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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the fiscal year ended December 31, 1997
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 000-23249
PRIORITY HEALTHCARE CORPORATION
(Exact name of registrant as specified in its charter)
INDIANA 35-1927379
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
285 WEST CENTRAL PARKWAY 32714
ALTAMONTE SPRINGS, FLORIDA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (407) 869-7001
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
CLASS B COMMON STOCK, $.01 PAR VALUE
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. X
---
$38,911,550
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock on March 13, 1998
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
10,214,286
Number of shares of Class A Common Stock, $.01 par value, outstanding at March
13, 1998.
2,300,922
Number of shares of Class B Common Stock, $.01 par value, outstanding at March
13, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document have been incorporated by reference into
this Annual Report on Form 10-K:
IDENTITY OF DOCUMENT PART OF FORM 10-K INTO WHICH
DOCUMENT IS INCORPORATED
Definitive Proxy Statement for the Annual PART III
Meeting of Shareholders
to be held May 21, 1998
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PRIORITY HEALTHCARE CORPORATION
Altamonte Springs, Florida
Annual Report to Securities and Exchange Commission
December 31, 1997
PART I
ITEM 1. BUSINESS.
BACKGROUND
Priority Healthcare Corporation ("Priority" or the "Company") was formed
by Bindley Western Industries, Inc. ("BWI") on June 23, 1994 as an Indiana
corporation to focus on the distribution of products and provision of services
to the alternate site segment of the healthcare industry. The Company conducts
the business activities of alternate site healthcare companies acquired by BWI
or the Company in five transactions since February 1993. The principal
executive offices of the Company are located at 285 West Central Parkway,
Altamonte Springs, Florida 32714 and its telephone number at that address is
(407) 869-7001. On October 29, 1997, the Company consummated an initial public
offering of its Class B Common Stock (the "Offering"). Unless otherwise
indicated, "Priority" and the "Company" refer to Priority Healthcare
Corporation and its subsidiaries, and "BWI" refers to Bindley Western
Industries, Inc. and its subsidiaries other than the Company.
ACQUISITION HISTORY
Effective as of February 28, 1993, BWI acquired substantially all of the
assets of Charise Charles, Ltd., Inc. ("Charise Charles"), a specialty
wholesale distributor of oncology and renal care biopharmaceuticals located in
Altamonte Springs, Florida. On October 6, 1993, BWI acquired substantially all
of the assets of PRN Medical, Inc. ("PRN"), a specialty wholesale distributor
of renal care supplies and dialysis equipment located in Orlando, Florida. In
August 1994, PRN was combined with Charise Charles as part of the formation of
the Company. On October 31, 1994, the Company acquired the stock of 3C Medical,
Inc. ("3C"), a specialty distributor of acute dialysis products located in
Santa Ana, California. Effective January 1, 1995, the Company acquired all of
the outstanding stock of IV-1, Inc., IV-One Services, Inc. and National
Pharmacy Providers, Inc. (collectively, the "IV One Companies"), three related
companies located in Altamonte Springs, Florida that provided specialty
pharmacy and other related healthcare services. On August 6, 1997, the Company
acquired substantially all of the assets of Grove Way Pharmacy, Inc. ("Grove
Way Pharmacy"), a specialty distributor of vaccines located in Castro Valley,
California.
The operations of Charise Charles, PRN, 3C and Grove Way Pharmacy are now
included in the Company's Priority Healthcare Distribution division ("Priority
Distribution"). The IV One Companies now comprise the Priority Pharmacy
Services division ("Priority Pharmacy").
GENERAL
Priority is a national distributor of specialty pharmaceuticals and
related medical supplies to the alternate site healthcare market and is a
provider of patient-specific, self-injectable biopharmaceuticals and disease
treatment programs to individuals with chronic diseases. Through Priority
Distribution, the Company sells over 3,500 SKUs of specialty pharmaceuticals
and medical supplies to outpatient renal care centers and office-based
physicians in the oncology and infectious disease markets. With the acquisition
of Grove Way Pharmacy, Priority Distribution has entered the vaccine market.
Priority Distribution offers value-added services to meet the specific needs of
these markets by shipping refrigerated pharmaceuticals overnight in special
packaging to maintain appropriate temperatures, offering automated order entry
services and offering customized distribution for group accounts. From
distribution centers in Altamonte Springs, Florida, Santa Ana, California and
Grove City, Ohio, Priority
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Distribution services over 2,000 customers in all 50 states and Puerto
Rico, including approximately 550 office-based oncologists and 800 renal
dialysis clinics.
Through Priority Pharmacy, the Company fills individual patient
prescriptions for self-injectable biopharmaceuticals for over 1,400 patients.
These patient-specific prescriptions are filled at two licensed pharmacies in
Altamonte Springs, Florida, where the Company reconstitutes in syringes the
components of the biopharmaceuticals, according to manufacturer's instructions,
and ships these products directly to the patient overnight in specialized
packages. Priority Pharmacy also provides disease treatment programs for
hepatitis, melanoma, cancer, human growth deficiency and the complications of
HIV. Management believes that it is the only provider that offers this range of
services on a nationwide basis.
Priority's net sales have increased from $79.6 million in 1993 to $231.0
million in 1997. In the same period, operating income has increased from $2.1
million in 1993 to $11.4 million in 1997. The Company's objective is to
continue to grow rapidly and enhance its market position as a leading specialty
distributor by capitalizing on its business strengths and pursuing the
following strategy: (i) continue to focus on and further penetrate the
alternate site market; (ii) enter new markets by distributing new product
categories and patient-specific biopharmaceuticals; (iii) accelerate growth of
its higher margin, patient-specific pharmacy business by leveraging
relationships with existing distribution customers; (iv) maintain intense cost
control while investing in infrastructure; and (v) pursue acquisitions to
complement existing product offerings or further penetrate markets.
INDUSTRY AND MARKET OVERVIEW
Priority sells the majority of its products and services into two large
and growing markets--oncology and chronic renal dialysis. The Company also
operates in certain segments of the infectious disease market and, with the
acquisition of Grove Way Pharmacy, has entered the vaccine market. The common
characteristics of these markets is that most products are administered in an
alternate site setting by physicians or the patients themselves and require
specialized shipping and support services.
Industry Overview. The alternate site supply market is fragmented with
many public and private companies focusing on different product or customer
niches. Few companies offer a wide range of pharmaceuticals and related
supplies targeted to multiple customer groups, specifically renal dialysis
clinics and office-based physicians. Historically, cancer therapy, renal
dialysis and most other treatments for chronic and life-threatening medical
conditions were administered almost exclusively in a hospital inpatient
setting. During the 1990s, the frequency with which these treatments have been
administered outside the hospital has increased dramatically in response to
cost containment efforts and the introduction of new biopharmaceutical
products, such as interferon, erythropoietin ("EPO") and cancer drugs.
The service needs of office-based physicians and clinics differ markedly
from those of the hospital market, creating logistical challenges and
increasing administrative costs for those offices. Office-based physicians and
clinics generally order relatively small quantities of drugs at irregular
intervals and do not have inventory management systems or sufficient pharmacy
staffing. Challenges facing these caregivers include providing necessary
administrative and financial resources, managing relationships with multiple
suppliers, managing inventories, billing patients and third-party payors, and
monitoring new clinical developments. The Company believes that the shift from
hospital-based to office-based or home-based care delivery has created a
significant opportunity, particularly in the oncology, renal dialysis, vaccine
and homecare markets.
Oncology. According to the American Cancer Society, in 1996 approximately
1.3 million new cases of cancer were diagnosed and approximately 550,000 deaths
were attributed to cancer in the United States. The principal treatments for
cancer are surgery and a regimen of pharmaceutical treatments. Surgery
typically involves hospitalization, but radiation and chemotherapy are
increasingly being delivered in alternate site settings such as the physician
office and the home.
The National Cancer Institute estimates that direct medical costs for the
treatment of cancer in the United States totaled $35 billion in 1996. Frost &
Sullivan estimated the U.S. market for oncology pharmaceuticals to be
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$4.1 billion in 1996 and projected it to grow at a compound annual rate
of 13.2% from 1996 through 2003. The Company believes that the office-based
segment of the cancer pharmaceutical market represents approximately 25% of
such market and has been growing faster than the cancer pharmaceutical market.
Growth in the cancer pharmaceutical market is expected to be driven by the
continued introduction of new pharmaceuticals and increases in the
incidence of cancer. In 1995, over 200 drugs for cancer and cancer-related
conditions were in development and in 1996, 30 diagnostic or therapeutic
biopharmaceuticals (including biopharmaceuticals other than cancer
biopharmaceuticals) received FDA approval for marketing in the United States as
compared to the previous record number of eight in 1995. In addition, the
overall incidence of cancer is expected to increase as the average age of the
U.S. population continues to increase. According to the National Institutes of
Health ("NIH"), over 50% of all cancers are diagnosed in people age 65 or over.
Renal Dialysis. End stage renal disease is characterized by the
irreversible loss of kidney function and requires kidney transplantation or
routine dialysis treatment (either periodialysis or hemodialysis), which
involves removing waste products and excess fluids from the blood. According to
the Health Care Financing Administration ("HCFA"), as of December 31, 1995,
over 80% of dialysis patients were receiving hemodialysis in outpatient
treatment centers. Hemodialysis typically utilizes various specialty
pharmaceuticals and related medical supplies as part of the treatment.
Hemodialysis treatments usually last three hours and are performed three times
a week at over 3,000 outpatient facilities in the United States. According to
the HCFA, the number of patients in the United States that received renal
dialysis treatments grew from approximately 157,000 in 1992 to approximately
200,000 at the end of 1995, a compound annual growth rate of approximately 8%.
The medication most frequently prescribed to hemodialysis patients is EPO,
which stimulates the production of red blood cells, as well as Calcijex
(calcium), INFeD (iron), hepatitis vaccine and other nutrient compounds. The
Company estimates that in 1996 the United States market for EPO alone exceeded
$1 billion. Growth in this market is driven by the general aging of the
population, favorable reimbursement trends and proposed regulatory changes,
expansion of ancillary services, and increased managed care contracts.
Vaccine Market. The worldwide vaccine market currently exceeds $3 billion
annually, and is expected to grow to $7 billion by 2001, according to
SmithKline Beecham, one of the leading vaccine manufacturers. The Company
estimates that pediatric vaccines represent 40% of the world market, and
hepatitis vaccines represent over 20% of the world market.
The Omnibus Budget Reconciliation Act of 1993 created the Vaccines for
Children ("VFC") program, which was implemented on October 1, 1994. The VFC
program provides vaccines at no cost for children up to 18 years of age who are
Medicaid enrolled, have no health insurance or are native American Indian or
Alaskan. In addition, children who have health insurance that does not cover
immunizations are eligible if they receive vaccines at a Federally Qualified
Health Center or a Rural Health Clinic. Since most states have already
established contracts for VFC distribution, the Company intends to focus its
efforts initially on the estimated 40% of pediatric vaccines administered by
private practice physicians and on the adult vaccine market, particularly
hepatitis vaccines.
Growth in the vaccine market is expected to be driven by the growth of
combination pediatric vaccines, travelers' vaccines, vaccines for adolescent
protection, vaccines for the elderly and vaccines to treat chronic infectious
disease and cancer.
Infectious Disease. Priority operates in the infectious disease market,
principally through the sale of interferon for the treatment of hepatitis C.
NIH estimates that nearly four million Americans are infected with hepatitis C
and that approximately 30,000 new acute hepatitis C infections occur each year.
According to NIH, the incidence of hepatitis C infection appears to be
declining from its peak in 1989. However, because only 25% to 30% of new
hepatitis C infections are currently diagnosed, as estimated by NIH, the
Company believes the treated portion of this population is likely to increase
as awareness of hepatitis disease management programs increases. According to
NIH, hepatitis C is responsible for 8,000 to 10,000 deaths annually and is
currently the leading reason for liver transplantation in the United States.
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BUSINESS STRENGTHS
Priority believes the following represent the Company's business strengths
and have been the principal factors in the Company's business success to date.
Knowledgeable Sales, Marketing and Support Staff. The Company has a
well-trained, knowledgeable telemarketing and sales support staff of
approximately 35 full-time associates, with over five years of experience on
average. The Company's sales support staff and telemarketers are most
experienced in the areas of renal care and oncology. Priority holds frequent
meetings and training sessions with its suppliers to enable the sales and
support staff to be well-informed about current and new biopharmaceuticals. The
sales and support staff provides not only superior and knowledgeable customer
service, but also promotes the sale of new products.
Clinical Expertise. The Company provides disease treatment programs to
patients and physicians through its highly trained clinical staff of patient
care coordinators, pharmacists and nurses. These personnel are available for
ongoing consultation with the patient and the dispensing physician regarding
the patient's therapy and progress seven days a week, 24 hours a day. In order
to serve the specific needs of its customers, Priority operates two licensed
pharmacies, one of which has been accredited with commendation by the Joint
Commission on Accreditation of Healthcare Organizations ("JCAHO").
Broad Product Offerings to Targeted Markets. Priority sells over 3,500
SKUs of pharmaceuticals and medical supplies which enable the Company to
provide "one-stop shopping" to its customers. Priority targets its selling
efforts of this broad range of products and services to customers in alternate
site settings, such as office-based physicians and renal dialysis clinics. The
Company continually evaluates new products that it can add to its offerings to
continue to meet the needs of these specialized markets.
Commitment to Customer Service. The Company is committed to providing
superior customer service that includes shipping products ordered before 6 p.m.
for delivery the next day and filling 99% of its orders within one day of being
ordered. Priority's software enables its salespeople to quickly determine
product availability, pricing, customer order history and billing information.
In addition, Priority Pharmacy provides patient education, counseling and
follow-up with 24-hour on-call nurses to assist its patients in better
understanding and complying with their treatments.
Efficient Infrastructure. In the last two years, Priority has focused
considerable time and expense on building an infrastructure, including computer
systems and training, that would enable the Company to operate efficiently and
manage rapid growth. Management also focuses on tightly controlling expenses
and is constantly re-evaluating the efficiency of its operations, including
purchasing and distribution.
GROWTH STRATEGY
The Company's objective is to continue to grow rapidly and enhance its
market position as a leading specialty distributor by capitalizing on its
business strengths and pursuing the following strategy.
Continue to focus on and further penetrate the alternate site market. By
focusing on the alternate site market, the Company has targeted growth segments
of the health care industry. The Company intends to increase its alternate site
market presence by expanding its product and service offerings, increasing its
sales and marketing personnel and focusing on group accounts.
Enter new markets by distributing new product categories and
patient-specific biopharmaceuticals. The Company plans to selectively enter new
markets through new program offerings, such as its disease treatment programs
for melanoma and human growth hormone. In addition, by targeting chronic
disease therapies that require patient-specific, self-injectable
biopharmaceuticals, the Company continues to expand its markets.
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Accelerate growth of its higher margin, patient-specific pharmacy business
by leveraging relationships with existing distribution customers. The Company
has over 2,000 customers, including physicians focusing on renal care,
oncology, infectious disease and human growth hormone deficiency. The Company
believes that a number of physicians that order supplies from the Company also
treat patients who require patient-specific, self-injectable
biopharmaceuticals. The Company's information database identifies these
cross-selling opportunities, and Priority believes it is well-positioned to
capture incremental revenue from these customers.
Maintain intense cost control while investing in infrastructure. The
Company's goal is to remain a low cost provider of specialty distribution
products yet increase the value-added services it provides to customers
such as 24-hour on-call nurse support, patient counseling, specialized shipping
and software to its larger customers. The Company's selling, general and
administrative expense was only 4.6% of revenues in 1997 even as the Company
continued to invest in its infrastructure.
Pursue acquisitions to complement existing product offerings or further
penetrate markets. The Company believes that the highly fragmented specialty
distribution industry affords it an opportunity to grow through selective
acquisitions. By acquiring complementary businesses, the Company can increase
its customer base, expand its product and geographic scope and leverage its
existing infrastructure. For example, the acquisition of Grove Way Pharmacy has
enabled the Company to target the distribution of vaccines into the alternate
site market.
PRODUCTS AND SERVICES
Priority Distribution. Priority Distribution provides a broad range of
services and supplies to meet the needs of the alternate site market, including
the outpatient renal care market, office-based oncology market and other
physician office specialty markets such as infectious disease. Priority
Distribution offers value-added services to meet the specialized needs of these
markets by shipping refrigerated pharmaceuticals overnight in special packaging
to maintain appropriate temperatures and offering automated order entry
services and customized group account distribution. Priority Distribution
distributes its products from distribution centers in Altamonte Springs,
Florida, Santa Ana, California and Grove City, Ohio. The Company sells over
3,500 SKUs of pharmaceuticals such as EPO, Calcijex and INFeD and related
medical supplies such as dialyzers, blood tubing, fistula needles, IV sets,
transducers, tape and sponges. During 1997, approximately 29% of the Company's
revenues were attributable to sales of EPO to the renal care market. EPO for
the renal care market is available from only one manufacturer, Amgen. Priority
Distribution services over 2,000 customers located in all 50 states and Puerto
Rico, including approximately 550 office-based oncologists and 800 renal
dialysis clinics.
Priority believes its knowledgeable salesforce provides a competitive
advantage when selling into the alternate site market. Since a majority of
customer orders are placed by telephone, the Company offers its customers a
toll-free telephone number and fax line and is beginning to use electronic data
interchange ("EDI") ordering capability to accept electronically transmitted
orders. Orders typically are received by the Company's telemarketing sales and
service personnel who use PC-based computer systems to enter customer orders,
and to access product information, product availability, pricing, promotions
and the customer's buying or referral history. As part of the Company's
commitment to superior customer service, the Company offers its customers ease
of order placement. Once an order is received, it is electronically sent to the
appropriate distribution center where it is filled and shipped. The Company
estimates that approximately 98% of all items are shipped without back
ordering, and that 99% of all orders received before 6 p.m. are shipped
on the same day that the order is received. See "--Sales and Marketing."
Priority Distribution has licensed comprehensive catalog ordering and
inventory management software from a national software company. The license
allows Priority Distribution to use the software in the Company's facilities
and to place the software in customer offices. Priority has already placed this
software on the systems of 13 customers. This software allows a customer to
determine product availability and transmit orders via EDI directly to the
Company's computers, which the Company believes should increase ordering
efficiencies and accuracy. Management intends to customize the software to
further enhance its value to its customers and its own operations. The Company
believes that the installation of these information systems within customers'
facilities should, over time, solidify Priority Distribution's long-term
relationship with its customers.
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Priority Pharmacy. Priority Pharmacy provides patient-specific,
self-injectable biopharmaceuticals and related disease treatment programs to
individuals with chronic diseases. Through two licensed pharmacies in Altamonte
Springs, Florida, Priority Pharmacy fills patient-specific prescriptions by
reconstituting the biopharmaceuticals into syringes and shipping them via
overnight delivery in special shipping containers to maintain appropriate
temperatures. These services are provided in combination with the Company's
disease treatment programs, through which the Company's pharmacy and nursing
staff provide education, counseling and other services to patients. Management
is not aware of any other provider that offers the same services as Priority
Pharmacy on a nationwide basis.
Priority Pharmacy currently provides disease treatment programs for
various diseases, including hepatitis and cancer, with biopharmaceuticals that
primarily consist of Interferon, a synthetic biopharmaceutical used to treat
hepatitis B and C, Octreotide, a synthetic hormone used to treat diarrhea
associated with intestinal peptide tumors, and Epoetin Alfa, a synthetic
biopharmaceutical used to treat anemia. Priority Pharmacy also recently began
dispensing Filgrastin, Saragramostin and human growth hormone and continues to
evaluate adding more products.
The disease treatment programs provided by the Company offer a number of
advantages to patients, physicians, third-party payors and drug manufacturers.
The advantages include: (i) increasing patient compliance with the recommended
therapy, thereby avoiding more costly future treatments; (ii) facilitating
patient education required to prepare and administer the products; (iii)
reducing the potential for patient errors in dosing or wastage of product; (iv)
decreasing patient or caregiver anxiety; (v) reducing the overall cost of
delivery; and (vi) collecting better outcomes data.
The Company's telemarketing efforts focus on marketing to physician
offices where new patient referrals occur. Upon referral, patients are
contacted via telephone by the Company's intake nurses who explain the program
and provide education on self-injection techniques, side effects and
potential drug interactions. Following the initial prescription delivery,
patients are contacted by patient care coordinators who assess patient
compliance and progress, inquire regarding any potential side effects, arrange
the next scheduled prescription delivery, verify the shipping address, listen
to patient concerns and direct questions to the Company's clinical staff. The
Company's pharmacists and registered nurses are available for ongoing
consultation with the patient and the dispensing physician regarding the
patient's therapy and progress seven days a week, 24 hours a day.
All parenteral, or injectable, prescriptions are prepared in sterile
conditions under class 100 laminar flow hoods. Licensed pharmacists verify the
prescription with the prescribing physician and recheck the prescription before
shipping. In order to ensure the safe delivery of prescriptions to the patient,
the Company telephones the patient several days before shipping to confirm that
the patient or another person will be at home to receive the package
immediately upon delivery. In addition, the Company requires the overnight
delivery service to obtain a signed receipt before leaving the drugs at a
residence.
In order to respond to the specific needs of its customers, Priority
Pharmacy maintains two licensed pharmacies. One pharmacy is accredited with
commendation by JCAHO. The JCAHO pharmacy responds to the needs of customers
and payors that require JCAHO-accredited services. The Company's IV-1, Inc.
nursing program is also accredited with commendation by JCAHO. The Company's
pharmacy and nursing programs maintain a planned and systematic Quality
Assessment and Quality Improvement ("QAQI") Program, which provides a means for
monitoring and evaluating the care and services provided to patients. Through
the QAQI Program, the Company strives to promote continuous quality
improvement. A multi-departmental QAQI Committee meets quarterly and is
responsible for the collection and review of quality data, which it presents on
a quarterly basis to the Company's Clinical Advisory Board and on an annual
basis to the Company's Chief Executive Officer.
Year 2000 Compliance. The Company is in the process of conducting a
thorough review of its computer systems to identify and address all code
changes, testing, and implementation procedures necessary to make its systems
year 2000 compliant. The Company presently believes that with modifications to
existing software, the year 2000 problem will pose no significant operational
problems for the Company's computer systems as so modified and converted, and
the Company expects to be fully compliant by the end of fiscal 1998. There
can be no
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assurance, however, that the systems of other companies with which
the Company transacts business will be updated or converted in a timely manner,
or that such failure will not have a material adverse effect on the Company's
operations. The Company estimates that during fiscal 1998 the cost of this
project, which includes the cost of updating non-compliant code, will be
immaterial to the Company's results of operations and cash flows.
SALES AND MARKETING
The Company employs approximately 35 full-time telemarketing and sales
support staff personnel with an average of five years of experience. The
Company strives to generate new customers and solidify existing customer
relationships through frequent direct marketing contact that emphasizes the
Company's broad product lines in specialty markets, competitive prices,
responsive service and ease of order placement. The Company telemarkets to
dialysis centers, oncology clinics and physician offices. The Company also has
five key account managers who target larger customers. The Company also links
the Priority Distribution and Priority Pharmacy databases to facilitate
cross-selling efforts between the two divisions. The Company believes that
there is a significant opportunity to provide its specialty pharmacy services
to patients of physicians that currently order supplies from Priority
Distribution.
The Company's sales personnel service both in-bound and out-bound calls
and are responsible for assisting customers in purchasing decisions, answering
questions and placing orders. Sales personnel also initiate out-bound calls to
market the Company's services to those customer accounts identified by the
Company as being high volume accounts, high order frequency accounts or
cross-selling opportunity accounts. The Company's sales personnel use PC-based
computer systems to enter customer orders and to access information about
products, product availability, pricing, promotions and customer buying and
referral history. All telemarketing sales personnel work to establish long-term
relationships with the Company's customers through regularly scheduled phone
contact and personalized service.
The Company's five key account managers work with selected large accounts
to develop customized distribution programs. The key account managers are
equipped with laptop computers and software to facilitate sales presentations,
customer communications and proposals, and, through synchronization software,
on-line changes with customer accounts.
Training for sales personnel is provided on a regular basis through
in-service meetings, seminars and field training and is supported by print and
video materials. Initial and ongoing training focuses on industry and product
information, selling skills, ethics and compliance requirements and computer
software skills. The Company believes that its investment in training is
critical to establishing its competitive position in the marketplace.
CUSTOMERS
Priority Distribution serves over 2,000 customers located in all 50 states
and Puerto Rico, including approximately 550 office-based oncologists and 800
renal dialysis clinics. Priority Pharmacy serves approximately 1,400 patients
nationwide.
During 1997, the Company's largest 20 customers accounted for
approximately 29% of the Company's revenues and one customer, Everest
Healthcare Services Corporation, accounted for 11% of the Company's revenues.
Significant declines in the level of purchases by one or more of the Company's
largest customers could have a material adverse effect on the Company's
business and results of operations. As is customary in its industry, the
Company generally does not have long-term contracts with its customers.
Management believes that the retention rate for the Company's customers is very
favorable. Although the Company has not to date experienced any failure to
collect accounts receivable from its largest customers, an adverse change in
the financial condition of any of these customers, including an adverse change
as a result of a change in governmental or private reimbursement programs,
could have a material adverse effect on the Company.
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PURCHASING
Management believes that effective purchasing is key to both profitability
and maintaining market share. In 1995, 1996 and 1997, the Company's single
largest supplier, Amgen, accounted for approximately 44%, 42% and 40%,
respectively, of the Company's revenues. The Company's purchases from Amgen are
currently guaranteed by BWI, and there can be no assurance that the Company, as
a stand-alone entity, will be able to purchase products from Amgen on terms as
favorable. The Company continually evaluates its purchase requirements and
likely increases in manufacturer prices in order to obtain products at the most
advantageous cost. It has negotiated several partnership relationships with
manufacturers that offer favorable pricing, volume-based incentives and
opportunities to reduce supply chain costs for both parties.
COMPETITION
The alternate site specialty pharmaceutical and medical supply industry is
highly competitive and is experiencing both horizontal and vertical
consolidation. The industry is fragmented, with many public and private
companies focusing on different product or customer niches. Some of the
Company's current and potential competitors include regional and national
full-line, full-service medical supply distributors; independent speciality
distributors; national full-line, full-service wholesale drug distributors,
such as Bergen Brunswig Corporation and Cardinal Health, Inc., that operate
their own specialty distribution businesses; institutional pharmacies;
hospital-based pharmacies; home healthcare agencies; mail order distributors
that distribute medical supplies on a regional or national basis; and certain
manufacturers, such as Bristol-Myers Squibb, that own distributors or that sell
their products both to distributors and directly to users, including clinics
and physician offices. Some of the Company's competitors have greater
financial, technical, marketing and managerial resources than the Company.
While competition is primarily price and service oriented, it can also be
affected by depth of product line, technical support systems, specific patient
requirements and reputation. There can be no assurance that competitive
pressures will not have a material adverse effect on the Company.
GOVERNMENT REGULATION
As a provider of healthcare services and products, the Company is subject
to extensive regulation by federal, state and local government agencies.
Licensing. The Company is required to register with the United States Drug
Enforcement Administration ("DEA"), the Food and Drug Administration ("FDA"),
and appropriate state agencies for various permits and/or licenses, and it also
must comply with the operating and security standards of such agencies. The
Company's Grove City, Altamonte Springs and Santa Ana distribution centers are
licensed to distribute pharmaceuticals in accordance with the Prescription Drug
Marketing Act of 1987. The Altamonte Springs location is also licensed to
distribute or dispense certain controlled substances in accordance with the
requirements of the Controlled Substances Act of 1970. Similarly, the Company's
pharmacy program and provider businesses are subject to licensing by the DEA as
well as by the state boards of pharmacy, state health departments, and other
state agencies where they operate. The Company also has one subsidiary that is
licensed as a home health agency.
On November 14, 1995, an investigator for the FDA, accompanied by an
inspector from the State of Florida Board of Pharmacy, inspected the Company's
pharmacy in Altamonte Springs, Florida. At the end of the inspection, the FDA
investigator issued an FDA Form-483, which is the form used by FDA
investigators to identify any observed or suspected noncompliance with the laws
administered by the agency. The FDA Form-483 identified the facility as a
pharmacy/repackager and listed three observations related to certain
requirements that the FDA typically imposes on manufacturers of sterile
products. The Company advised the FDA in December 1995 that the Company
believes it is not, within the statutory or regulatory meaning of these terms,
a repackager or a manufacturer. A second inspection of the same facility
occurred on June 26, 1997, in which the FDA investigator was again accompanied
by Florida pharmacy authorities. The FDA investigator issued a substantially
identical FDA
9
<PAGE> 10
Form-483 at the end of that inspection. The Florida State Board
of Pharmacy did not issue any deficiencies regarding the operations of the
Altamonte Springs pharmacy in either of these inspections.
On March 16, 1992, the FDA issued a Compliance Policy Guide (CPG 460.200),
which explains the criteria the FDA uses to distinguish between pharmacy
operations that are properly regulated under state law and drug manufacturing
regulated by the FDA. The Company's response to the FDA in December 1995 cited
this CPG and explained the Company's contention that, according to the FDA's
own criteria, the Altamonte Springs pharmacy is properly regulated under state
and local laws.
On November 21, 1997, the President signed into law the FDA Modernization
Act of 1997, which, among a number of other items, adds a new section on
pharmacy compounding to the Federal Food, Drug and Cosmetic Act. In this
provision, Congress clarified a gray area by explicitly identifying the
circumstances in which pharmacies may compound drugs without the need for
filing a New Drug Application, observing the FDA's Good Manufacturing Practice
regulations or complying with certain other specific Federal Food, Drug and
Cosmetic Act requirements. Congress provided that the term "compounding" does
not include mixing or reconstituting that is done in accordance with directions
contained in approved labeling provided by the manufacturer of the product.
The Company believes that, as a result of this amendment, so long as it follows
the manufacturer's approved labeling in each case, and prepares drugs only for
identified individual patients using licensed practitioners, the Company's
activities should be regulated by the Florida State Board of Pharmacy and not
be subjected by the FDA to a full New Drug Application requirement
demonstrating the basic safety and effectiveness of the drugs.
If the Company is correct and its operations are limited to those engaged
in by pharmacies, there should be no material adverse effect from the FDA
Form-483s because the Company believes it is currently in compliance in all
material respects with applicable state and local laws. If the Company is
deemed to be a sterile product manufacturer or a sterile product repackager, it
would be subject to additional regulatory requirements. If for some reason the
FDA or other legal authorities decide that the Company must file for approval
of a New Drug Application, such an event could have a material adverse effect
on the Company.
There can be no assurance that future legislation, future rulemaking, or
active enforcement by the FDA of a determination that the Company is a drug
manufacturer will not have a material adverse effect on the business of the
Company.
The State of Florida Board of Pharmacy regulates the compounding
activities of Florida pharmacies, including certain activities of the Company.
The Company has obtained a Community/Special Parenteral/Enteral Compounding
Pharmacy Permit. Over the past several years, the Florida Board of Pharmacy has
proposed certain changes to its compounding requirements. The Company believes
that it is in compliance with such current requirements, but there can be no
assurance that other conditions or requirements would not be imposed in the
future that would have a material adverse effect on the Company.
Referral Restrictions. The Company is subject to federal and state laws
which govern financial and other arrangements between healthcare providers.
These laws include the federal anti-kickback statute, which was originally
enacted in 1977 and amended in 1987, and which prohibits, among other things,
knowingly and willfully soliciting, receiving, offering or paying any
remuneration directly or indirectly in return for or to induce the referral of
an individual to a person for the furnishing of any item or service for which
payment may be made in whole or in part under Medicare or Medicaid.
Many states have enacted similar statutes which are not necessarily limited to
items and services for which payment is made by Medicare or Medicaid.
Violations of these laws may result in fines, imprisonment and exclusion from
the Medicare and Medicaid programs or other state-funded programs. Federal and
state court decisions interpreting these statutes are limited, but have
generally construed the statutes to apply if "one purpose" of remuneration is
to induce referrals or other conduct within the statute.
In July 1991 and November 1992, in part to address concerns regarding the
anti-kickback statute, the federal government published regulations that
provide exceptions, or "safe harbors," for transactions that will be deemed not
to violate the anti-kickback statute. Proposed regulations to clarify these
safe harbors and to provide additional safe harbors were published in July 1994
and in September 1995, respectively. Final regulations have not
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<PAGE> 11
yet been published. Although the Company believes that it is not in
violation of the anti-kickback statute, its operations do not fit within any of
the existing or proposed safe harbors. Until recently, there were no procedures
for obtaining binding interpretations or advisory opinions from the Health and
Human Services Office of the Inspector General ("OIG") on the application of
the federal anti-kickback statute to an arrangement or its qualification for a
safe harbor upon which the Company can rely. However, the Health Insurance
Portability and Accountability Act of 1996 requires the Secretary of Health and
Human Services to issue written advisory opinions regarding the applicability
of certain aspects of the anti-kickback statute to specific arrangements or
proposed arrangements. Advisory opinions will be binding as to the Secretary
and the party requesting the opinion.
The OIG has issued "Fraud Alerts" identifying certain questionable
arrangements and practices which it believes may implicate the federal
anti-kickback statute. The OIG has issued a Fraud Alert providing its views on
certain joint venture and contractual arrangements between healthcare
providers. The OIG recently has issued a Fraud Alert concerning prescription
drug marketing practices that could potentially violate the federal
anti-kickback statute. Pharmaceutical marketing activities may implicate the
federal anti-kickback statute because drugs are often reimbursed under the
Medicaid program. According to the Fraud Alert, examples of practices that may
implicate the statute include certain arrangements under which remuneration is
made to pharmacists to recommend the use of a particular pharmaceutical
product. In addition, a number of states have recently undertaken enforcement
actions against pharmaceutical manufacturers involving pharmaceutical marketing
programs, including programs containing incentives to pharmacists to dispense
one particular product rather than another. These enforcement actions arise
under state consumer protection laws which generally prohibit false
advertising, deceptive trade practices and the like. Further, a number of the
states involved in these enforcement actions have requested that the FDA
exercise greater regulatory oversight in the area of pharmaceutical promotional
activities by pharmacists. It is not possible to determine whether the FDA will
act in this regard or what effect, if any, FDA involvement would have on the
Company's operations.
Significant prohibitions against physician referrals were enacted by
Congress in 1993. These prohibitions, commonly known as "Stark II," amended
prior physician self-referral legislation known as "Stark I" by dramatically
enlarging the field of physician-owned or physician-interested entities to
which the referral prohibitions apply. Effective on January 1, 1995, Stark II
prohibits a physician from referring Medicare or Medicaid patients to an entity
providing "designated health services" in which the physician has an ownership
or investment interest, or with which the physician has entered into a
compensation arrangement. Stark II also prohibits the entity from billing the
government for services rendered pursuant to a prohibited referral. The
designated health services include clinical laboratory services, radiology
services, radiation therapy services and supplies, physical and occupational
therapy services, durable medical equipment and supplies, parenteral and
enteral nutrients, equipment, and supplies, prosthetic devices, orthotics and
prosthetics, outpatient prescription drugs, home health services, and inpatient
and outpatient hospital services. The penalties for violating Stark II include
a prohibition on payment by these government programs, civil penalties of as
much as $15,000 for each violative referral and $100,000 for participation in a
"circumvention scheme," and exclusion from further participation in Medicare or
Medicaid.
Federal regulatory and law enforcement authorities have recently increased
enforcement activities with respect to Medicare and Medicaid fraud and abuse
regulations and other reimbursement laws and rules, including laws and
regulations that govern the activities of many of the Company's customers.
There can be no assurance that increased enforcement activities will not
indirectly have a material adverse effect on the Company.
Other Regulatory Issues. Certain states have adopted, or are considering
adopting, restrictions similar to those contained in the federal anti-kickback
and physician self-referral laws. Although the Company believes that its
operations do not violate applicable state laws, there can be no assurance that
state regulatory authorities will not challenge the Company's activities under
such laws or challenge the dispensing of patient-specific, self-injectable
biopharmaceuticals by the Company as being subject to state laws regulating
out-of-state pharmacies.
The Company believes that its pharmacy practices and its contract
arrangements with other healthcare providers and pharmaceutical suppliers are
in compliance with these laws. To address the risks presented by such laws, the
Company has appointed an employee trained as a lawyer as Vice President of
Administration, arranged for compliance reviews conducted by outside advisors,
and implemented an ethics and corporate compliance program.
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<PAGE> 12
There can be no assurance that such laws will not, however, be interpreted in
the future in a manner inconsistent with the Company's interpretation and
application.
REIMBURSEMENT
A substantial portion of the sales of Priority Pharmacy is derived from
third-party payors, including private insurers and managed care organizations
such as HMOs and PPOs. Similar to other medical service providers, the Company
experiences lengthy reimbursement collection periods as a result of third party
payment procedures. Consequently, management of accounts receivable through
effective patient registration, billing, collection and reimbursement
procedures is critical to financial success.
Private payors typically reimburse a higher amount for a given service and
provide a broader range of benefits than governmental payors, although net
revenue and gross profits from private payors have been affected by the
continuing efforts to contain or reduce the costs of healthcare. A portion of
the Company's revenue has been derived in recent years from agreements with
HMOs, PPOs and other managed care providers. Although these agreements often
provide for negotiated reimbursement at reduced rates, they generally result in
lower bad debts, provide for faster payment terms and provide opportunities to
generate greater volumes than traditional indemnity referrals.
In 1997, reimbursement from Medicare and Medicaid accounted for less than
1% of the Company's revenues. Nevertheless, due to the reliance of office-based
oncologists and renal dialysis clinics on Medicare and Medicaid reimbursement,
changes in such governmental programs could have a material effect on the
Company's financial condition and results of operations.
In 1997, HCFA adopted new reimbursement guidelines, which prohibit
Medicare reimbursement for EPO furnished to a patient having an hematocrit
level exceeding 36.5% based on a 90 day rolling average basis. Previously,
Medicare policy provided for payment for EPO for hematocrit levels exceeding
such level if supported by medical documentation. This change in Medicare
reimbursement policy has had an adverse effect on the sales of EPO by the
Company. However, HCFA recently announced that effective March 10, 1998, it
would allow reimbursement for patients with higher than the specified
hematocrit level based on medical justification. The Company is unable to
predict what effect this change will have on sales of EPO by the Company in the
future.
Because the Medicare program represents a substantial portion of the
federal budget, Congress takes action in almost every legislative session to
modify the Medicare program for the purpose of reducing the amounts otherwise
payable from the program to healthcare providers. Legislation or regulations
may be enacted in the future that may significantly modify the end stage renal
dialysis program or substantially reduce the amount paid for dialysis or
oncology treatments. Further, statutes or regulations may be adopted which
impose additional requirements in order for the Company's customers to be
eligible to participate in the federal and state payment programs. Such new
legislation or regulations could adversely affect the Company's business
operations.
Additionally, the Budget Act, which was enacted in August 1997, contained
numerous provisions related to Medicare and Medicaid reimbursement. Although
many of the details will not be solidified for the next one to six years, the
general thrust of the provisions dealing with Medicare and Medicaid
contained in the Budget Act is intended to provide incentives to providers to
deliver services at lower costs. The Budget Act contains changes to
reimbursement rates for certain Medicare and Medicaid covered services, as well
as certain limitations on the coverage of such services. Although less than 1%
of the Company's revenues in 1997 were derived from Medicare and Medicaid
reimbursement, the Budget Act may affect the Company's suppliers and customers,
which in turn could have an adverse effect on the Company.
In addition, the Company expects that private payors will continue their
efforts to contain or reduce healthcare costs through reductions in
reimbursement rates or other cost-containment measures. The continuation of
such efforts could have a material adverse effect on the Company's financial
condition and results of operations.
12
<PAGE> 13
EMPLOYEES
At December 31, 1997, the Company had approximately 135 full-time
equivalent employees. None of the Company's employees is currently represented
by a labor union or other labor organization. Approximately 7% of the employees
are pharmacists or nurses. The Company believes that its relationship with its
employees is good.
ITEM 2. PROPERTIES.
The Company's headquarters are located in Altamonte Springs, Florida, and
consist of approximately 14,800 square feet of office space and an 18,000
square foot distribution center and pharmacies leased through December 1999.
Priority Distribution has an 11,900 square foot distribution center in Santa
Ana, California, which was leased through February 1998. The Company is
continuing to rent the existing location on a month to month basis until it
leases a new distribution center in the same vicinity. Priority Distribution
also has a 36,000 square foot distribution center in Grove City, Ohio, which is
leased through July 2002.
The Company's distribution centers have been constructed or adapted to the
Company's specifications for climate control, alarm systems and, where
required, segregated security areas for controlled substances.
The Company intends to expand its distribution capabilities to further
enhance service and provide for continued growth. The Company began
distributing medical supplies from its newly-leased facility in Grove City,
Ohio during the last quarter of 1997 and began distributing pharmaceuticals
from there in early 1998. By locating closer to a large share of its current
customers and potential new customers, the Company believes that it can lower
distribution costs, while increasing its appeal to certain national and
regional customers. Overall, the Company believes that its facilities are
suitable and adequate for its current needs, and for projected internal growth
through at least 1999.
ITEM 3. LEGAL PROCEEDINGS.
IV-1, Inc. ("IV-1") and IV-One Services, Inc. ("IV-One Services") have
been named as defendants in a second amended counterclaim filed by Amgen, Inc.
("Amgen") on May 14, 1996, in the Circuit Court of the Eighteenth Judicial
District of Seminole County, Florida. Amgen has asserted that these entities
tortiously interfered with a license agreement (the "License Agreement")
between Amgen and Ortho Pharmaceutical Corporation ("Ortho"). Pursuant to this
agreement, Amgen licensed Ortho to sell EPO for use in the treatment of
non-dialysis patients, while Amgen reserved the exclusive right to sell EPO for
use in the treatment of dialysis patients. Amgen has asserted that, prior to
the purchase of IV-1 and IV-One Services by the Company, these entities induced
Ortho to sell EPO to them for resale in the dialysis market in contravention of
the License Agreement. Amgen has also alleged that IV-1 and IV-One Services
were involved in a civil conspiracy to circumvent the terms of the License
Agreement to allow the resale of EPO to the dialysis market. Furthermore, Amgen
has asserted unfair competition claims against IV-1, including that IV-1
manufactured and distributed unapproved prefilled syringes of EPO and another
product manufactured by Amgen in container systems unapproved by Amgen. Amgen
did not specify a time frame for the acts complained of in the civil conspiracy
and unfair competition allegations. In each count, Amgen has demanded an
unspecified amount of compensatory damages, including costs and interest.
The Company believes that the sellers of IV-1, IV-One Services and Charise
Charles are contractually obligated to provide legal defense and to indemnify
the Company for losses and liabilities with respect to this litigation, to the
extent that the alleged acts occurred prior to the purchase of such entities by
the Company. To date, the sellers have provided the legal defense for IV-1 and
IV-One Services in the litigation. Indemnification from the sellers of IV-1 and
IV-One Services is limited to no more than $1.5 million and indemnification
from the sellers of Charise Charles is limited to no more than $2.0 million. As
of January 31, 1998, approximately $111,000 of claims for indemnification had
been submitted to the sellers. The Company does not expect the Amgen
litigation to be material to the Company's results of operations, financial
condition or cash flows; however, no assurance can be given that this
litigation will not have a material adverse effect on the Company. In addition,
Amgen is the
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<PAGE> 14
Company's largest supplier. Consequently, this litigation presents
the risk of adversely affecting the Company's business relationship with Amgen,
which could have a material adverse effect on the Company.
The Company is also subject to ordinary and routine litigation incidental
to its business, none of which is material to the Company's results of
operations, financial condition or cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company did not submit any matters to a vote of security holders
during the fourth quarter of 1997.
EXECUTIVE OFFICERS OF THE COMPANY
Name Age Position
----------- --- ----------------------------------------------------
Willliam E. Bindley 57 Chairman of the Board
Robert L. Myers 52 President, Chief Executive Officer and Director
Guy F. Bryant 39 Executive Vice President--Priority Healthcare
Distribution
Steven D. Cosler 42 Executive Vice President--Priority Pharmacy
Services
Donald J. Perfetto 51 Vice President, Chief Financial Officer and
Treasurer
Melissa E. McIntyre 37 Vice President--Clinical Services
Barbara J. Luttrell 57 Vice President--Administration
William M. Woodard 39 Vice President--Marketing
William E. Bindley is the Chairman of the Board, Chief Executive
Officer and President of BWI, positions he has held since founding BWI in 1968.
He is also a director of BWI and Shoe Carnival, Inc., a shoe retailer. Mr.
Bindley was the Chief Executive Officer of the Company from July 1994 until May
1997 and the President of the Company from May 1996 until July 1996. He has
served as a director of the Company since June 1994.
Robert L. Myers has been the President of the Company since July 1996 and
the Chief Executive Officer of the Company since May 1997. From July 1996 to
May 1997, he was the Chief Operating Officer of the Company. From June 1995
through June 1996, Mr. Myers was a consultant to the healthcare industry. From
1971 to June 1995, he was employed by Eckerd Corporation, a retail drug store
chain, where he served as a corporate officer from 1981 through 1995 and as
senior vice president of pharmacy from 1990 to 1995. Mr. Myers has served as a
director of the Company since May 1997. Mr. Myers is a registered pharmacist.
Guy F. Bryant serves as the Executive Vice President--Priority Healthcare
Distribution, a position that he has held since September 1995. Prior to
joining the Company, he was employed in sales management positions by Major
Pharmaceuticals, a distributor of generic pharmaceuticals, since September 1992
and was vice president of sales from August 1994 to August 1995.
Steven D. Cosler became Executive Vice President--Priority Pharmacy
Services of the Company in August 1997. Prior to that time and since July 1996,
he was Senior Vice President and General Manager of Priority
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<PAGE> 15
Healthcare Services Corporation, a subsidiary of BWI. From January 1992
to June 1996, he was senior vice president of sales and operations for
Coresource, a managed care and third party administrator.
Donald J. Perfetto has been the Vice President, Chief Financial Officer
and Treasurer of the Company since June 1997. From 1986 to May 1997, he was
employed by Bimeco, Inc., a distributor of medical products. During such time,
Mr. Perfetto held the positions of vice president of finance and operations and
secretary/treasurer of Bimeco, Inc.
Melissa E. McIntyre, RN, OCN, is the Vice President--Clinical Services of
the Company, a position that she has held since August 1997. She has also been
President and Chief Operating Officer of IV-1, IV-One Services and National
Pharmacy Providers, Inc. ("NPP"), subsidiaries of the Company since February
1995 and was Director of Clinical Services of IV-1 from June 1994 to January
1995. Prior to joining the Company, and since June 1991, she was employed by
Intracare, an outpatient infusion center, as clinical director of nursing.
Barbara J. Luttrell is the Vice President--Administration of the Company,
a position she has held since May 1997. Prior to joining the Company in January
1997, she was employed by Physician's Alliance, a physician group, as director
of human resources since September 1996. She attended law school from
May 1993 to December 1995 and practiced as an attorney from May 1996 to
September 1996. From December 1995 to May 1996, Ms. Luttrell prepared for the
bar examination. From July 1992 to February 1993, she was a human resources
consultant employed by Infusion Therapy, Inc. Ms. Luttrell has 15 years of
experience in human resource management.
William M. Woodard is the Vice President--Marketing of the Company, a
position that he has held since May 1997. From February 1995 to May 1997, he
was Executive Vice President of Sales of IV-1, IV-One Services and NPP; from
July 1994 to February 1995, he was President of NPP; and from April 1993 to
February 1995, he was President of IV-1. From March 1990 until April 1993, Mr.
Woodard was a sales representative for Tri State Hospital Supply, a distributor
of medical supplies.
The above information includes business experience during the past five
years for each of the Company's executive officers. Executive officers of the
Company serve at the discretion of the Board of Directors. There is no family
relationship between any of the Directors or executive officers of the Company.
(Pursuant to General Instruction G(3) of Form 10-K, the foregoing
information regarding executive officers is included as an unnumbered Item in
Part I of this Annual Report in lieu of being included in the Company's Proxy
Statement for its 1998 Annual Meeting of Shareholders.)
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<PAGE> 16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICES
The Company's Class B Common Stock is traded on the Nasdaq Stock Market's
National Market under the symbol PHCC. Prior to October 24, 1997, there was no
public market for the Class B Common Stock. The prices set forth below reflect
the high and low sales quotations for the Company's Class B Common Stock as
reported by Nasdaq for the calendar period indicated, commencing on October 24,
1997. As of March 20, 1998, there were 30 holders of record and approximately
1,500 beneficial owners of the Company's Class B Common Stock.
Calendar 1997
High Low
-------------------
Fourth Quarter (From October 24, 1997) $ 16.50 $ 14.00
The Company's Class A Common Stock has no established public trading
market. All outstanding shares of the Company's Class A Common Stock are held
by BWI.
DIVIDENDS
The Company does not intend to pay cash dividends on its Common Stock in
the foreseeable future, but rather intends to use future earnings principally
to support operations and to finance expansion and possible acquisitions. The
payment of cash dividends in the future will be at the discretion of the
Company's Board of Directors and will depend on a number of factors, including
the Company's financial condition, capital requirements, future business
prospects, the terms of any documents governing indebtedness of the Company,
and such other factors as the Board of Directors of the Company may deem
relevant. Subject to the terms of any preferred stock created by the Company's
Board of Directors, each outstanding share of Common Stock will be entitled
equally to such dividends as may be declared from time to time by the Board of
Directors.
On March 31, 1997, the Company paid a dividend in the form of a
subordinated promissory note (the "Dividend Note") with a principal amount of
$6.0 million to BWI to return to BWI a portion of its equity investment in the
Company. The Dividend Note bears interest at the rate of 7.25% per annum.
Interest on the Dividend Note must be paid by the Company on a quarterly basis,
with the principal amount due in a single payment on March 31, 1999.
SALES OF UNREGISTERED SECURITIES
The following information is furnished as to securities of the Company
sold during 1997 that were not registered under the Securities Act of 1933, as
amended (the "Securities Act"). All of the information is adjusted for the
recapitalization of all of the Company's 1,000 shares of outstanding Common
Stock into 10,214,286 shares of Class A Common Stock on August 25, 1997.
(a) On March 31, 1997, the Company paid a dividend in the form of a
subordinated promissory note with a principal amount of $6.0 million to BWI.
(b) On August 25, 1997, the Company completed a recapitalization, whereby
all of the Company's 1,000 outstanding shares of Common Stock were converted
into 10,214,286 shares of Class A Common Stock.
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<PAGE> 17
(c) On August 25, 1997, the Company granted options for an aggregate of
455,050 shares of Class B Common Stock to certain officers, key employees and
consultants, effective on the closing of the initial public offering, at an
exercise price equal to 100% of the initial public offering price.
(d) On October 29, 1997, the Company issued 922 shares of Class B
Common Stock to its two non-employee Directors as the stock portion of their
annual retainer.
(e) On December 16, 1997, the Company granted options for an aggregate
of 18,000 shares of Class B Common Stock to key employees at an exercise price
of $15.00 per share.
The transactions described in paragraphs (c), (d) and (e) above are exempt
from the registration requirements of the Securities Act pursuant to Section
4(2) thereof. The transactions described in paragraphs (a) and (b) above are
exempt from the registration requirements of the Securities Act because they
did not involve a "sale" of a security within the meaning of Section 2(3) of
the Securities Act.
USE OF PROCEEDS
The Company's Registration Statement on Form S-1 (File No. 333-34463) was
declared effective on October 23, 1997. The Company registered 2,300,000
shares of Class B Common Stock, all of which were sold in a firm commitment
underwriting at an aggregate offering price to the public of $33,350,000.
After the underwriters' discount of $2,334,500, the Company received proceeds
aggregating $31,015,500 before expenses of the Offering.
Through March 13, 1998, the aggregate amount of expenses incurred for the
Company's account in connection with the issuance and distribution of its Class
B Common Stock was $1,048,000. Included in the offering expenses is $156,000
that was paid to BWI for services provided by BWI to facilitate the marketing
and sale of the Offering. None of the other expenses were direct or indirect
payments to affiliates.
The net offering proceeds to the Company, after deducting the
underwriters' discount and offering expenses, was $30.0 million. As of March
13, 1998, $16.7 million of the net offering proceeds have been used to repay
indebtedness to BWI, $11.2 million has been advanced to BWI and the balance of
the net offering proceeds has been invested in interest bearing investment
grade securities.
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<PAGE> 18
ITEM 6. SELECTED FINANCIAL DATA.
Effective February 28, 1993, BWI acquired substantially all of the assets
of Charise Charles, Ltd., Inc. During the periods presented, five acquisitions
were made by or on behalf of the Company. See "Item 1. Business - Acquisition
History." These acquisitions were accounted for under the purchase method of
accounting and, accordingly, the results of operations of the acquired entities
are included in the Company's financial statements from their respective dates
of acquisition. As a result, period-to-period comparisons of financial
position and results of operations are not necessarily meaningful. The
following data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Consolidated Financial Statements and related notes included elsewhere in this
report.
<TABLE>
<CAPTION>
Two Ten Year Ended December 31,
Months Months
Ended Ended
February 28, December 31,
1993 1993 ----------------------------------------------------------------
1994 1995 1996 1997
(In thousands, except share amounts)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Net sales........................ $11,728 $67,823 $107,449 $ 123,990 $158,247 $ 230,982
Cost of products sold............ 10,911 63,161 100,254 111,448 141,074 207,755
Gross profit..................... 817 4,662 7,195 12,542 17,173 23,227
Selling, general and
administrative expense......... 508 2,498 4,394 7,836 8,443 10,620
Depreciation and
amortization................... 14 333 512 998 1,009 1,161
Earnings from operations......... 295 1,831 2,289 3,708 7,721 11,446
Stock option expense............. - - - - - 350
Interest expense, net............ 60 (21) 200 511 437 887
Earnings before income taxes..... 235 1,852 2,089 3,197 7,284 10,209
Provision for income taxes....... 3 741 835 1,311 2,915 4,058
Net earnings..................... 232 1,111 1,254 1,886 4,369 6,151
Earning per share:..............
Basic......... $ .11 $ .12 $ .18 $ .43 $ .58
Diluted ...... $ .11 $ .12 $ .18 $ .43 $ .58
Weighted average
shares outstanding: .........
Basic......... 10,214,286 10,214,286 10,214,286 10,214,286 10,622,941
Diluted ...... 10,214,286 10,214,286 10,214,286 10,214,286 10,626,589
<CAPTION>
February 28, December 31,
1993 ----------------------------------------------------------------------
1993 1994 1995 1996 1997
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital................. $3,744 $11,599 $12,955 $16,000 $20,792 $57,488
Receivable from parent.......... - - - - - 5,290
Total assets.................... 11,897 26,705 36,849 41,584 57,220 93,302
Payable to parent............... - 985 8,345 3,873 9,290 -
Long-term debt.................. - - 113 751 560 272
Note payable to parent.......... - - - - - 6,000
Total liabilities............... 7,822 8,853 16,610 16,553 27,820 33,419
Shareholders' equity............ 4,075 17,852 20,239 25,031 29,400 59,883
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This discussion and analysis should be read in conjunction with the
Company's Consolidated Financial Statements and related notes included
elsewhere in this report.
INTRODUCTION
The Company was formed in June 1994 to succeed to the business operations
of companies previously acquired by BWI, as described below. From its formation
through its initial public offering ("IPO") on October 24, 1997, the Company
operated as a wholly owned subsidiary of BWI, and procured a number of services
from, and engaged in a number of financial and other transactions with, BWI.
Since the IPO, the Company continues to be controlled by BWI, but operates on a
stand-alone basis. Accordingly, since the IPO the Company has incurred and will
continue to incur incremental recurring legal, audit, risk management and
administrative costs related to operating as a stand-alone entity that it did
not experience as a wholly owned subsidiary of BWI. The financial information
included in this Annual Report on Form 10-K is not necessarily indicative of
the Company's future results of operations, financial position and cash flows
as a stand-alone public company.
The Company provides specialty pharmaceuticals and related medical
supplies as well as disease treatment services to the office-based physician,
outpatient renal dialysis and homecare markets. The Company's operations are
derived from the acquisition by BWI of substantially all of the assets of
Charise Charles, a specialty wholesale distributor of oncology and renal care
biopharmaceuticals, in February 1993 and of PRN, a specialty wholesale
distributor of renal care supplies and dialysis equipment, in October 1993. The
Company subsequently acquired 3C, a specialty distributor of acute dialysis
products, in October 1994, the IV One Companies, three related companies that
provided specialty pharmacy and related healthcare services, in January 1995,
and Grove Way Pharmacy, a vaccine and injectable drug distributor, in August
1997. These acquisitions were accounted for under the purchase method of
accounting and, accordingly, the results of operations of the acquired
companies are included in the Company's financial statements from their
respective dates of acquisition. As a result, period-to-period comparisons of
financial position and results of operations are not necessarily meaningful.
The operations of Charise Charles, PRN, 3C and Grove Way Pharmacy are now
included in the Company's Priority Distribution division, and the IV One
Companies comprise the Priority Pharmacy division. During 1995, 1996 and 1997,
Priority Distribution represented 93%, 92% and 92% of net sales, respectively,
and Priority Pharmacy represented the balance. Historically, Priority Pharmacy
has generated substantially higher margins than Priority Distribution and has
contributed a significant portion of the Company's earnings.
RESULTS OF OPERATIONS
1997 Compared to 1996
Net Sales. Net sales increased to $231.0 million in 1997 from $158.2
million in 1996, an increase of 46%. This increase was generated from internal
growth that included a 40% increase in sales by Priority Pharmacy and a 46%
increase in sales by Priority Distribution. The growth reflected the addition
of new customers, new product introductions, additional sales to existing
customers and, to a lesser extent, inflationary price increases of
approximately 4%.
Gross Margin. Gross margin increased to $23.2 million in 1997 from $17.2
million in 1996, an increase of 35%. The increase in gross margin reflected
increased sales by both Priority Distribution and Priority Pharmacy. Gross
margin as a percentage of net sales decreased in 1997 to 10.1% from 10.9% in
1996. This decrease was primarily attributable to the change in sales mix
resulting from the significant increase in sales by Priority
19
<PAGE> 20
Distribution which generated lower gross margins than those of Priority
Pharmacy. Competition continues to exert pressure on margins, particularly those
of Priority Distribution.
Selling, General and Administrative Expense. Selling, general and
administrative ("SGA") expense increased to $10.6 million in 1997 from $8.4
million in 1996, an increase of 26%. However, SGA expense as a percentage of
net sales decreased to 4.6% in 1997 from 5.3% in 1996. Management continually
monitors SGA expense and remains focused on controlling these increases through
improved technology and efficient asset management. The decrease in SGA expense
as a percentage of net sales resulted from the revenue growth in excess of the
fixed portion of SGA expense.
Depreciation and Amortization. Depreciation and amortization increased to
$1.2 million in 1997 from $1.0 million in 1996, an increase of 15%. The
increase was primarily the result of depreciation of new equipment,
particularly management information systems.
Stock Option Expense. Upon completion of the IPO, the Company granted a
consultant of the Company a 10-year option to purchase 50,000 shares of the
Company's Class B Common Stock at the initial public offering price. The grant
of this option resulted in a one-time compensation expense charge of $350,000
in 1997.
Interest Expense, Net. Interest expense increased to $1,040,000 in 1997
from $457,000 in 1996. This expense was primarily related to financing provided
to the Company by BWI through the IPO date. The expense also included $324,000
of interest due on the Dividend Note issued to BWI on March 31, 1997.
The interest expense on the intercompany borrowings was calculated by applying
the BWI average incremental borrowing rate to the average outstanding
borrowings, while interest on the Dividend Note was calculated at the fixed
7.25% face rate of the Note. During 1997 and 1996, the average outstanding
balances (excluding the Dividend Note) were $10.3 million and $6.4 million,
respectively, and the average incremental borrowing rate charged was 6.4% in
both periods.
Interest income increased to $153,000 in 1997 from $20,000 in 1996. This
income included $87,000 earned on short-term investments with outside financial
institutions and finance charges from customers. The remaining $66,000 of
interest income was from advances to BWI. This interest income was calculated
by applying the BWI average incremental borrowing rate to the average
outstanding borrowings. During the last two months of 1997, the average
outstanding balance was $5.9 million and the average incremental borrowing rate
was 6.4%.
Income Taxes. The Company participates in the consolidated federal and
state income tax returns filed by BWI. BWI charges federal and state income tax
expense to the Company as if the Company filed its own separate federal and
state income tax returns. The provision for income taxes in 1997 represented
39.8% of earnings before taxes as compared to 40.0% for 1996.
1996 Compared to 1995
Net Sales. Net sales increased to $158.2 million in 1996 from $124.0
million in 1995, a 28% increase. All of the increase was generated from
internal growth, including a 56% increase in sales by Priority Pharmacy and a
26% increase in sales by Priority Distribution. The internal growth reflected
primarily the addition of new customers, new product introductions, additional
sales to existing customers and, to a lesser extent, inflationary price
increases of approximately 4%.
Gross Margin. Gross margin increased to $17.2 million in 1996 from $12.5
million in 1995, an increase of 37%. The increase in gross margin reflected
increased sales by both Priority Distribution and Priority Pharmacy. Gross
margin as a percentage of net sales had a slight increase in 1996 to 10.9% from
10.1% in 1995. Margins were enhanced by the increase in the sales mix of the
higher margin sales of Priority Pharmacy. Competition continually exerted
pressure on margins.
20
<PAGE> 21
Selling, General and Administrative Expense. SGA expense increased to $8.4
million in 1996 from $7.8 million in 1995, an increase of 8%. SGA expense as a
percentage of net sales decreased from 6.3% in 1995 to 5.3% in 1996. The
decrease in SGA expense as a percentage of net sales resulted from the revenue
growth, principally at Priority Distribution, in excess of the fixed portion of
SGA expense.
Depreciation and Amortization. Depreciation and amortization remained
relatively constant in 1996 and 1995.
Interest Expense, Net. Interest expense decreased to $457,000 in 1996 from
$526,000 in 1995, a decrease of 13%. Interest expense primarily related to
financing provided to the Company by BWI. The interest expense on these
intercompany borrowings was calculated by applying the BWI average incremental
borrowing rate to the average outstanding borrowings. During 1996 and 1995, the
average outstanding balances were $6.4 million and $6.4 million and the average
incremental borrowing rates charged were 6.4% and 7.1%, respectively.
Income Taxes. The Company participates in the consolidated federal and
state income tax returns filed by BWI. BWI charges federal and state income tax
expense to the Company as if the Company filed its own separate federal and
state income tax returns. The provision for income taxes in 1996 represented
40.0% of earnings before taxes as compared to 41.0% for 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital requirements have been to fund working
capital needs to support internal growth, for acquisitions and for capital
expenditures. The Company's principal working capital needs are for inventory
and accounts receivable. Management controls inventory levels in order to
minimize carrying costs and maximize purchasing opportunities. The Company
sells inventory to its customers on various payment terms. This requires
significant working capital to finance inventory purchases and entails accounts
receivable exposure in the event any of its major customers encounter financial
difficulties. Although the Company monitors closely the creditworthiness of its
major customers, there can be no assurance that the Company will not incur some
collection loss on major customer accounts receivable in the future.
The Company had cash and working capital of $9.5 and $57.5 million,
respectively, at December 31, 1997.
Net Cash Used by Operating Activities. The Company's operations required
$6.3 million in cash for 1997. Accounts receivable increased $13.5 million,
primarily to support the increase in sales and the extension of credit terms to
meet competitive conditions. Inventory increased $8.6 million in 1997 due to
incremental purchases necessary to serve the increased customer base and to
maximize purchasing opportunities. The $7.6 million increase in accounts
payable partially reduced the cash requirements for accounts receivable and
inventory; this increase was attributable to the timing of payments and the
increase in inventory. The Company anticipates that its operations will
continue to require cash to fund its growth. Depreciation and amortization
totaled $1.2 million in 1997.
Net Cash Used by Investing Activities. In 1997 the Company purchased
$727,000 in fixed assets, primarily computer hardware and software.
Additionally, the Company spent $250,000 for the acquisition of businesses. The
Company expects that capital expenditures during 1998 will be $650,000. The
Company anticipates that these expenditures will relate primarily to the
purchase of computer hardware and software and telecommunications equipment.
Net Cash Provided by Financing Activities. In 1997 the Company paid $9.3
million to eliminate its payable to parent. Additionally, the Company's
receivable from parent increased by $5.3 million as it advanced excess cash to
BWI on an interest-bearing basis. The Company also issued a $6.0 million
subordinated note payable to BWI to fund a dividend distribution to BWI. The
Company generated $30.0 million in net proceeds from the IPO.
21
<PAGE> 22
Historically, the Company has financed its operations through capital
contributions and advances from BWI. The Company used $16.7 million of the net
proceeds of the IPO to repay the amount of the working capital advances
outstanding at the time of the closing of the IPO. In connection with the IPO,
BWI made available to the Company a $30.0 million line of credit, which the
Company may utilize for working capital purposes and possible acquisitions. The
maturity date for the line is December 31, 1998. Outstanding principal amounts
under the line will bear interest, payable quarterly, at a rate equal to the
rate then paid by BWI under its primary line of credit agreement. At December
31, 1997, no amounts had been borrowed under the line.
Management believes that the net proceeds of the IPO, together with cash
from operations and borrowings from BWI, will be sufficient to meet the
Company's working capital needs for at least two years.
INFLATION
The Company's financial statements are prepared on the basis of historical
costs and are not intended to reflect changes in the relative purchasing power
of the dollar. Because of its ability to take advantage of forward purchasing
opportunities, the Company believes that its gross profits generally increase
as a result of manufacturers' price increases in the products it distributes.
Gross profits may decline if the rate of price increases by manufacturers
declines.
Generally, price increases are passed through to customers as they are
received by the Company and therefore they reduce the negative effect of
inflation. Other non-inventory cost increases, such as payroll, supplies and
services, have been partially offset during the past three years by increased
volume and productivity.
YEAR 2000 COMPLIANCE
The Company is in the process of conducting a thorough review of its
computer systems to identify and address all code changes, testing, and
implementation procedures necessary to make its systems year 2000 compliant.
The Company presently believes that with modifications to existing software,
the year 2000 problem will pose no significant operational problems for the
Company's computer systems as so modified and converted, and the Company
expects to be fully compliant by the end of fiscal 1998. There can be no
assurance, however, that the systems of other companies with which the Company
transacts business will be updated or converted in a timely manner, or that
such failure will not have a material adverse effect on the Company's
operations. The Company estimates that during fiscal 1998 it will incur
approximately $75,000 for the cost of this project, which includes the cost of
updating non-compliant code.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements which represent
the Company's expectations or beliefs, and which involve certain risks and
uncertainties, including but not limited to, changes in interest rates,
competitive pressures, changes in customer mix, financial stability of major
customers, investment procurement opportunities, changes in governmental
regulations or the interpretation thereof and the ability of the Company and
the entities with which it transacts business to modify or redesign their
computer systems to work properly in the year 2000, which could cause actual
results to differ from those in the forward-looking statements. For this
purpose, any statement contained in this report that is not a statement of
historical fact may be deemed to be a forward-looking statement. These
statements by their nature involve substantial risks and uncertainties, certain
of which are beyond the Company's control, and actual results may differ
materially depending on a variety of important factors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
22
<PAGE> 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------------
1995 1996 1997
(In thousands, except share data)
<S> <C> <C> <C>
Net sales.................................... $123,990 $158,247 $230,982
Cost of products sold........................ 111,448 141,074 207,755
--------- ----------- -----------
Gross profit ................................ 12,542 17,173 23,227
Selling, general and administrative expense.. 7,836 8,443 10,620
Depreciation and amortization................ 998 1,009 1,161
--------- ----------- -----------
Earnings from operations..................... 3,708 7,721 11,446
Stock option expense ........................ - - 350
Interest expense, net (primarily related
party)..................................... 511 437 887
--------- ----------- -----------
Earnings before income taxes................. 3,197 7,284 10,209
--------- ----------- -----------
Provision for income taxes:
Current................................. 1,301 3,061 4,495
Deferred................................ 10 (146) (437)
--------- ----------- -----------
1,311 2,915 4,058
--------- ----------- -----------
Net earnings................................. $ 1,886 $ 4,369 $ 6,151
========= =========== ===========
Earnings per share: .........................
Basic .................................. $ .18 $ .43 $ .58
Diluted ................................ $ .18 $ .43 $ .58
Weighted average shares outstanding: ........
Basic................................... 10,214,286 10,214,286 10,622,941
Diluted ................................ 10,214,286 10,214,286 10,626,589
</TABLE>
(See accompanying notes to consolidated financial statements.)
23
<PAGE> 24
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1996 1997
(In thousands, except share data)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents..................................................... $ 1,656 $ 9,484
Accounts receivable, less allowance for doubtful accounts of
$815 and $402, respectively .................................................. 29,541 43,643
Receivable from parent ....................................................... -- 5,290
Finished goods inventory...................................................... 16,132 25,082
Deferred income taxes......................................................... 451 869
Other current assets ......................................................... 152 166
--------- -----------
47,932 84,534
--------- -----------
Fixed assets, at cost............................................................. 2,138 2,492
Less: accumulated depreciation................................................ 804 997
--------- -----------
1,334 1,495
--------- -----------
Intangibles, net 7,954 7,273
--------- -----------
Total assets...................................................... $57,220 $93,302
========= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Payable to parent.............................................................. $ 9,290 $ --
Accounts payable............................................................... 16,449 24,754
Other current liabilities...................................................... 1,401 2,292
--------- -----------
27,140 27,046
--------- -----------
Long-term obligations............................................................. 560 272
--------- -----------
Deferred income taxes............................................................. 120 101
--------- -----------
Subordinated note payable to parent............................................... -- 6,000
--------- -----------
Shareholders' equity:
Preferred stock, no par value, 5,000,000 shares authorized, none
issued and outstanding....................................................... -- --
Common stock
Class A, $0.01 par value, 15,000,000 shares authorized,
10,214,286 issued and outstanding......................................... 102 102
Class B, $0.01 par value, 40,000,000 shares authorized, zero and............
2,300,922 issued and outstanding, respectively............................ -- 23
Additional paid in capital.................................................. 22,598 52,907
Retained earnings........................................................... 6,700 6,851
--------- -----------
Total shareholders' equity.............................................. 29,400 59,883
--------- -----------
Commitments and contingencies..................................................... -- --
--------- -----------
Total liabilities and shareholders' equity.............................. $57,220 $93,302
========= ===========
</TABLE>
(See accompanying notes to consolidated financial statements.)
24
<PAGE> 25
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------------------------
1995 1996 1997
(In thousands)
<S> <C> <C> <C>
Cash flow from operating activities:
Net income............................................................... $ 1,886 $ 4,369 $ 6,151
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Depreciation and amortization............................................ 998 1,009 1,161
Loss on disposal of fixed assets......................................... -- -- 126
Compensation expense on stock and option grants.......................... -- -- 365
Deferred income taxes.................................................... 10 (146) (437)
Change in assets and liabilities, net of acquisitions:
Accounts receivable...................................................... 560 (12,208) (13,549)
Finished goods inventory................................................. 426 (3,485) (8,554)
Trade accounts payable................................................... 2,384 5,657 7,566
Other current assets and liabilities..................................... (293) 280 877
--------- --------- ---------
Net cash provided (used) by operating
activities......................................................... 5,971 (4,524) (6,294)
--------- --------- ---------
Cash flow from investing activities:
Purchase of fixed assets................................................ (474) (405) (727)
Acquisition of businesses............................................... (2,538) -- (250)
--------- --------- ---------
Net cash used by investing activities................................. (3,012) (405) (977)
--------- --------- ---------
Cash flow from financing activities:
Net increase (decrease) in amount due to /from parent................. (4,471) 5,417 (14,580)
Payments on long-term obligations..................................... (185) (191) (288)
Proceeds from initial public offering, net ........................... -- -- 29,967
Contribution by parent................................................ 2,906 -- --
--------- --------- ---------
Net cash provided (used) by financing activities.................. (1,750) 5,226 15,099
--------- --------- ---------
Net increase in cash......................................................... 1,209 297 7,828
Cash and cash equivalents at beginning of year............................... 150 1,359 1,656
--------- --------- ---------
Cash and cash equivalents at end of year..................................... $ 1,359 $ 1,656 $ 9,484
========= ========= =========
Supplemental cash flow information:
Interest paid............................................................ $ 526 $ 445 $ 1,040
Income taxes paid........................................................ $ 1,301 $ 3,061 $ 4,495
</TABLE>
(See accompanying notes to consolidated financial statements.)
25
<PAGE> 26
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Class A Common Stock Class B Common Stock
-------------------- --------------------
Additional
Shares Shares Paid in Retained Shareholders'
Outstanding Amount Outstanding Amount Capital Earnings Equity
---------- ------ ----------- ------ ---------- -------- -----------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1994.............. 10,214,286 $102 -- $ -- $19,692 $ 445 $ 20,239
Net earnings............................... 1,886 1,886
Contribution by parent..................... 2,906 2,906
---------- ---- --------- ------ ------- -------- -----------
Balances at December 31, 1995.............. 10,214,286 102 -- -- 22,598 2,331 25,031
Net earnings............................... 4,369 4,369
---------- ---- --------- ------ ------- -------- -----------
Balances at December 31, 1996.............. 10,214,286 102 -- -- 22,598 6,700 29,400
Net earnings............................... 6,151 6,151
Dividend to parent......................... (6,000) (6,000)
Issuance of Class B common stock:
Initial public offering............... 2,300,000 23 29,944 29,967
Board of Directors' compensation ..... 922 -- 15 15
Stock option grant......................... 350 350
---------- ---- --------- ------ ------- -------- -----------
Balances at December 31, 1997.............. 10,214,286 $ 102 2,300,922 $ 23 $ 52,907 $ 6,851 $ 59,883
========== ====== ========= ====== ======== ======== ===========
</TABLE>
(See accompanying notes to consolidated financial statements.)
26
<PAGE> 27
PRIORITY HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--Significant Accounting Policies
Basis of presentation. Priority Healthcare Corporation (the "Company") was
formed by Bindley Western Industries, Inc. ("BWI") on June 23, 1994, as an
Indiana corporation to focus on the distribution of products and provision of
services to the "alternate site" segment of the healthcare industry. On August
1, 1994, BWI transferred the net assets of its Charise Charles and PRN
divisions to the Company in exchange for 1,000 shares of common stock, no par
value. The Company now operates as a national distributor of specialty
pharmaceuticals and related medical supplies to the alternate site healthcare
market and is a provider of patient-specific, self-injectable
biopharmaceuticals and disease prevention programs to individuals with chronic
diseases.
On August 25, 1997 the Board of Directors and BWI, as the sole shareholder
of the Company, completed a recapitalization of the Company. Effective on that
date, the Company's capitalization consisted of: (i) 15,000,000 authorized
shares of Class A Common Stock, $0.01 par value, 10,214,286 shares of which
were issued and outstanding and owned by BWI, (ii) 40,000,000 shares of Class B
Common Stock, $0.01 par value (of which 2,300,000 shares were subsequently
issued in an initial public offering described in Note 2--Related Party
Transactions), and (iii) 5,000,000 shares of Preferred Stock, without par
value, none of which are issued and outstanding. This recapitalization has been
given retroactive effect in these consolidated financial statements.
The consolidated financial statements of the Company include certain
allocations of corporate overhead and other expenses incurred by BWI on behalf
of the Company. These expenses and the basis of allocations are discussed in
Note 2--Related Party Transactions. The Company's financial statements are not
necessarily indicative of the results the Company would have reported had it
existed as a stand-alone public entity, or of the financial position, results
of operations and cash flows of the Company in the future.
Principles of consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
Revenue recognition. Revenues are recognized when products are shipped to
unaffiliated customers with appropriate provisions recorded for estimated
discounts and allowances.
Cash and cash equivalents. The Company considers all investments with a
maturity of less than 3 months to be a cash equivalent.
Inventories. Inventories are stated on the basis of lower of cost or
market using the first-in, first-out ("FIFO") method.
Fixed assets. Depreciation is computed on the straight-line method for
financial reporting purposes. Accelerated methods are primarily used for income
tax purposes. Assets, valued at cost, are generally being depreciated over
their estimated useful lives as follows:
Estimated
useful life
(years)
-------
Furnishings......................... 5-7
Leasehold improvements.............. 12
Transportation and other equipment.. 3-7
In the event facts and circumstances indicate an asset could be impaired, an
evaluation of the undiscounted estimated future cash flows from operations is
compared to the asset's carrying amount to determine if a write-down is
required. At December 31, 1996 and December 31, 1997, no impairments existed.
27
<PAGE> 28
Intangibles. The Company continually monitors its cost in excess of net
assets acquired (goodwill), covenants not to compete and its other intangibles
(customer lists and consulting agreements) to determine whether any impairment
of these assets has occurred. In making such determination, the Company
evaluates the expected future cash flows from operations, on an undiscounted
basis, of the underlying businesses which gave rise to such amounts. Goodwill
is being amortized on the straight-line method over 40 years. Other intangibles
are being amortized on the straight-line method over 6 to 15 years.
Earnings per share. Historical earnings per share. The Company has
adopted the provisions of Statement of Financial Accounting Standard ("SFAS")
No. 128 for all periods presented. Basic earnings per share is computed by
dividing net income by the weighted average of Class A and Class B shares
outstanding for the period. Diluted earnings per share computations assume
outstanding stock options with a dilutive effect on earnings were exercised.
These common stock equivalents are added to the weighted average number of
shares outstanding in the diluted calculation. A reconciliation of the basic
and diluted weighted average shares outstanding is as follows for the years
ended December 31:
<TABLE>
<CAPTION>
(thousands) 1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Weighted average number of Class A and Class B
Common shares outstanding used as the denominator
in the basic earnings per share calculation 10,214 10,214 10,623
Additional shares assuming exercise of dilutive
stock options - - 4
------ ------ ------
Weighted average number of Class A and Class B
Common and equivalent shares used as the denominator
in the diluted earnings per share calculation 10,214 10,214 10,627
====== ====== ======
</TABLE>
Unaudited pro forma earnings per share. Unaudited pro forma earnings per share
was $0.55 for the year ended December 31, 1997, and was calculated by dividing
pro forma net earnings of $6,248,000 by pro forma average shares outstanding of
11,430,229. The pro forma adjustments to reported net earnings reflect, on a
net of tax basis (i) additional legal, audit, risk management and
administrative costs required to present the Company as if it had operated as a
stand-alone public company for all of 1997, (ii) the elimination of the
interest expense associated with the Company's payable to BWI, which was
liquidated with proceeds from the IPO and (iii) three months of additional
interest expense on the $6.0 million note payable on the dividend to BWI, as if
it was outstanding as of January 1, 1997. The pro forma average shares
outstanding amount includes an incremental number of Class B shares required to
be issued to liquidate the payable to BWI. This amount was calculated by
dividing the average balance of the payable to BWI from January 1, 1997 through
the IPO date by the net proceeds per share from the IPO.
Income taxes. The Company participates in the consolidated federal and
state income tax returns filed by its parent company, BWI. BWI charges federal
and state income tax expense to the Company as if the Company filed its own
separate federal and state income tax returns.
In accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 109 "Accounting for Income Taxes," the Company accounts
for income taxes using the asset and liability method. The asset and liability
method requires the recognition of deferred tax assets and liabilities for
expected future tax consequences of temporary differences that currently exist
between the tax bases and financial reporting bases of the Company's assets and
liabilities.
Use of estimates. The preparation of financial statements in accordance
with generally accepted accounting principles requires the use of estimates
made by management. Actual results could differ from those estimates.
28
<PAGE> 29
Fair value of financial instruments. The carrying values of cash, accounts
receivable, payable to/from parent, other current assets, accounts payable and
other current liabilities approximate their fair market values due to the
short-term maturity of these instruments.
NOTE 2--RELATED PARTY TRANSACTIONS
On October 29, 1997, the Company consummated an initial public offering
("IPO") of 2,000,000 shares of Class B Common Stock. An additional 300,000
shares of Class B Common Stock were sold on November 25, 1997 pursuant to the
exercise of the underwriters' overallotment option. Prior to the IPO, the
Company was a wholly-owned subsidiary of BWI. Since the IPO, BWI continues to
own over 80% of the Company's outstanding capital stock. The Company and BWI
have entered into certain related party transactions which are described
below. Had the Company operated as a stand-alone, non-public entity for the
periods presented, management believes the costs and expenses incurred by the
Company would not have differed materially from those reported in the financial
statements. In addition, the Company has participated in the BWI profit sharing
plan which is discussed in Note 7--Profit Sharing Plan.
BWI provided management and consulting services to the Company which
included, but were not limited to, legal, human resources, payroll and tax. The
Company was charged $75,000, $65,000 and $65,000 for 1995, 1996 and 1997,
respectively. These amounts were based on an allocation of the actual services
rendered by BWI and were calculated in a manner considered reasonable by
management.
The Company was also provided coverage under the BWI insurance plans.
These expenses were charged to the Company based on a combination of a pro rata
allocation and the push-down of actual expenses incurred, depending on the type
of expenditure. These methods are considered reasonable by management. The
insurance expense was $100,000, $132,000 and $151,000 for 1995, 1996 and 1997,
respectively.
At December 31, 1996, the Company owed BWI $9.3 million. At December 31,
1997, BWI owed the Company $5.3 million. These amounts are due on demand and
represent financing and payment of transactions by BWI on behalf of the
Company, offset in part by cash collections from operations transferred to BWI,
and in October of 1997, from the proceeds of the IPO used to repay the payable
to BWI and advance certain excess cash balances of the Company to BWI on a
short-term, interest-bearing basis. Net interest expense attributable to these
related party borrowings were $455,000 for 1995, $408,000 for 1996 and $605,000
(net of $66,000 of interest income) for 1997. These amounts were calculated by
applying the BWI average incremental borrowing rate to the average outstanding
borrowing/advances. For 1995, 1996 and 1997 the average outstanding borrowings
were $6.4 million, $6.4 million and $10.3 million, respectively. The average
incremental borrowing rates applied to these borrowings in 1995, 1996 and 1997
were 7.1%, 6.4% and 6.4%, respectively.
For 1995, 1996 and 1997, intercompany purchases of inventory from BWI (at
the price paid by BWI) totaled $8.3 million, $1.8 million and $2.0 million,
respectively.
On March 31, 1997, the Company declared and paid a dividend to BWI in the
form of a $6.0 million subordinated promissory note that becomes due on March
31, 1999. The note carries an interest rate of 7.25% per annum. For 1997,
interest expense associated with this note totaled $324,000.
Certain employees of the Company have been granted options to purchase BWI
stock under a BWI stock option plan. 66,500, 155,750 and 15,000 such options
were granted by BWI to Company employees in 1995, 1996 and 1997 (prior to the
IPO), respectively, with exercise prices equal to the market price of the BWI
stock at the date of grant. No compensation expense was recognized on these
pursuant to Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees". If the Company had recognized compensation expense
based on the grant date fair value of those options as prescribed by SFAS No.
123, "Accounting for Stock-Based Compensation", net income for the years ended
December 31, 1995, 1996 and 1997 would have decreased $46,000, $280,000 and
$377,000, respectively, on a pro forma basis. See Note 8 for a calculation of
pro forma earnings per share required by SFAS No. 123. The weighted average
fair value of each 1995, 1996 and 1997 BWI option
29
<PAGE> 30
granted of $5.90, $6.04 and $7.21, respectively, was estimated using the
Black-Scholes option pricing model, and certain assumptions relevant to those
BWI options and the underlying BWI common stock.
NOTE 3--ACQUISITIONS
During the three years ended December 31, 1997, the Company purchased
IV-1, Inc., IV-One Services, Inc. and National Pharmacy Providers, Inc.
(collectively, the "IV One Companies") and Grove Way Pharmacy, Inc. ("Grove Way
Pharmacy"). Each of these acquisitions was accounted for as a purchase and
their results of operations are included in the consolidated financial
statements from their respective dates of acquisition.
The acquisition of the IV One Companies was effective January 1, 1995. The
IV One Companies provide pharmacy and other healthcare services. The
consideration exchanged for the IV One Companies was approximately $2.9
million, which exceeded the fair value of net assets acquired and resulted in
approximately $2.6 million of intangibles. These intangibles include a
four-year consulting agreement with the prior owner. At December 31, 1996 and
1997, the balance owed under this agreement was $727,000 and $547,000,
respectively ($527,000 and $272,000, respectively, is included in long-term
obligations).
The acquisition of Grove Way Pharmacy was effective August 6, 1997. Grove
Way Pharmacy was a specialty distributor of vaccines and medical supplies to
the physicians market. The consideration exchanged for Grove Way Pharmacy was
approximately $250,000, which approximates the fair value of net assets
acquired. Additionally, a three-year non-compete agreement was obtained from the
prior owner for $100,000 due in four equal installments in 1998. The results
of operations of Grove Way Pharmacy for 1996 and for the pre-acquisition period
in 1997 were not material to the Company's consolidated sales and net earnings.
NOTE 4--FIXED ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
------------- -------------
1996 1997
---- ----
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
Furnishings......................... $ 574 $ 797
Leasehold improvements.............. 220 274
Transportation and other equipment.. 1,344 1,421
------------- -------------
2,138 2,492
Less: Accumulated depreciation (804) (997)
------------- -------------
$ 1,334 $ 1,495
============= =============
</TABLE>
NOTE 5--INTANGIBLES
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
------------- -------------
1996 1997
---- ----
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
Goodwill........................ $ 6,109 $ 6,012
Accumulated amortization........ (457) (609)
------------- -------------
Goodwill, net................... 5,652 5,403
------------- -------------
Other........................... 3,883 4,001
Accumulated amortization........ (1,581) (2,131)
------------- -------------
Other, net...................... 2,302 1,870
------------- -------------
Intangibles, net................ $ 7,954 $ 7,273
============= =============
</TABLE>
30
<PAGE> 31
Note 6--Income Taxes
The provision for income taxes includes state income taxes of $213,000,
$479,000 and $669,000 in 1995, 1996 and 1997, respectively.
The following table indicates the significant elements contributing to the
difference between the U.S. federal statutory tax rate and the effective tax
rate:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1995 1996 1997
<S> <C> <C> <C>
Percentage of earnings before taxes:
U.S. federal statutory rate........... 35.0% 35.0% 35.0%
State and local taxes on income,
net of federal income tax benefit... 4.3% 4.3% 4.3%
Other ................................ 1.7% 0.7% 0.5%
---- ---- ----
Effective rate............................ 41.0% 40.0% 39.8%
==== ==== ====
</TABLE>
Presented below are the significant elements of the net deferred tax balance
sheet accounts at December 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
---- ----
(In Thousands)
<S> <C> <C>
Deferred tax asset:
Current:
Accounts receivable................ $ 320 $ 491
Inventories........................ 131 206
Deferred compensation and stock
option expense ................. -- 172
----- -----
Subtotal.................... 451 869
----- -----
Long-term: -- --
----- -----
Total deferred tax assets.... $ 451 $ 869
===== =====
Deferred tax liabilities:
Current:.............................. -- --
Long-term:
Fixed assets...................... $ 95 $ 60
Intangibles....................... 25 41
----- -----
Subtotal.................... 120 101
----- -----
Total deferred tax
liabilities................ $ 120 $ 101
===== =====
</TABLE>
31
<PAGE> 32
NOTE 7--PROFIT SHARING PLAN
The Company's eligible employees participate in the BWI qualified Profit
Sharing Plan ("Profit Sharing Plan"). All employees are generally eligible to
participate in the Profit Sharing Plan as of the first January 1, April 1, July
1 or October 1 after having completed at least one year of service (as defined
in the Profit Sharing Plan) and having reached age 21 ("Participant"). The
annual contribution of the Company to the Profit Sharing Plan is at the
discretion of the Board of Directors of BWI and is generally 8% of the
Participant's compensation for the year. The employer contribution for a year
is allocated among the Participants employed on the last day of the year in
proportion to their relative compensation for the year. The BWI contributions
to the Profit Sharing Plan with respect to the Company which are included as
expense in the statement of earnings for 1995, 1996 and 1997 were $119,000,
$230,000 and $260,000, respectively.
Subject to limitations imposed by the Internal Revenue Code of 1986, as
amended, a Participant may have a whole percentage (ranging from 1% to 13%) of
his or her compensation withheld from pay and contributed to the Profit Sharing
Plan and make "rollover" contributions to the Profit Sharing Plan of qualifying
distributions from other employers' qualified plans.
A Participant's interest in amounts withheld from his or her pay and
contributed to the Profit Sharing Plan or in rollover contributions and in the
earnings on those amounts are fully vested at all times. A Participant's
interest in employer contributions made on his or her behalf and the earnings
on those contributions become 20% vested after three years of service and an
additional 20% vested during each of the next four years. A Participant's
interest in employer contributions made on his or her behalf and the earnings
on those contributions also become fully vested when the employee retires at
age 65 or older, dies or becomes totally disabled.
All contributions to the Profit Sharing Plan are paid in cash to a
Cleveland, Ohio bank, as trustee, and are invested by the trustee until
distributed to Participants or their beneficiaries. Participants are permitted
to direct the trustee as to the investment of their accounts by choosing among
several investment funds that are offered under the Profit Sharing Plan,
including one fund consisting of BWI common stock. Participants may elect to
invest in one fund or a combination of the available funds according to their
investment goals. If a Participant does not make an investment election, his or
her Profit Sharing Plan accounts will be invested in a fund designated by the
Company.
Except in certain cases of financial hardship, a Participant (or his or
her beneficiary) receives his or her interest in the Profit Sharing Plan only
at death, retirement or termination of employment.
NOTE 8--CAPITAL STOCK
As described in Note 1--Significant Accounting Policies, on August 25,
1997, the Board of Directors and BWI, as the sole shareholder of the Company,
approved a recapitalization of the Company. The recapitalization resulted in
the authorization of Class A Common Stock, Class B Common Stock and Preferred
Stock. The two classes of Common Stock entitle holders to the same rights and
privileges, except that holders of shares of Class A Common Stock are entitled
to three votes per share on all matters submitted to a vote of holders of
Common Stock and holders of Class B Common Stock are entitled to one vote per
share on such matters. The two classes of Common Stock vote together, as a
single class on all matters except as otherwise required by applicable law.
The Class A Common Stock will automatically be converted into shares of
Class B Common Stock on a share-for-share basis upon any transfer or purported
transfer to any person other than: (i) a dividend or other distribution of the
shares of Class A Common Stock to the shareholders of BWI or; (ii) family
members of the transferee, or trusts for the benefit of or entities controlled
by the transferee or family members of the transferee.
On October 29, 1997, the Company consummated an initial public offering of
2,000,000 shares of Class B Common Stock. An additional 300,000 shares of
Class B Common Stock were sold on November 25, 1997 pursuant to the exercise of
the underwriters' overallotment option. All shares were issued at an initial
price of
32
<PAGE> 33
$14.50 per share. Net proceeds to the Company, after deducting
underwriting discounts and commissions and other expenses of the offering, was
$29,967,000.
On October 29, 1997, 922 shares of Class B Common Stock were granted to
the two non-employee directors of the Company, representing the stock portion
of their annual retainer for serving on the Board of Directors.
On August 25, 1997 the Board of Directors and BWI, as sole shareholder of
the Company, adopted the 1997 Stock Option and Incentive Plan (the "1997 Stock
Option Plan"). Under the 1997 Stock Option Plan, the Company may award stock
options and shares of restricted stock to officers, key employees, and
consultants of the Company. The aggregate number of shares of Class B Common
Stock that may be awarded under the 1997 Stock Option Plan is 1,250,000,
subject to adjustment in certain events. No individual participant may receive
awards for more than 300,000 shares in any calendar year. Under the 1997 Stock
Option Plan, awards of restricted shares may be made, in which case the grantee
would be granted shares of Class B Common Stock, subject to any determined
forfeiture or transfer restrictions.
The Compensation Committee of the Board of Directors administers the 1997
Stock Option Plan and has the authority to select those officers and key
employees to whom awards will be made, to designate the number of shares to be
covered by each award, to establish vesting schedules, and to specify all other
terms of the awards. With respect to stock options that are intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code, the option price must be at least 100% (or, in the case of a holder of
more than 10% of the total combined voting power of the Company's stock, 110%)
of the fair market value of a share of Class B Common Stock on the date of the
grant of the stock option. The Compensation Committee will establish the
exercise price of options that do not qualify as incentive stock options
("non-qualified stock options"). No options may be exercised more than ten
years from the date of grant, or for such shorter period as the Compensation
Committee may determine at the date of grant. Awards of options and shares of
restricted stock as to which restrictions have not lapsed are not transferable
other than pursuant to the laws of descent and distribution.
On August 25, 1997, the Company's Board of Directors granted a combination
of incentive and non-qualified stock options to employees under the 1997 Stock
Option Plan for an aggregate of 405,050 shares of Class B Common Stock,
effective at the inception of the IPO. The Board of Directors also granted a
non-qualified stock option to a consultant of the Company for 50,000 shares of
Class B Common Stock effective at the closing date of the IPO.
In accordance with the provision of SFAS No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123), the Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25) and related Interpretations in accounting for its stock
option plans, and accordingly, generally does not recognize compensation
expense related to options granted to employees. If the Company had elected to
recognize compensation expense based on the fair value of the options at the
grant date, whether granted by the Company or by BWI as described in Note
2--Related Party Transactions, as prescribed by SFAS No. 123, pro forma net
income and earnings per share would have been:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Net earnings - as reported........................................ $1,886 $4,369 $6,151
Pro forma impact of
BWI option grants (Note 2).............................. (46) (280) (377)
Pro forma impact of
Company option grants................................... -- -- (224)
------ ------ ------
Pro forma net earnings............................................ $1,840 $4,089 $5,550
====== ====== ======
Pro forma earnings per share:
Basic....................................................... $ 0.18 $ 0.40 $ 0.52
Diluted..................................................... $ 0.18 $ 0.40 $ 0.52
</TABLE>
33
<PAGE> 34
The fair value of the Company's 1997 option grant was estimated on the
date of grant using the Black-Scholes option pricing model, with the following
weighted average assumptions:
<TABLE>
<CAPTION>
1997
<S> <C>
Risk free interest rate 5.90%
Expected dividend yield .00%
Expected life of options 4.60
Volatility of stock price 54.79%
Weighed average fair value of options $7.52
</TABLE>
The option to acquire 50,000 shares granted to the consultant of the
Company (a non-employee under SFAS No. 123 and APB 25) resulted in $350,000 of
compensation expense that was recorded by the Company in October, 1997. The
compensation expense was determined based on the fair value of those options at
the date of grant as estimated by using the Black-Scholes option pricing model.
On August 25, 1997, the Board of Directors and BWI, as sole shareholder of
the Company, approved the adoption of the Outside Directors Stock Option Plan
(the "Directors Plan"). The Directors Plan reserves for issuance 25,000 shares
of the Company's Class B Common Stock, subject to adjustment in certain events.
Pursuant to the Directors Plan, each non-employee director will be
automatically granted an option to purchase 1,000 shares of Class B Common
Stock on June 1 of each year beginning June 1, 1998. The option exercise price
per share will be the fair market value of one share of Class B Common Stock on
the date of grant. Each option becomes exercisable six months following the
date of grant and expires ten years following the date of grant.
Changes in stock options under all of the Company's plans are shown below:
<TABLE>
<CAPTION>
Number of Option price per
shares share
--------- ----------------
<S> <C> <C>
Options outstanding at December 31, 1996..................................... -- --
Forfeited during 1997........................................................ (13,800) $14.50 to $14.50
Granted during 1997.......................................................... 473,050 $14.50 to $15.00
Exercised during 1997........................................................ -- --
-------
Options outstanding at December 31, 1997..................................... 459,250 $14.50 to $15.00
=======
Exercisable at December 31, 1997............................................. --
=======
Available for grant at December 31, 1997..................................... 815,750
=======
</TABLE>
Additional information regarding the Company's options outstanding at
December 31, 1997 is shown below:
Exercise Price Range
<TABLE>
<CAPTION>
$14.50 $15.00 Total
------ ------ -------
<S> <C> <C> <C>
Number of options outstanding.............. 441,250 18,000 459,250
Weighted average exercise price............ $14.50 $15.00 $14.52
Remaining contractual life................. 9.81 9.96 9.82
Weighted average exercisable price......... -- -- --
</TABLE>
34
<PAGE> 35
NOTE 9--COMMITMENTS
The Company leases warehouse and office space under noncancelable
operating leases expiring at various dates through 2002, with options to renew
for various periods. Minimum commitments under leases aggregate $476,000 for
1998 and 1999, $107,000 for 2000 and 2001, and $72,000 for 2002.
The consolidated rent expense for 1995, 1996 and 1997 was $490,000,
$470,000, and $515,000, respectively, of which approximately $75,000 in 1996
and $89,000 in 1997 pertained to leases with terms of one year or less. In
1995, all leases had terms greater than one year.
NOTE 10--MAJOR CUSTOMERS AND OTHER CONCENTRATIONS
The Company services customers in 50 states and Puerto Rico. For the years
ended December 31, 1996 and December 31, 1997, the Company had one customer,
Everest Healthcare Services Corporation, which accounted for 12% and 11%,
respectively, of the Company's revenues. For the year ended December 31, 1995,
no customer accounted for greater than 10% of the Company's revenues. The
Company sells goods and services to its customers on various payment terms
which entail accounts receivable exposure. Although the Company monitors
closely the creditworthiness of its customers, there can be no assurance that
the Company will not incur the write-off or writedown of a significant account
in the future.
The Company's largest vendor accounted for approximately 44% of total
revenues in 1995, 42% in 1996 and 40% in 1997. In addition, the sale of one
product supplied by this vendor accounted for 36% of revenues in 1996 and 29%
in 1997. This product is available from only one manufacturer, with which the
Company must maintain a good working relationship. The Company is a party in a
lawsuit involving this vendor. See Note 11--Legal Proceedings.
NOTE 11--LEGAL PROCEEDINGS
IV-1, Inc. ("IV-1") and IV-One Services, Inc. ("IV-One Services") have
been named as defendants in a second amended counterclaim filed by Amgen, Inc.
("Amgen") on May 14, 1996, in the Circuit Court of the Eighteenth Judicial
District of Seminole County, Florida. Amgen has asserted that these entities
tortiously interfered with a license agreement (the "License Agreement")
between Amgen and Ortho Pharmaceutical Corporation ("Ortho"). Pursuant to this
agreement, Amgen licensed Ortho to sell EPO for use in the treatment of
non-dialysis patients, while Amgen reserved the exclusive right to sell EPO for
use in the treatment of dialysis patients. Amgen has asserted that, prior to
the purchase of IV-1 and IV-One Services by the Company, these entities induced
Ortho to sell EPO to them for resale in the dialysis market in contravention of
the License Agreement. Amgen has also alleged that IV-1 and IV-One Services
were involved in a civil conspiracy to circumvent the terms of the License
Agreement to allow the resale of EPO to the dialysis market. Furthermore, Amgen
has asserted unfair competition claims against IV-1, including that IV-1
manufactured and distributed unapproved prefilled syringes of EPO and another
product manufactured by Amgen in container systems unapproved by Amgen. Amgen
did not specify a time frame for the acts complained of in the civil conspiracy
and unfair competition allegations. In each count, Amgen has demanded an
unspecified amount of compensatory damages, including costs and interest.
The Company believes that the sellers of IV-1, IV-One Services and Charise
Charles are contractually obligated to provide legal defense and to indemnify
the Company for losses and liabilities with respect to this litigation, to the
extent that the alleged acts occurred prior to the purchase of such
entities by the Company. To date, the sellers have provided the legal defense
for IV-1 and IV-One Services in the litigation. Indemnification from the sellers
of IV-1 and IV-One Services is limited to no more than $1.5 million and
indemnification from the sellers of Charise Charles is limited to no more than
$2.0 million. The Company does not expect the Amgen litigation to be material
to the Company's results of operations, financial condition or cash flows;
however, no assurance can be given that this litigation will not have a material
adverse effect on the Company. In addition, Amgen is the Company's largest
supplier. Consequently, this litigation presents the risk of adversely affecting
the Company's business relationship
35
<PAGE> 36
with Amgen, which could have a material adverse effect on the Company. See
Note 10--Major Customers and Other Concentrations.
The Company is also subject to ordinary and routine litigation incidental
to its business, none of which is material to the Company's results of
operations, financial condition, or cash flows.
On November 14, 1995, an investigator for the FDA, accompanied by an
inspector from the State of Florida Board of Pharmacy, inspected the Company's
pharmacy in Altamonte Springs, Florida. At the end of the inspection, the FDA
investigator issued an FDA Form-483, which is the form used by FDA
investigators to identify any observed or suspected noncompliance with the laws
administered by the agency. The FDA Form-483 identified the facility as a
pharmacy/repackager and listed three observations related to certain
requirements that the FDA typically imposes on manufacturers of sterile
products. The Company advised the FDA in December 1995 that the Company
believes it is not, within the statutory or regulatory meaning of these terms,
a repackager or a manufacturer. A second inspection of the same facility
occurred on June 26, 1997, in which the FDA investigator was again accompanied
by Florida pharmacy authorities. The FDA investigator issued a substantially
identical FDA Form-483 at the end of that inspection. The Florida State Board
of Pharmacy did not issue any deficiencies regarding the operations of the
Altamonte Springs pharmacy in either of these inspections.
On March 16, 1992, the FDA issued a Compliance Policy Guide (CPG 460.200),
which explains the criteria the FDA uses to distinguish between pharmacy
operations that are properly regulated under state law and drug manufacturing
regulated by the FDA. The Company's response to the FDA in December 1995 cited
this CPG and explained the Company's contention that, according to the FDA's
own criteria, the facility is a pharmacy properly regulated under state and
local laws.
On November 21, 1997, the President signed into law the FDA
Modernization Act of 1997, which, among a number of other items, adds a new
section on pharmacy compounding to the Federal Food, Drug and Cosmetic Act. In
this provision, Congress clarified a gray area by explicitly identifying the
circumstances in which pharmacies may compound drugs without the need for filing
a New Drug Application, observing the FDA's Good Manufacturing Practice
regulations or complying with certain other specific Federal Food, Drug
and Cosmetic Act requirements. Congress provided that the term "compounding"
does not include mixing or reconstituting that is done in accordance with
directions contained in approved labeling provided by the manufacturer of the
product. The Company believes that, as a result of this amendment, so long as
it follows the manufacturer's approved labeling in each case, and prepares drugs
only for identified individual patients using licensed practitioners, the
Company's activities should be regulated by the Florida State Board of Pharmacy
and not be subjected by the FDA to a full New Drug Application requirement
demonstrating the basic safety and effectiveness of the drugs.
If the Company is correct and its operations are limited to those engaged
in by pharmacies, there should be no material adverse effect from the FDA
Form-483s because the Company believes it is currently in compliance in all
material respects with applicable state and local laws. If the Company is
deemed to be a sterile product manufacturer or a sterile product repackager, it
would be subject to additional regulatory requirements. If for some reason the
FDA or other legal authorities decide that the Company must file for approval
of a New Drug Application, such an event could have a material adverse effect
on the Company.
There can be no assurance that future legislation, future rulemaking, or
active enforcement by the FDA of a determination that the Company is a drug
manufacturer will not have a material adverse effect on the business of the
Company.
36
<PAGE> 37
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Priority Healthcare Corporation
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of earnings, of shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Priority Healthcare Corporation and its subsidiaries at December 31, 1996 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Indianapolis, Indiana
February 25, 1998
37
<PAGE> 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no changes in or disagreements with the Company's
independent accountants on accounting or financial disclosures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item concerning the Directors and
nominees for Director of the Company and concerning disclosure of delinquent
filers under Section 16(a) of the Exchange Act is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders, to be filed with the Commission pursuant to Regulation
14A within 120 days after the end of the Company's last fiscal year.
Information concerning the executive officers of the Company is included under
the caption "Executive Officers of the Company" at the end of Part I of this
Annual Report. Such information is incorporated herein by reference, in
accordance with General Instruction G(3) to Form 10-K and Instruction 3 to Item
401(b) of Regulation S-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item concerning remuneration of the
Company's officers and Directors and information concerning material
transactions involving such officers and Directors is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders which will be filed with the Commission pursuant to
Regulation 14A within 120 days after the end of the Company's last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item concerning the stock ownership of
management and five percent beneficial owners is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders which will be filed with the Commission pursuant to
Regulation 14A within 120 days after the end of the Company's last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Shareholders which
will be filed with the Commission pursuant to Regulation 14A within 120 days
after the end of the Company's last fiscal year.
38
<PAGE> 39
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements:
The following consolidated financial statements of the Company and its
subsidiaries are set forth in Part II, Item 8.
Consolidated Statements of Earnings for the years ended December 31,
1995, December 31, 1996 and December 31, 1997
Consolidated Balance Sheets as of December 31, 1996 and
December 31, 1997
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, December 31, 1996 and December 31, 1997
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1995, December 31, 1996 and December 31, 1997
Notes to Consolidated Financial Statements
Report of Independent Accountants
2. Financial Statement Schedules:
None
3. Exhibits:
A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits, which immediately precedes such
exhibits, and is incorporated herein by reference.
(b) Reports on Form 8-K
None
39
<PAGE> 40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Priority Healthcare Corporation
By: /s/ ROBERT L. MYERS
-------------------------------
Dated: March 26, 1998 Robert L. Myers
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ WILLIAM E. BINDLEY Chairman of the Board March 26, 1998
- -----------------------------
William E. Bindley
/s/ ROBERT L. MYERS President, Chief Executive March 26, 1998
- ------------------------------ Officer and Director
Robert L. Myers (Principal Executive
Officer)
/s/ DONALD J. PERFETTO Chief Financial Officer March 26, 1998
- ------------------------------ (Principal Financial and
Donald J. Perfetto Accounting Officer)
/s/ MICHAEL D. MCCORMICK Director March 26, 1998
- ------------------------------
Michael D. McCormick
/s/ RICHARD W. ROBERSON Director March 26, 1998
- -------------------------------
Richard W. Roberson
/s/ THOMAS J. SALENTINE Director March 26, 1998
- -------------------------------
Thomas J. Salentine
/s/ REBECCA M. SHANAHAN Director March 26, 1998
- -------------------------------
Rebecca M. Shanahan
S-1
<PAGE> 41
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIAL
EXHIBIT PAGE
NUMBER DOCUMENT DESCRIPTION NUMBER
- ------- -------------------------------------------------------- ------------
<S> <C> <C>
3-A (1) Restated Articles of Incorporation of the Registrant.
3-B (1) By-Laws of the Registrant, as amended to date.
3-C (1) Articles of Restatement of the Restated Articles of
Incorporation of the Registrant.
10-A (1) Administrative Services Agreement between the Registrant and BWI.
10-B (1) Tax Sharing Agreement between the Registrant and BWI.
10-C (1) *1997 Stock Option and Incentive Plan of the Registrant.
10-D (1) *Outside Directors Stock Option Plan of the Registrant.
10-E (1) *Termination Benefits Agreement between the Registrant and
Robert L. Myers dated July 1, 1996.
10-F (1) *(i) Employment Agreement between the Registrant and
Melissa E. McIntyre dated June 1, 1997; and (ii) Noncompete
Agreement between the Registrant and Melissa E. McIntyre dated
June 1, 1997.
10-G (1) *(i) Employment Agreement between the Registrant and William M.
Woodard dated June 1, 1997; and (ii) Noncompete Agreement between
the Registrant and William M. Woodard dated June 1, 1997.
10-H (1) *(i) Employment Agreement between the Registrant and Guy F.
Bryant dated June 1, 1997; and (ii) Noncompete Agreement between
the Registrant and Guy F. Bryant dated June 1, 1997.
10-I (1) *(i) Employment Agreement between the Registrant and Donald J.
Perfetto dated June 23, 1997; and (ii) Noncompete Agreement
between the Registrant and Donald J. Perfetto dated June 23,
1997.
10-J (1) *(i) Employment Agreement between the Registrant and Steven D.
Cosler dated June 1, 1997; and (ii) Noncompete Agreement between
the Registrant and Steven D. Cosler dated June 1, 1997.
10-K (1) Subordinated Promissory Note between the Registrant and BWI.
10-L (1) Indemnification and Hold Harmless Agreement between the
Registrant and BWI.
10-M (1) *Consulting Agreement dated as of January 1, 1995, by and among
the Registrant, BWI and Martin A. Nassif.
10-N (1) Revolving Credit Promissory Note between the Registrant and BWI.
21 Subsidiaries of the Registrant.
</TABLE>
E-1
<PAGE> 42
27 Financial Data Schedule.
*The indicated exhibit is a management contract, compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.
(1) The copy of this exhibit filed as the same exhibit number to the
Company's Registration Statement on Form S-1 (Registration No. 333-34463) is
incorporated herein by reference.
E-2
<PAGE> 1
PRIORITY HEALTHCARE CORPORATION
LIST OF SUBSIDIARIES
1. IV-1, Inc. - Altamonte Springs, FL
2. IV-One Services, Inc. - Altamonte Springs, FL
3. National Pharmacy Providers, Inc. - Altamonte Springs, FL
EXHIBIT 21
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 9,484
<SECURITIES> 0
<RECEIVABLES> 43,643
<ALLOWANCES> 402
<INVENTORY> 25,082
<CURRENT-ASSETS> 84,534
<PP&E> 2,492
<DEPRECIATION> (997)
<TOTAL-ASSETS> 93,302
<CURRENT-LIABILITIES> 27,046
<BONDS> 272
125
0
<COMMON> 0
<OTHER-SE> 59,758
<TOTAL-LIABILITY-AND-EQUITY> 93,302
<SALES> 230,982
<TOTAL-REVENUES> 230,982
<CGS> 207,755
<TOTAL-COSTS> 11,446
<OTHER-EXPENSES> 350
<LOSS-PROVISION> 283
<INTEREST-EXPENSE> 887
<INCOME-PRETAX> 10,209
<INCOME-TAX> 4,058
<INCOME-CONTINUING> 6,151
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,151
<EPS-PRIMARY> 0.58
<EPS-DILUTED> 0.58
</TABLE>
