FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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, Suite 1704
Altamonte Springs, Florida 32714
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (407) 869-7001
No Change
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No __
As of May 1, 1998, the number of shares outstanding of each of the issuer's
classes of common stock were as follows:
Class A Common Stock - 10,214,286
Class B Common Stock - 2,300,922
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(000's omitted except share data)
(unaudited)
Three-month period ended
March 31,
1998 1997
-----------------------------------
Net sales................................... $ 58,129 $ 52,094
Cost of products sold....................... 51,313 46,527
-----------------------------------
Gross profit................................ 6,816 5,567
Selling, general and administrative expense. 3,167 2,650
Depreciation and amortization............... 311 286
-----------------------------------
Earnings from operations.................... 3,338 2,631
Interest (income) expense, net.............. (109) 177
-----------------------------------
Earnings before income taxes................ 3,447 2,454
Provision for income taxes.................. 1,370 982
-----------------------------------
Net earnings................................ $ 2,077 $ 1,472
===================================
Earnings per share:
Basic............................... $.17 $.14
Diluted............................. $.17 $.14
Weighted average shares outstanding:
Basic............. 12,515,208 10,214,286
Diluted.............................. 12,545,051 10,214,286
(See accompanying notes to consolidated financial statements.)
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(000's omitted except share data)
(unaudited)
March 31, December 31,
1998 1997
-----------------------------------
ASSETS:
Current assets:
Cash and cash equivalents.............. $ 7,948 $ 9,484
Accounts receivable, less allowance
for doubtful accounts of $431 for
1998 and $402 for 1997................. 41,882 43,643
Receivable from parent............... 9,734 5,290
Finished goods inventory................ 22,556 25,082
Deferred income taxes................... 869 869
Other current assets.................... 163 166
-----------------------------------
83,152 84,534
-----------------------------------
Fixed assets, at cost........................ 2,725 2,492
Less: accumulated depreciation.......... 1,163 997
-----------------------------------
1,562 1,495
-----------------------------------
Intangibles, net 7,090 7,273
-----------------------------------
Total assets.................. $ 91,804 $ 93,302
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Accounts payable........................ $ 21,588 $ 24,754
Other current liabilities............... 1,902 2,292
-----------------------------------
23,490 27,046
-----------------------------------
Long-term obligations........................ 253 272
-----------------------------------
Deferred income taxes........................ 101 101
-----------------------------------
Subordinated note payable to parent.......... 6,000 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,
2,300,922 issued and outstanding.. 23 23
Additional paid in capital.......... 52,907 52,907
Retained earnings.................. 8,928 6,851
-----------------------------------
Total shareholders' equity.... 61,960 59,883
-----------------------------------
Commitments and contingencies................ -- --
-----------------------------------
Total liabilities and
shareholders' equity......... $ 91,804 $ 93,302
===================================
(See accompanying notes to consolidated financial statements.)
PRIORITY HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000's omitted)
(unaudited)
Three-month period ended
March 31,
1998 1997
-----------------------------------
Cash flow from operating activities:
Net income.............................. $ 2,077 $ 1,472
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation and amortization........... 311 286
Loss on disposal of fixed assets..... -- 69
Deferred income taxes................... -- 14
Change in assets and liabilities:
Accounts receivable..................... 1,761 (5,305)
Finished goods inventory................ 2,526 (1,937)
Trade accounts payable.................. (3,166) 929
Other current assets and liabilities.... (387) (14)
-----------------------------------
Net cash provided (used) by operating
activities...................... 3,122 (4,486)
----------------------------------
Cash flow from investing activities:
Purchase of fixed assets................ (195) (196)
-----------------------------------
Net cash used by investing
activities........................ (195) (196)
-----------------------------------
Cash flow from financing activities:
Net change in amounts due to /from
parent................................. (4,444) 3,315
Proceeds from long-term obligations..... -- 3
Payments on long-term obligations....... (19) --
-----------------------------------
Net cash provided (used) by
financing activities.............. (4,463) 3,318
-----------------------------------
Net decrease in cash......................... (1,536) (1,364)
Cash and cash equivalents at beginning
of period................................... 9,484 1,656
-----------------------------------
Cash and cash equivalents at end of period... $ 7,948 $ 292
===================================
Supplemental cash flow information:
Interest paid........................... $ 116 $ 177
Income taxes paid....................... $ 1,370 $ 968
(See accompanying notes to consolidated financial statements.)
PRIORITY HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. The accompanying consolidated financial statements have been prepared by
the Company without audit. Certain information and footnote disclosures,
including significant accounting policies, normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. The Company believes that the
financial statements for the three-month periods ended March 31, 1998 and
1997 include all necessary adjustments for fair presentation. Results for
any interim period may not be indicative of the results of the entire year.
2. 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, Ltd., Inc. ("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 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 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.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Forward Looking Statements.
Certain statements included in this quarterly report, which are not
historical facts, are forward looking statements. Such forward looking
statements are made pursuant to the safe harbor provisions of the
Private/Securities Litigation Reform Act of 1995. These forward looking
statements represent the Company's expectations or beliefs and involve
certain risks and uncertainties including, but not limited to, changes in
interest rates, competitive pressures, changes in customer mix, changes in
third party reimbursement rates, financial stability of major customers,
investment procurement opportunities, changes in government 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. The forward looking
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.
Results of Operations.
Net sales increased to $58.1 million in the first three months of 1998 from
$52.1 million in the first three months of 1997, an increase of 12%. The
increase was generated from a 33% increase in sales by the Company's
Priority Pharmacy division ("Priority Pharmacy") and a 10% increase in
sales by the Company's Priority Distribution division ("Priority
Distribution"). The growth reflected primarily the addition of new
customers, new product introductions, additional sales to existing
customers and, to a lesser extent, the acquisition of Grove Way Pharmacy
and inflationary price increases.
Gross margin increased to $6.8 million in the first three months of 1998
from $5.6 million in the first three months of 1997, an increase of 21%.
Gross margin as a percentage of net sales increased in the first three
months of 1998 to 11.7% from 10.7% in the first three months of 1997. The
increase in gross margin reflected increased sales by both Priority
Distribution and Priority Pharmacy. The increase in gross margin as a
percentage of net sales was primarily attributed to the change in sales
mix. Priority Distribution generated more sales of higher gross margin
items and Priority Pharmacy also experienced increased sales, which
generate higher gross margins than Priority Distribution. Competition
continues to exert pressure on margins, particularly those of Priority
Distribution.
Selling, general and administrative ("SGA") expense increased to $3.2
million in the first three months of 1998 from $2.7 million in the first
three months of 1997, a 19% increase. SGA expense as a percentage of net
sales increased to 5.4% in the first three months of 1998 from 5.1% in the
first three months of 1997. The increase in SGA expense as a percentage of
net sales resulted from incurring expenses associated with its Columbus,
Ohio facility, which opened in November, 1997, training costs from hiring
additional sales personnel at Priority Pharmacy, and increased overall
costs of being a publicly traded company. Management continually monitors
SGA expense and remains focused on controlling these increases through
improved technology and efficient asset management.
Depreciation and amortization increased to $311,000 in the first three
months of 1998 from $286,000 in the first three months of 1997, an increase
of 9%. The increase was primarily the result of depreciation of new
equipment, particularly in management information systems.
Interest income, net, equaled $109,000 in the first three months of 1998 as
opposed to interest expense, net, which equaled $177,000 in the first three
months of 1997. In 1998, interest income of $111,000 and $112,000 is
primarily related to amounts earned by investing funds received from the
October 1997 Initial Public Offering ("Offering") in overnight repurchase
agreements with a major financial institution and loaning funds to Bindley
Western Industries, Inc. ("BWI"), respectively. This interest income is
partially offset by interest expense of $109,000 for interest due on the
subordinated note issued to BWI on March 31, 1997. The interest income on
the intercompany loans was calculated by applying BWI's average incremental
borrowing rate to the average outstanding loans. During the first three
months of 1998 the average outstanding loans to BWI were $7.0 million.
During the first three months of 1997 the interest expense was primarily
related to borrowings from BWI. During the first three months of 1997 the
average outstanding intercompany borrowings from BWI was $10.3 million. The
interest expense on the intercompany borrowings was calculated by applying
BWI's average incremental borrowing rate to the average outstanding
borrowings. The average incremental borrowing rate was 6.4 % in the first
three months of 1998 and 1997.
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 provisions for income taxes represented 40% of
earnings before taxes for both the first three months of 1998 and 1997.
Liquidity - Capital Resources.
Net cash provided by operating activities. The Company's operations
generated $3.1 million in cash for the three months ended March 31, 1998.
Accounts receivable decreased $1.8 million, primarily due to increased
collection efforts. Inventory decreased $2.5 million due to the liquidation
of inventory purchased to take advantage of the 1997 year end buy-in
opportunities. The $3.2 million decrease in accounts payable partially
reduced the cash provided from the decreases in accounts receivable and
inventory; this decrease is primarily attributable to the timing of
payments and the decrease in inventory. Depreciation and amortization
totaled $311,000.
Net cash used by investing activities. Capital expenditures during the
first three months of 1998 totaled $195,000. The Company expects that
capital expenditures during the last nine months of 1998 will be
approximately $455,000 and during 1999 will be approximately $800,000. The
Company anticipates that these expenditures will relate primarily to the
purchase of computer hardware and software and telecommunications
equipment.
Net cash used by financing activities. The Company's receivable from BWI
increased by $4.4 million, primarily due to loaning BWI excess funds
available.
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.
Historically, the Company has financed its operations through capital
contributions and advances from BWI. These advances were repaid with a
portion of the proceeds of the Company's Offering. In connection with the
Offering, BWI has made available to the Company a $30.0 million line of
credit, which the Company may utilize until 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.
Management believes that the net proceeds from the Offering, 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.
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.
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in Note 2 to the Notes to Consolidated
Financial Statements (unaudited) set forth elsewhere in this Report is
incorporated herein by reference.
Item 2. Changes in Securities and Use of Proceeds.
(d) 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 May 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 May
13, 1998 $16.7 million of the net offering proceeds have been used to repay
indebtedness to BWI and $13.3 million has been advanced to BWI at interest
rates equal to the BWI average incremental borrowing rate.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 27 Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K
None.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
May 13, 1998 PRIORITY HEALTHCARE CORPORATION
BY: /s/ DONALD J. PERFETTO
Donald J. Perfetto
Vice President and Chief Financial
Officer
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