| STANDARD MANAGEMENT CORP Item 1A Risk Factors In addition to the other information in this report and our other filings with the U S Securities and Exchange Commission (“SEC”), the following risk factors should be carefully considered in evaluating Standard Management and our businesses |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties, not presently known to us or otherwise, may also impair our business operations or the trading of our common stock |
| If any of the risks described below or such other risks actually occur, our business, financial condition or results of operations could be materially and adversely affected |
| - 7 - _________________________________________________________________ [42]Table of Contents Our pharmacy business has not been profitable and we expect it to continue to incur losses for at least the next year |
| Since we began operating our pharmacy business in 2002, it has incurred substantial net losses each year |
| For the years 2005, 2004 and 2003, net losses from our continuing operations were dlra20dtta3 million, dlra20dtta6 million and dlra16dtta7 million, respectively |
| We expect net losses to continue until we generate significant revenues and achieve economies of scale in our operations through acquisitions and organic growth |
| There can be no assurance that we will ever be able to successfully develop and operate a profitable pharmacy business |
| Our future profitability will depend on several factors including: • our ability to identify and acquire appropriately priced and profitable businesses that provide cash flow and synergies to our current business; • our ability to execute a planned strategy that will provide for cash flow from operations which will fund growth and service debt; and • our ability to access reasonably priced capital that will provide long-term flexibility for the Company |
| Unless we receive a significant cash infusion or significantly increase cash flow from operations, we may not have sufficient cash to meet our cash requirements at some point during 2006 |
| Our pharmacy business alone has not generated sufficient revenues to support our operations and service our debt obligations |
| We implemented a growth plan, subsequent to the sale of our financial services business in June 2005, focused on acquiring profitable existing businesses to increase our revenues and cash flows |
| The funding of this growth plan and our ability to meet our working capital and other cash requirements generally, depend on, among other things, current cash and cash equivalents and proceeds from outside financing activities |
| At December 31, 2005, we had approximately dlra2dtta2 million in cash and cash equivalents |
| On April 13, 2006, we received dlra2dtta8 million of debt financing from one of our officers |
| Nevertheless, based on current estimates of cash flow, management believes that, absent significant additional cash infusion or significantly increased cash flow from operations, at some point during 2006, we may not have sufficient cash to meet our cash requirements |
| Management is currently negotiating a series of transactions it believes would alleviate the potential liquidity shortfall |
| There can be no assurance, however, that outside financing activities will generate sufficient net proceeds or that the other initiatives currently being negotiated by management can be consummated in full or at sufficient levels to provide us with sufficient cash to meet our cash requirements |
| Our independent auditors have expressed substantial doubt regarding the Company’s ability to continue as a going concern |
| In their report, our independent auditors stated that our financial statements for the years ended December 31, 2005 and 2004 were prepared assuming that the Company would continue as a going concern |
| The auditors expressed “substantial doubt” about the Company’s ability to continue as a going concern based on a lack of liquidity combined with recurring losses from continuing operations |
| The fact that we have received this “going concern opinion” from our auditors will likely make it more difficult for us to raise capital on favorable terms and could hinder, to some extent, our operations and acquisition program |
| We will require additional financing, which may be difficult to obtain |
| Any such financing in the form of debt will contain restrictive covenants and will require us to utilize cash to service it |
| Our pharmacy business has had negative cash flows and net losses since its inception in 2002 |
| We expect negative cash flows from operations to continue until we achieve critical mass through acquisitions and organic growth |
| Our business has significant cash needs for operations and for acquisitions |
| As a result, we will likely need to seek additional capital, which we may do through public or private equity or debt financing |
| In addition to seeking equity financing, we are currently negotiating with various potential lenders to provide senior debt financing |
| There can be no assurance that we can reach agreement with any lenders for such financing |
| The terms of any such debt financing, will likely restrict our ability to, among other things, incur additional indebtedness, pay dividends or make certain other restricted payments in certain situations, consummate certain asset sales, enter into certain transactions with affiliates, incur liens, or merge or consolidate with any other person or sell, assign, transfer, - 8 - _________________________________________________________________ [43]Table of Contents lease, convey or otherwise dispose of all or substantially all of our assets |
| The terms of such indebtedness would also likely require us to meet certain financial tests and comply with certain other reporting, affirmative and negative covenants |
| Finally, if we obtain such debt financing, a substantial portion of our cash flow from operations would be dedicated to debt service requirements |
| Our management team has a limited history of operating a pharmacy business |
| Because we have only operated our pharmacy business since 2002, our management team does not have a significant operating history upon which an investor can easily evaluate our future potential |
| In attempting to execute our business model, we may need to significantly change our operating model, sales and implementation practices, customer service and support operations and management focus |
| We are also facing new risks and challenges, including a lack of meaningful historical financial data upon which to plan future budgets and the need to develop strategic relationships |
| We are subject to various risks relating to our acquisition strategy |
| A significant component of our growth strategy contemplates our making selected acquisitions that will help expand our pharmacy offerings |
| Acquisitions involve inherent uncertainties |
| These uncertainties include the ability to identify suitable acquisition candidates and negotiate acceptable terms for their acquisition, the ability to integrate the acquired businesses into a larger organization and the availability of management resources to oversee the operations of these businesses |
| The successful integration of acquired businesses will require, among others: • consolidation of financial functions and elimination of redundancies; • achievement of purchasing efficiencies; • the integration of key personnel; and • the maintenance and growth of existing business |
| We also may acquire businesses with unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations |
| We have procedures in place to conduct detailed due diligence reviews of potential acquisition candidates for compliance with healthcare laws and to conform the practices of acquired businesses to our standards and applicable laws, but there can be no assurance that our procedures will detect all potential problems |
| If such procedures fail, we may incur material liabilities for past activities of acquired businesses |
| We cannot be sure that an acquisition will not have an adverse impact on our results of operations or financial condition |
| We face uncertainties relating to ongoing litigation that, if decided adversely to us, would have a material adverse impact on our liquidity and financial position |
| We are currently engaged in binding arbitration with our former President/Chief Financial Officer |
| This former executive resigned all positions with us effective May 31, 2005 and has initiated legal proceedings to recover certain severance amounts to which he alleges he is entitled |
| We believe that the executive’s claims are entirely without merit |
| We are vigorously defending this action |
| While we are confident in the merits of our legal position in the arbitration, we cannot predict the outcome of this action nor the amount the arbitrators will ultimately rule is due to the executive, if anything |
| A decision by the arbitrators requiring us to pay a significant amount to the executive would have a substantial negative impact on our liquidity and financial position |
| Our profitability and ability to conduct business could be negatively impacted by a change in our relationships with our largest institutional clients |
| A large portion of the present and future growth of our institutional pharmacy business currently is contingent upon our ability to acquire and retain institutional care facilities |
| Currently we have more than 80 contractual relationships with institutional clients |
| We are presently attempting to expand the number of these contracts |
| The financial condition and profitability of our institutional clients can impact our profitability and opportunities for future growth |
| In addition, although we believe our current relationships with our institutional clients are strong, the loss of key institutional clients would materially affect the operation of our business |
| - 9 - _________________________________________________________________ [44]Table of Contents We face intense competition |
| We operate in a highly competitive environment |
| The institutional pharmacy industry is dominated by three companies, which together control approximately 65prca of the market |
| If we are unable to compete with our competition due to our size, failure to develop innovative distribution methods or failure to satisfy our customers, our financial results will be immediately and significantly affected |
| We are subject to significant governmental regulation, and changes in such regulation could have a substantial impact on our profitability |
| We are subject to substantial regulations at both the state and federal levels regarding payment or reimbursement for pharmacy services, financial relationships with our clients and manufacturers of pharmaceuticals, and licensure and certification of our operations, and changes in these regulations may have a material and adverse effect on our profitability as more fully described below |
| We are dependent on payment or reimbursement from government reimbursement programs, principally Medicare and Medicaid, and the constant changes in the government reimbursement programs pose substantial risk to our results of operations |
| The provision of pharmaceuticals and pharmacy benefits is a highly dynamic and evolving business that is tied closely to changes in government reimbursement programs at both the state and federal levels and is in a constant state of flux |
| As of December 31, 2005, approximately 36prca of our pharmacy billings were directly reimbursed by government sponsored programs |
| Government sponsored programs include Medicaid and, to a lesser extent, Medicare |
| Our remaining billings are currently paid or reimbursed by individual residents, long-term care facilities and other third-party payors, including private insurers |
| A portion of these revenues are indirectly dependent on government programs |
| We anticipate that direct reimbursement from government sponsored programs will become a material portion of our pharmacy billings |
| There are currently a number of active state and federal initiatives that could materially and adversely affect our profitability, the most important of which is the Medicare Prescription Drug Improvement and Modernization Act of 2004, which created a comprehensive voluntary prescription drug benefit administered under Medicare Part D and became effective on January 1, 2006 |
| This Act provides certain cost-sharing government subsidies for individuals who might otherwise qualify for drug coverage under Medicaid or similar government-funded aid programs |
| Since a substantial portion of our future institutional pharmacy business will involve the provision of prescription drugs to Medicare beneficiaries who may qualify for this new benefit, it may have a material and adverse effect on the profitability of our business |
| Since important elements of this Act relating to issues such as formulary development, drug pricing, and drug discount cards have yet to be finalized, the precise impact of implementation of Medicare Part D on our industry is unknown |
| We also expect significant reforms to be proposed in 2006 regarding the Medicare Part B drug payment methodology |
| The United States Department of Health and Human Services, Centers for Medicare and Medicaid Services has indicated that the pharmacy reimbursement methodology will change to either an “average sales price” or “competitive acquisition program” payment methodology, and this change may have a material and adverse effect on our profitability |
| Many state Medicaid programs use the “average wholesale price” reimbursement methodology (“AWP”) and the “maximum allowable costs” reimbursement methodology (“MAC”), but many states, including states in which we operate or may operate, have indicated an intention to discontinue or modify these payment methodologies, and such changes may have a material and adverse effect on our profitability |
| Currently, virtually all of our contracts with major facility customers use these methodologies as a basis for calculating the prices charged for drugs ordered through our pharmacy |
| In the event state reimbursement programs decide to use alternative methods for calculating these prices, our reimbursement may suffer |
| If we or our client institutions fail to comply with Medicaid and Medicare reimbursement regulations, our revenue could be reduced, we could be subject to penalties and we could lose our eligibility to participate in these programs |
| The Medicaid and Medicare programs are highly regulated |
| The failure, even if inadvertent, by either us or our client institutions to comply with applicable reimbursement regulations could adversely affect reimbursement under these programs and our or our clients’ ability to continue to participate in these programs |
| In addition, our - 10 - _________________________________________________________________ [45]Table of Contents failure to comply with these regulations could subject us and our clients to allegations of filing false claims to the governmental reimbursement programs, which could subject us to substantial financial damages and exclusion from the governmental reimbursement programs |
| If we fail to comply with licensure requirements, fraud and abuse laws, or other applicable laws, we may need to curtail operations, and we could be subject to significant penalties |
| While we continually monitor the effects of regulatory activity on our operations and believe we currently have all necessary pharmacy licenses, the failure to obtain or renew any required regulatory approvals or licenses could adversely affect the continued operation of the business |
| The long-term care facilities that contract for our services are also subject to federal, state and local regulations and are required to be licensed in the states in which they are located |
| The failure by these long-term care facilities to comply with these or future regulations or to obtain or renew any required licenses could result in our inability to provide pharmacy services to these facilities and their residents |
| We are also subject to federal and state laws that prohibit some types of direct and indirect payments between healthcare providers |
| These laws, commonly known as the fraud and abuse laws, prohibit payments or any other remuneration intended to induce or encourage the referral of items or services payable by Medicare or Medicaid, including prescription drugs |
| For example, payment by pharmaceutical manufacturers of access or performance rebates to institutional pharmacies that are designed to prefer, protect, or maintain that manufacturer’s product selection by the pharmacy or to increase the volume of that manufacturer’s products that are dispensed by the pharmacy under its formulary are currently under scrutiny and may violate the fraud and abuse laws |
| Violation of these laws can result in loss of licensure, civil and criminal penalties, and exclusion from the Medicaid, Medicare and other federal and state healthcare programs |
| Our failure to comply with federal or state health care privacy standards could subject us to civil and criminal liability |
| The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) requires us to comply with the electronic transaction, privacy and security standards relating to the health care information of individuals who receive drugs and pharmaceuticals through our operations |
| Although we have taken and intend to continue to take all steps necessary to ensure that we comply with all HIPAA standards, if we fail to comply with the HIPAA regulations, we could suffer significant civil and criminal penalties |
| We may also become subject to various state legislative and regulatory privacy initiatives that will restrict the use of private medical records, and, if these regulations are implemented, we may incur additional expense and may be required to change certain of our business practices |
| We are also subject to other state and federal laws that govern the distribution of pharmaceuticals, the enforcement of which could have a material and adverse effect on our profitability |
| We are also subject to the risk of changes in various local, state, federal and international laws relating to pharmaceuticals, which include the operating and security standards of the United States Drug Enforcement Administration, the United States Food and Drug Administration, various state boards of pharmacy and comparable agencies |
| These changes may affect our operations, including distribution of prescription pharmaceuticals (including certain controlled substances), operation of pharmacies and packaging of pharmaceuticals |
| A review of our business by regulatory authorities may result in determinations that could adversely affect the operations of the business |
| We are also subject to cost controls imposed by non-government reimbursement program payors and pricing changes from our suppliers that could have a material and adverse effect on our profitability |
| Cost controls imposed by other third-party payors, such as managed care companies and insurance companies, in an attempt to exercise control over increasing health care costs and changes in pharmaceutical manufacturers’ pricing or distribution policies could also have a material and adverse effect on our profitability by substantially reducing our revenues |
| There are few barriers to entry in the institutional pharmacy market, and we may experience unforeseen competition in our markets |
| There are relatively few barriers to entry in the local markets that we serve, and we may encounter substantial competition from new local market entrants as well as increasing competition from pharmacies operating - 11 - _________________________________________________________________ [46]Table of Contents outside the United States which ship drugs to US residents over the Internet and through other distribution channels |
| This competition could have a material and adverse effect on our business |
| Future sales of common stock could depress the price of our common stock |
| We have previously announced that we are attempting to raise additional capital |
| The planned financings may include, but not be limited to, a combination of privately placed common stock, senior debt and subordinated debt |
| The amounts may vary depending upon the structure of each financing instrument |
| Sales of significant amounts of common stock in the public market, or the perception that sales will occur, could materially depress the market price of our common stock |
| We expect that any common stock sold in any of this private financing will be registered for resale under the Securities Act within 120 days following the closing of such offering and thus would be freely tradable |
| We also have outstanding three series of convertible notes, which, as of December 31, 2005 are convertible into an aggregate of 2cmam927cmam483 shares of common stock |
| We have registered these shares for resale so that, upon conversion, such shares will be freely tradable |
| Further, we have outstanding warrants to purchase an aggregate of 748cmam130 shares of common stock |
| The shares of common stock underlying such warrants are subject to registration rights or are otherwise currently freely tradable |
| In addition, as of December 31, 2005 we have an aggregate of 2cmam222cmam180 shares of common stock issuable in our two stock option plans upon the exercise of stock options currently outstanding |
| Those shares, if issued, will be eligible for immediate resale in the market (other than 1cmam427cmam614 shares underlying exercisable options held by our executive officers and directors) |
| Finally, we have announced our intention to commence an exchange offer for all or a portion of our outstanding trust preferred securities, in which holders will be offered the opportunity to exchange their trust preferred securities for shares of our common stock |
| We have not yet determined the terms of the exchange offer, including the exchange ratio |
| As a result, while the exchange offer will likely result in the issuance of a significant number of additional shares of our common stock, we cannot presently quantify how many new shares will be issued |
| The market price of our common stock is volatile |
| The market price of our common stock historically has experienced and may continue to experience significant volatility |
| This volatility may or may not be related to our operating performance |
| Some of this volatility may be related to our recent shift to operating solely in the healthcare business and as a much smaller company, and may reflect the market’s difficulty in valuing our business until we establish a longer operating history |
| In addition, announcements of our quarterly operating results, changes in recommendations by financial analysts, fluctuations in the stock price and operating results of our competitors and similar events could cause the market price of our common stock to fluctuate substantially |
| We cannot guarantee that our securities will continue to meet the listing and maintenance criteria for the Nasdaq Stock Market |
| Our common stock is currently traded on the Nasdaq National Market |
| Continued inclusion on the Nasdaq National Market currently requires, among other things, a minimum stockholder’s equity of dlra10 million |
| As of December 31, 2005, our stockholder’s equity was dlra4dtta9 million |
| In addition, Nasdaq requires that the minimum bid price for listed companies exceed dlra1dtta00 per share |
| Recently, our shares of common stock have traded consistently under the dlra1dtta00 minimum bid price |
| In a letter dated April 3, 2006, we were notified by Nasdaq that our stock price traded under dlra1dtta00 per share for the last 30 consecutive business days |
| The letter advised that we have until October 2, 2006 to regain compliance with this minimum bid price requirement |
| We intend to monitor the bid price of our common stock between now and October 2, 2006, and consider various options available to us in the event our common stock does not trade at a level that is likely to regain compliance |
| If we fail to maintain the minimum threshold requirements to maintain our inclusion on the Nasdaq National Market, our securities would lose their listing which could further negatively impact the price and marketability of our shares, and trading would be conducted, if we qualify, on the Nasdaq Capital Market or if we do not qualify for such market, then in the over-the-counter market known as the NASD OTC Electronic Bulletin Board |
| As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of our securities |
| - 12 - _________________________________________________________________ [47]Table of Contents In addition, the SEC has adopted regulations which generally define “penny stock” to be any equity security that has a market price less than dlra5dtta00 per share or an exercise price of less than dlra5dtta00 per share subject to certain exceptions |
| If our securities are removed from listing on the Nasdaq Market, and are traded at a price below dlra5dtta00, they may become subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and institutional accredited investors |
| For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of the securities and have received the purchaser’s written consent to the transaction prior to the purchase |
| Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a disclosure schedule prepared by the SEC relating to the penny stock market and the risks of investing in our securities |
| The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities, and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market |
| Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks |
| Consequently, the “penny stock” rules may restrict the ability of broker-dealers to sell our securities and may affect your ability to sell our securities in the secondary market |
| You may experience dilution as a result of future issuances of shares of our common stock |
| As of December 31, 2005, we had 9cmam095cmam208 shares of common stock outstanding |
| Additionally, as of December 31, 2005, we had stock options, warrants and convertible securities outstanding that were convertible or exercisable into up to 5cmam897cmam793 shares of our common stock |
| Furthermore, in connection with our acquisition strategy, we may issue shares of our common stock as consideration in certain future acquisition transactions |
| We are also likely to issue a significant number of shares in the planned exchange offer for our trust preferred securities |
| We may also issue additional shares as warrants to purchase additional shares in the future through various financing or restructuring transactions, although, there are no firm plans for such transactions at this time |
| In the event that we issue additional common stock in the future, our shareholders will experience dilution the significance of which will depend on the number of shares issued |