violations of various sections of the Securities Exchange Act of 1934 |
| Plaintiffs in the derivative suit allege that the officers and former directors have breached their fiduciary duty to Accredo |
| Many of these lawsuits, investigations and audits challenge some of Medco’s important business practices, and an adverse determination could significantly negatively affect Medco’s ability to obtain rebates and otherwise materially limit Medco’s business practices |
| Many of these lawsuits also seek damages in unspecified amounts, which could be material, and some seek treble or punitive damages or restitution of profits, any of which could be material in amount |
| In addition, to the extent that Medco is required to indemnify Merck for liabilities arising out of a lawsuit and Merck is required to make any payments in connection with such a lawsuit, Medco would need to make indemnification payments to Merck in amounts that could be material to Medco, in addition to any amounts that Medco may be required to pay directly as a result of such a lawsuit |
| While Medco believes that it has acted appropriately in its business practices, the outcome of each of these lawsuits is uncertain, and an adverse determination in any one of them could result in material damages or restitution and could have a material adverse effect on Medco’s business, financial condition, liquidity and operating results |
| Competition in our industry is intense and could impair our ability to attract and retain clients |
| Competition in the PBM industry is intense |
| Our competitors include many profitable and well-established companies that have significant financial, marketing and other resources |
| We compete with a wide variety of competitors, including large national PBMs such as Caremark Rx, Inc |
| and Express Scripts, Inc |
| Further consolidation within the PBM industry, as well as the acquisition of any of our competitors by larger companies, may also lead to increased competition |
| We also compete with insurers such as CIGNA Corporation and managed care organizations such as WellPoint Health Networks Inc, which offer prescription benefit plans in combination with other health benefits, using their own pharmacy benefit management facilities |
| In certain instances we also compete with large retail chains, or large retail stores with in-store pharmacy operations, that are motivated to preserve their share of retail pharmacy business, and may offer their own mail order programs or otherwise seek to limit acceptance of our mail order programs |
| 24 ______________________________________________________________________ [52]Table of Contents We compete based on innovation and service, as well as on price |
| To attract new clients and retain existing clients, we must continually develop new products and services to assist clients in managing their pharmacy benefit programs |
| We may not be able to develop innovative products and services, including new Medicare Part D offerings that are attractive to clients |
| Moreover, although we need to continue to expend significant resources to develop or acquire new products and services in the future, we may not be able to do so |
| We cannot be sure that we will continue to remain competitive, nor can we be sure that we will be able to market our PBM services to clients successfully at our current levels of profitability |
| If we do not continue to earn and retain purchase discounts and rebates from manufacturers at current levels, our gross margins may decline |
| We have contractual relationships with pharmaceutical manufacturers that provide us purchase discounts on drugs dispensed from our mail order pharmacies and rebates on brand-name prescription drugs dispensed through mail order and retail |
| These discounts and rebates are generally passed on to clients in the form of steeper price discounts and rebate pass-backs |
| Without purchase discounts and rebates from pharmaceutical manufacturers, we would not have been profitable in each of 2005, 2004 and 2003 |
| Some of our arrangements with pharmaceutical manufacturers, which typically have terms of three to ten years, are terminable by the manufacturer upon notice of 180 days or less, and manufacturer rebates often depend on our ability to meet contractual market share or other requirements |
| Pharmaceutical manufacturers have also increasingly made rebate payments dependent upon our agreement to include a broad array of their products in our formularies |
| Rebates on drugs on which patents are expected to expire over the next several years currently contribute significantly to our earned rebates |
| Over the next five years, we estimate that patents will expire on medications representing more than dlra46 billion in brand-name sales |
| As these patents expire, the introduction of generic products may substantially reduce the market share of the brand-name drugs and the rebates manufacturers provide to us for including their brand-name drugs in the formularies we manage |
| We may also not be able to negotiate rebates for new brand-name drugs comparable to those rebates we earn on brand-name drugs on which patents are expected to expire |
| We generally earn higher margins on generic drugs dispensed by our mail order pharmacies than we earn on brand-name drugs |
| However, manufacturers of newly-introduced generic drugs sometimes benefit from an exclusive marketing period, generally six months, during which we may be unable to earn these higher margins |
| The typically higher margins we earn on generic drugs and the rebates we earn by adding newly-approved, brand-name drugs to our formularies may not offset any decline in rebates for brand-name drugs on which patents expire |
| Competitive pressures in the PBM industry have also caused us and many other PBMs to share with clients a larger portion of the rebates received from pharmaceutical manufacturers and to increase the discounts offered to clients |
| For further information regarding our margins, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” included in Part II, Item 7 of this Annual Report on Form 10-K Our ability to sustain the level of our gross margins depends to a significant degree upon our ability to earn purchase discounts and rebates at levels at least equivalent to those in prior years, and our ability to mitigate the impacts of steeper drug price discounts and rebate pass-backs to clients with other fees and new revenue sources, as well as gains in operating efficiencies |
| Our margins may decline as we attract larger clients, who typically have greater bargaining power than smaller clients |
| Similarly, the amount of rebates that we earn may decline if pharmaceutical manufacturers decrease the amount of rebates they offer |
| Changes in existing federal or state laws or regulations or in their interpretation by courts and agencies or the adoption of new laws or regulations relating to patent term extensions, rebate arrangements with pharmaceutical manufacturers, as well as some of the formulary and other services we provide to pharmaceutical manufacturers, could also reduce the discounts or rebates we receive and harm our business, financial condition, liquidity and operating results |
| Failure to retain key clients could result in significantly decreased revenues and could harm our profitability |
| Our largest client, UnitedHealth Group, represented approximately dlra8cmam800 million, or 23prca, of our net revenues during 2005 |
| Our current agreement with UnitedHealth Group has an initial term ending December 31, 2009 and, at UnitedHealth Group’s option, may be extended for two additional years ending December 31, 2011 |
| Although none of our other clients individually represented more than 10prca of our net revenues in 2005, our top 10 clients as of December 31, 2005, including UnitedHealth Group, represented approximately 45prca of our net revenues during 2005 |
| 25 ______________________________________________________________________ [53]Table of Contents Our larger clients frequently distribute requests for proposals and seek bids from other PBM providers, as well as us, before their contracts with us expire |
| In addition, a client that is involved in a merger or acquisition with a company that is not a client may not renew, and in some instances may terminate, its PBM contract with us |
| If several of our large clients terminate, cancel or do not renew their agreements with us or stop contracting with us for some of the services we provide because they accept a competing proposal or because they are involved in a merger or acquisition, and we are not successful in generating new sales with comparable operating margins to replace the lost business, our revenues and results of operations could suffer |
| Failure to satisfy contractual obligations to clients could require us to pay performance penalties and could result in the termination of their contracts |
| Many of our contracts with clients contain provisions that guarantee the level of service we will provide or the minimum level of rebates or discounts the client will receive |
| Many of our client contracts also include guaranteed cost savings from our utilization management programs |
| An increase in drug costs, if the result is an overall increase in the cost of the drug plan to the client, may prevent us from satisfying contractual obligations under which we have guaranteed certain cost savings or minimum levels of rebates or discounts |
| Additionally, these clients may be entitled to performance penalties or the right to terminate their contracts with us if we fail to meet a service, rebate or cost savings guarantee we provide to them |
| Clients that are party to these types of contracts represented, in aggregate, over 90prca of our net PBM revenues in 2005 |
| Our clients are generally entitled to audit our compliance with their contracts and on occasion a client or former client has claimed that it overpaid us for our services based on the results of an audit |
| Payment disputes may adversely affect our results of operations if they result in refunds or the termination or non-renewal of a client contract |
| If we fail to comply with complex and rapidly evolving laws and regulations or increasingly sophisticated contractual obligations, we could suffer penalties, lose clients or be required to pay substantial damages or make significant changes to our operations |
| We are subject to numerous federal and state regulations |
| If we fail to comply with existing or future applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate our mail order pharmacies and our ability to participate in federal and state healthcare programs |
| We also continue to enter into detailed and complex contractual obligations |
| As a consequence of the severe penalties we could face, we must devote significant operational and managerial resources to complying with these laws and regulations and contractual obligations |
| Although we believe that we are substantially compliant with all existing statutes and regulations applicable to our business, different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations |
| In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure that we will be able to obtain or maintain the regulatory approvals required to operate our business |
| Our specialty pharmacy business is highly dependent on our relationships with a limited number of biopharmaceutical suppliers and the loss of any of these relationships could significantly impact our ability to sustain or grow our revenues |
| The majority of the IVIG (intravenous immunoglobulin) and blood clotting factor products sold through our specialty pharmacy business were purchased from Baxter Healthcare Corporation |
| We also derive a substantial percentage of our specialty segment revenue and profitability from our relationships with Biogen Idec, Inc, Genzyme Corporation, GlaxoSmithKline, Inc, MedImmune, Inc |
| and Genentech, Inc |
| Our agreements with these suppliers are short-term and cancelable by either party without cause on 60 to 365 days prior notice |
| These agreements also generally limit our ability to handle competing drugs, or provide services related to competing drugs, during and, in some cases, after the term of the agreement, but allow the supplier to distribute through channels other than us |
| Further, these agreements provide that pricing and other terms of these relationships be periodically 26 ______________________________________________________________________ [54]Table of Contents adjusted for changing market conditions or required service levels |
| Any termination or modification to any of these relationships could have a material adverse effect on a significant portion of our business, financial condition and results of operations |
| The ability of our Specialty Pharmacy segment to grow our specialty pharmacy business could be limited if we do not expand our existing base of drugs or if we lose patients |
| The Accredo Health, Incorporated component of our specialty pharmacy segment has 23 primary products |
| It focuses almost exclusively on a limited number of complex and expensive drugs that serve small patient populations, primarily with the following disease states: • Hemophilia, Autoimmune Disorders and Primary Immunodeficiency Disease • Pulmonary Arterial Hypertension • Multiple Sclerosis • Gaucher Disease • Growth Hormone-Related Disorders • Respiratory Syncytial Virus, or RSV Due to the small patient populations that use the drugs that our specialty pharmacy business handles, our future growth is dependent on expanding our base of drugs |
| Further, a loss of patient base or reduction in demand for any reason of the drugs we currently handle could have a material adverse effect on a significant portion of our specialty pharmacy business, financial condition and results of operations |
| The terms and covenants relating to our existing indebtedness could adversely impact our economic performance |
| Like other companies that incur debt, we are subject to risks normally associated with debt financing, such as the insufficiency of cash flow to meet required debt service payment obligations and the inability to refinance existing indebtedness |
| Our credit facility, accounts receivable financing facility and the indenture governing our senior notes contain customary restrictions, requirements and other limitations on our ability to incur indebtedness, including a total debt to EBITDA ratio and debt service coverage ratios |
| Our continued ability to borrow under our credit facility and accounts receivable financing facility is subject to our compliance with such financial and other covenants |
| In the event that we were to fail to satisfy these covenants, we would be in default under the credit facility, accounts receivable financing facility and indenture, and may be required to repay such debt with capital from other sources |
| Under such circumstances, other sources of capital may not be available to us, or be available only on unattractive terms |
| As of December 31, 2005, we had outstanding borrowings of approximately dlra1cmam181 million bearing interest at variable rates |
| Increases in interest rates on variable rate indebtedness would increase our interest expense and adversely affect our earnings |
| Prescription volumes may decline, and our net revenues and profitability may be negatively impacted, when products are withdrawn from the market or when increased safety risk profiles of specific drugs result in utilization decreases |
| We dispense significant volumes of brand-name and generic drugs from our mail order pharmacies and through our network of retail pharmacies |
| These volumes are the basis for our net revenues and profitability |
| When products are withdrawn by manufacturers, or when increased safety risk profiles of specific drugs or classes of drugs result in utilization decreases, physicians may cease writing or reduce the numbers of prescriptions written for these drugs |
| Additionally, negative press regarding drugs with higher safety risk profiles may result in reduced consumer demand for such drugs |
| In cases where there are no acceptable prescription drug equivalents or alternatives for these prescription drugs, our volumes, net revenues, profitability and cash flows may decline |
| 27 ______________________________________________________________________ [55]Table of Contents Risks related to bioterrorism and mail tampering, and mail irradiation and other procedures the government may implement to manage these risks, could adversely affect and limit the growth of our mail order business |
| Many prescription drugs are delivered to retail pharmacies or directly to consumers through the mail |
| In particular, our mail order pharmacies ship over one million parcels per week through the US Postal Service and other couriers |
| A number of our contracts also require us to deliver pharmaceutical products within a designated average period of time following receipt of an order |
| We have no control, however, over delays caused by disruptions to the US mail or other courier services |
| Moreover, should the risks related to bioterrorism or mail tampering increase or mail service experience interruptions or significant delays, we may have difficulty satisfying our contractual performance obligations and consumers may lose confidence in mail order pharmacies |
| We may be subject to liability claims for damages and other expenses that are not covered by insurance |
| Our product and professional liability insurance policies are expected to cover individual claims of up to dlra40 million |
| Because of the difficulty in obtaining, as well as the high cost of commercial insurance coverage, our retained liability has been established at levels that require certain self insurance reserves to cover potential claims |
| A successful product or professional liability claim in excess of our insurance coverage could harm our financial condition and results of operations |
| For example, a prescription drug dispensing error could result in a patient receiving the wrong or incorrect amount of medication, leading to personal injury or death |
| Misinformation from one of our call center pharmacies or our websites could also lead to adverse medical conditions |
| Our business, financial condition and results of operations could suffer if we face negative publicity or we pay damages or defense costs in connection with a claim that is outside the scope of any applicable contractual indemnity or insurance coverage |
| We believe that the claims described in Note 14, “Commitments and Contingencies,” to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K are unlikely to be covered by insurance |
| The success of our business depends on maintaining a well-secured business and technology infrastructure |
| We are dependent on our infrastructure, including our information systems for many aspects of our business operations |
| A fundamental requirement for our business is the secure storage and transmission of personal health information and other confidential data |
| Our business and operations may be harmed if we do not maintain our business processes and information systems, and the integrity of our confidential information |
| Although we have developed systems and processes that are designed to protect information against security breaches, failure to protect such information or mitigate any such breaches may adversely affect our operating results |
| Malfunctions in our business processes, breaches of our information systems or the failure to maintain effective and up-to-date information systems could disrupt our business operations, result in customer and member disputes, damage our reputation, expose us to risk of loss or litigation, result in regulatory violations, increase administrative expenses or lead to other adverse consequences |
| The use of personal health information in our business is regulated at federal, state and local levels |
| These laws and rules change frequently and developments often require adjustments or modifications to our technology infrastructure |
| Noncompliance with these regulations could harm our business, financial condition and results of operations |
| Changes in technology could cause our products and services to become obsolete and, as a result, we may lose clients and members |
| We rely heavily on our technology, which is subject to rapid change and evolving industry standards |
| For example, automated dispensing for mail order, online pharmacies and electronic prescribing are among the recent technological innovations of our industry |
| To be successful, we must adapt to this rapidly evolving market by continually improving the responsiveness, functionality and features of our products and services to meet our clients’ changing needs |
| We may not be successful in developing or acquiring technology that is competitive and responsive to the needs of our clients and might lack sufficient resources to continue to make the necessary investments in technology to compete with our competitors |
| Without the timely introduction of new products and enhancements that take advantage of the latest technology, our products and services could become obsolete over time and we could lose a number of our clients and members |
| 28 ______________________________________________________________________ [56]Table of Contents Any disruption of, or failure in, either of our two automated pharmacies or our data centers could significantly reduce our ability to process and dispense prescriptions and provide products and services to our clients |
| Currently, our automated pharmacies in Willingboro, New Jersey and Las Vegas, Nevada together dispense over 90prca of our mail order prescriptions |
| Our data center, located in Fair Lawn, New Jersey, provides primary support for all applications and systems required for our business operations, including our integrated prescription claims processing, billing, communications and mail order systems |
| These facilities depend on the infrastructure in the areas where they are located and on the uninterrupted operation of our computerized dispensing systems and our electronic data processing systems |
| Significant disruptions at any of these facilities due to failure of our technology or any other failure or disruption to these systems or to the infrastructure due to fire, electrical outage, natural disaster, acts of terrorism or malice or some other catastrophic event could, temporarily or indefinitely, significantly reduce, or partially or totally eliminate, our ability to process and dispense prescriptions and provide products and services to our clients |
| We could be required to record a material non-cash charge to income if our recorded intangible assets are impaired, or if we shorten intangible asset useful lives |
| We had over dlra2dtta7 billion of recorded intangible assets, net, on our consolidated balance sheet as of December 31, 2005 |
| Our gross intangible assets increased by dlra794 million primarily as a result of the Accredo acquisition |
| The majority of our intangible assets were created at the time of the Merck acquisition of Medco in 1993, and represents the value of client relationships at the time of acquisition |
| Under current accounting rules, intangible assets are amortized over their useful lives |
| These assets may become impaired with the loss of significant clients that were in the client base at time of acquisition |
| If the carrying amount of the assets exceeds the undiscounted pre-tax expected cash flows from the remaining client base, we would be required to record a non-cash impairment charge to our statement of income in the amount the carrying value of these assets exceeds the discounted expected future cash flows from these clients |
| In addition, while the intangible assets may not be impaired, the useful lives are subject to continual assessment, taking into account historical and expected losses of clients that were in the client base at time of acquisition |
| This assessment may result in a reduction of the remaining weighted average useful life of these assets, resulting in potentially significant increases to non-cash amortization expense that is charged to our consolidated statement of income |
| In 2004, we were notified of the loss of the Independence Blue Cross and the Federal Employees Health Benefit Plan accounts, which resulted in a reduction of the intangible asset weighted average useful life from 35 years to 23 years, with the annual amortization expense increasing to dlra180 million in 2004 from dlra94 million in 2003 |
| An intangible asset impairment charge, or a reduction of amortization lives, could have a material adverse effect on our earnings and stockholders’ equity in the periods recorded and could adversely affect the price of our common stock |
| See “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Use of Estimates and Critical Accounting Policies–Critical Accounting Policies” included in Part II, Item 7 of this Annual Report on Form 10-K The anti-takeover provisions of the Delaware General Corporation Law (“DGCL”), our certificate of incorporation and our bylaws could delay or deter a change in control and make it more difficult to remove incumbent officers and directors |
| Our certificate of incorporation and bylaws and various provisions of the DGCL may make it more difficult to effect a change of control of our company or remove incumbent officers and directors |
| The existence of these provisions may adversely affect the price of our common stock, discourage third parties from making a bid to acquire our company or reduce any premium paid to our shareholders for their common stock |
| Our Board of Directors has authority to issue up to 10cmam000cmam000 shares of “blank check” preferred stock and to attach special rights and preferences to this preferred stock |
| The issuance of this preferred stock may make it more difficult for a third party to acquire control of us |
| Our Board of Directors is divided into three classes as nearly equal in size as possible with staggered three-year terms |
| This classification of our Board of Directors could have the effect of making it more difficult for a third party to acquire our company or of discouraging a third party from acquiring control of our company because it will generally make it more difficult for shareholders to replace a majority of the directors |
| It is not possible to remove a director except for cause and only by a vote of holders of at least 80prca of the voting power of our outstanding shares of stock |
| Additionally, as a result of our ownership of three insurance companies, a third party attempting to effect a change of control of our company may be required to obtain approval from the applicable state insurance regulatory officials |
| The need for this approval may discourage third parties from making a bid for our company or make it more difficult for a third party to acquire our company, which may adversely affect the price of our common stock |
| Risks Relating to Our Industry PBMs could be subject to claims under ERISA if they are found to be a fiduciary of a health benefit plan governed by ERISA PBMs typically provide services to corporations and other sponsors of health benefit plans |
| These plans are subject to ERISA, which regulates employee pension benefit plans and employee welfare benefit plans, including health and medical plans |
| The US Department of Labor, which is the agency that enforces ERISA, could assert that the fiduciary obligations imposed by the statute apply to some or all of the services provided by a PBM We are party to several lawsuits that claim we are a fiduciary under ERISA If a court were to determine, in litigation brought by a private party or in a proceeding arising out of a position taken by the Department of Labor, that we were a fiduciary in connection with services we provide, we could potentially be subject to claims for breaching fiduciary duties and/or entering into certain “prohibited transactions |
| ” Legislative or regulatory initiatives that restrict or prohibit the PBM industry’s ability to use patient identifiable medical information could limit our ability to use information that is critical to the operation of our business |
| Many of our products and services rely on our ability to use patient identifiable information in various ways |
| In addition to electronically reviewing hundreds of millions of prescriptions each year, we collect and process confidential 29 ______________________________________________________________________ [57]Table of Contents information through many of our programs and alliances, including RationalMed and point-of-care initiatives |
| There is currently substantial regulation at the federal, state and international levels addressing the use and disclosure of patient identifiable medical and other information |
| Sanctions for failing to comply with standards issued pursuant to state or federal statutes or regulations include criminal penalties and civil sanctions |
| See Item 1, “Business—Government Regulation” above |
| These and future regulations and legislation that severely restrict or prohibit our use of patient identifiable medical and other information could limit our ability to use information that is critical to the operation of our business |
| If we violate a patient’s privacy or are found to have violated any state or federal statute or regulation with regard to the confidentiality, dissemination or use of patient medical information, we could be liable for significant damages, fines or penalties |
| Government efforts to reduce healthcare costs and alter healthcare financing practices could lead to a decreased demand for our services or to reduced rebates from manufacturers |
| During the past several years, the US healthcare industry has been subject to an increase in governmental regulation at both the federal and state levels |
| Efforts to control healthcare costs, including prescription drug costs, are underway at the federal and state government levels |
| Congress frequently considers proposals to reform the US healthcare system |
| These proposals may increase governmental involvement in healthcare and PBM services and may otherwise change the way our clients do business |
| Healthcare organizations may react to these proposals and the uncertainty surrounding them by cutting back or delaying the purchase of our PBM services, and manufacturers may react by reducing rebates or reducing supplies of certain products |
| These proposals could lead to a decreased demand for our services or to reduced rebates from manufacturers |
| In addition, both Congress and state legislatures are expected to consider legislation to increase governmental regulation of managed care plans |
| Some of these initiatives would, among other things, require that health plan members have greater access to drugs not included on a plan’s formulary and give health plan members the right to sue their health plans for malpractice when they have been denied care |
| The scope of the managed care reform proposals under consideration by Congress and state legislatures and enacted by states to date vary greatly, and we cannot predict the extent of future legislation |
| However, these initiatives could greatly limit our business practices and impair our ability to serve our clients |
| Risks and uncertainties regarding the implementation and effects of the Medicare Part D prescription drug benefit |
| On December 8, 2003, President Bush signed into law HR 1, the “Medicare Prescription Drug, Improvement, and Modernization Act of 2003” (PL 108-173) (the “Act”) |
| The Act offers far-reaching changes to the Medicare program, including changes to the Medicare+Choice program, administrative and contracting reforms, changes to Medicare provider reimbursement, and the creation of a new type of health savings account |
| Most notably, the Act establishes a new Medicare Part D outpatient prescription drug benefit for over 40 million Americans who are age 65 and older, or disabled the most significant change to healthcare coverage for beneficiaries since the inception of Medicare nearly 40 years ago |
| Seniors have had the opportunity to enroll in Medicare Part D since January 1, 2006 |
| The Medicare Part D prescription benefit could make policies or plans less valuable to beneficiaries and reduce the total market for PBM services |
| Moreover, our clients could decide to discontinue providing prescription drug benefits to their Medicare-eligible members |
| If this occurs, the adverse effects of the Part D benefit may outweigh any opportunities for new business generated by the new benefit |
| We are not yet able to assess the impact that Medicare Part D will have on our clients’ decisions to continue to offer a prescription drug benefit to their Medicare-eligible members |
| Although we have been approved by CMS as a national Medicare Part D prescription drug plan sponsor, we are not yet in a position to predict the impact of such participation on our business, financial condition or results of operations |
| At least one Medicaid program has adopted, and other Medicaid programs, some states and some commercial payors may adopt, those aspects of the Act that either result in or appear to result in price reductions for drugs covered by such programs |
| Adoption of average sale price in lieu of average wholesale price as the measure for determining reimbursement by state Medicaid programs for the drugs sold in our specialty pharmacy business could materially reduce the revenue and gross margins of the specialty business |
| In order to deal with budget shortfalls, some states are attempting to create state administered prescription drug discount plans, to limit the number of prescriptions per person that are covered and to raise Medicaid co-pays and 30 ______________________________________________________________________ [58]Table of Contents deductibles, and are proposing more restrictive formularies and reductions in pharmacy reimbursement rates |
| For example, California’s Medicaid program, Medi-Cal, recently adopted a plan that shifted away from use of acquisition cost plus 1prca and instead uses average sales price plus 20prca for blood clotting factor products |
| This reduction and any further reductions in the reimbursement from Medi-Cal could adversely impact revenues and profitability from the sale of drugs by our specialty pharmacy business to patients covered by Medi-Cal |
| Any reductions in amounts reimbursable by other government programs for specialty pharmacy services or changes in regulations governing such reimbursements could materially and adversely affect our business, financial condition, liquidity and operating results |