Back to GetFilings.com

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

For the quarterly period ended July 3, 2004

OR

For the transition period from              to             

Commission file number 000-23249

PRIORITY HEALTHCARE CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (407) 804-6700

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  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

As of July 23, 2004, the number of shares outstanding of each of the issuer’s classes of common stock were as follows:

Class A Common Stock – 6,628,942

Class B Common Stock – 37,005,759

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

PRIORITY HEALTHCARE CORPORATION

CONSOLIDATED STATEMENTS OF EARNINGS

(000’s omitted, except share data)

(unaudited)

See accompanying notes to consolidated financial statements.

2

PRIORITY HEALTHCARE CORPORATION

CONSOLIDATED BALANCE SHEETS

(000’s omitted, except share data)

See accompanying notes to consolidated financial statements.

3

PRIORITY HEALTHCARE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(000’s omitted)

(unaudited)

See accompanying notes to consolidated financial statements.

4

PRIORITY HEALTHCARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

For a summary of all of the Company’s accounting policies see Note 1 of the consolidated financial statements contained in the Company’s Form 10-K for the fiscal year ended January 3, 2004. The only such item that has changed, which had no significant impact on results of operations or financial position, since the description in the Company’s Form 10-K for the fiscal year ended January 3, 2004 is as follows:

Revenue Recognition - Revenues are recognized when products are delivered to unaffiliated customers with appropriate provisions recorded for estimated discounts and contractual allowances. Discounts and contractual allowances are estimated based on historical collections from all unaffiliated customers. Any differences between the estimates and actual collections are reflected in operations in the year payment is received. Differences may result in the amount and timing of revenues for any period if actual performance varies from the estimates. Financing charge revenues are recognized when received.

5

Options to purchase 3.2 million and 3.5 million shares with exercise prices greater than the average market prices of common stock during the three-month periods ended July 3, 2004 and June 28, 2003 were outstanding at July 3, 2004 and June 28, 2003, respectively. These options were excluded from the respective computations of diluted earnings per share because their effect would be anti-dilutive.

The Company has elected to continue to measure compensation for stock options issued to its employees and outside directors pursuant to APB No. 25 under the intrinsic value method. All stock options are granted with an exercise price at or above fair market value at the date of grant. Accordingly, no compensation expense has been recognized in connection with the issuance of stock options. Had compensation cost been determined based upon the fair value of the stock options at grant date, consistent with the method under SFAS No. 123, the Company’s net earnings and earnings per share would have been reduced to the following pro forma amounts indicated:

On April 2, 2004, the Company completed an acquisition of certain assets of Partners In Care Pharmacy, LLC (“Partners In Care”), an infertility specialty pharmacy. The acquisition was accounted for using the purchase method of accounting and the results of operations are included in the consolidated financial statements subsequent to the date of acquisition. The total purchase price for the Partners In Care assets was approximately $5.8 million, which included approximately $290,000 for inventory, deposits and fixed assets, and resulted in approximately $5.8 million of goodwill, which included other transaction costs. In addition, the former owners

6

of Partners In Care are eligible to receive additional consideration based upon revenues received from new customers under a certain contract. The results of operations of Partners In Care prior to the date of acquisition were not material to the results of the Company for the periods presented in these financial statements.

On June 14, 2004, the Company completed an acquisition of 100 percent of the stock of HealthBridge Reimbursement and Product Support, Inc. (“HealthBridge”), a service company specializing in drug launch and reimbursement support for the biotech and pharmaceutical industry. The acquisition was accounted for using the purchase method of accounting and the results of operations are included in the consolidated financial statements subsequent to the date of acquisition. The total purchase price for the HealthBridge stock was approximately $9.8 million, which included approximately $2.1 million for cash, accounts receivable, other current assets and fixed assets, approximately $830,000 in assumed accounts payable and other current liabilities, and resulted in approximately $7.4 million of goodwill, which included other transaction costs, $210,000 of trademark intangible assets and $140,000 of non compete intangible assets. In addition, the former owners of HealthBridge are eligible to receive additional consideration if HealthBridge achieves certain predetermined financial results during the 12-month periods ending May 31, 2005 and May 31, 2006. In addition, the former owners of HealthBridge are obligated to return consideration if HealthBridge does not achieve certain predetermined financial results during the 12-month period ending May 31, 2005. The results of operations of HealthBridge prior to the date of acquisition were not material to the results of the Company for the periods presented in these financial statements.

The following is a reconciliation of the beginning and ending liability balances showing separately the changes during the three-month period ended July 3, 2004 attributable to costs incurred and charged to expense and costs paid:

The Company is also subject to ordinary and routine lawsuits and governmental inspections, investigations and proceedings incidental to its business, none of which is expected to be material to the Company’s results of operations, financial condition or cash flows.

7

stock was approximately $45 million, which included approximately $35 million of cash paid in July 2004, $5 million of the Company’s shares of Class B Common Stock paid in July 2004 and $5 million of cash to be paid in July 2005. The results of operations of Integrity prior to the date of acquisition were not material to the results of the Company for the periods presented in these financial statements.

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 our 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, changes in government regulations or the interpretation of these regulations, changes in supplier relationships, growth opportunities, cost savings, revenue enhancements, synergies and other benefits anticipated from acquisition transactions, difficulties related to integrating acquired businesses, the accounting and tax treatment of acquisitions, and asserted and unasserted claims, 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 our control, and actual results may differ materially depending on a variety of important factors. Readers are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date herein.

Overview

We were formed in June 1994 to succeed to the business operations of companies previously acquired by Bindley Western Industries, Inc. (“BWI”). From our formation through our initial public offering, or IPO, on October 24, 1997, we 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. After the IPO, we continued to be controlled by BWI, but operated on a stand-alone basis. On December 31, 1998, BWI distributed to the holders of BWI common stock on December 15, 1998 all of the shares of our Class A Common Stock owned by BWI, making Priority Healthcare Corporation a stand-alone public company.

Priority is a national specialty pharmacy and distributor that provides biopharmaceuticals, complex therapies and related disease treatment programs and services to individuals with chronic diseases. Priority fills individual patient prescriptions, primarily for self-administered biopharmaceuticals. These patient-specific prescriptions are filled at 32 licensed pharmacies in 17 states and are primarily shipped directly to the patient overnight in specialized packages. We also provide disease treatment programs for hepatitis, cancer, infertility, hemophilia, human growth hormone deficiency, rheumatoid arthritis, Crohn’s disease, infertility, pulmonary hypertension, pain management, multiple sclerosis, sinusitis, age-related macular degeneration and others.

We also sell over 5,000 SKUs of specialty pharmaceuticals and medical supplies to office-based physicians in oncology and other specialty markets and to outpatient renal care centers. Priority 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 Sparks, Nevada and Grove City, Ohio, we service over 5,000 customers in all 50 states, including office-based oncologists, renal dialysis clinics, ambulatory surgery centers and primary care physicians.

Our objective is to continue to grow rapidly and enhance our market position as a leading healthcare company by capitalizing on our business strengths and pursuing the following strategy: (i) continue to focus on further penetrating the core specialty distribution and pharmacy market; (ii) develop new manufacturer relationships that provide access to new products and services; (iii) continue to develop group purchasing organization and payor networks; (iv) enter new specialty markets; and (v) pursue acquisitions to complement existing product offerings and further penetrate markets.

8

Over the past three years, we have continued to grow as we have executed on our growth strategy. Due to the nature of healthcare and the pharmaceutical industry, there is constant pressure on profit margins. Competition has resulted in some margin reduction on our products. However, as we have done in the past, we expect to be able to partially offset this impact through the continuing benefits of scale, as well as cost containment measures.

Critical Accounting Policies

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. For a summary of all of our accounting policies see Note 1 of the consolidated financial statements contained in our Form 10-K for the fiscal year ended January 3, 2004. For the items in our financial statements that we believe are the most dependent on the applications of significant estimates and judgments see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” contained in our Form 10-K for the fiscal year ended January 3, 2004. The only such item that has changed, which had no significant impact on results of operations or financial position, since the description in our Form 10-K for the fiscal year ended January 3, 2004 is as follows:

Revenue Recognition - Revenues are recognized when products are delivered to unaffiliated customers with appropriate provisions recorded for estimated discounts and contractual allowances. Discounts and contractual allowances are estimated based on historical collections from all unaffiliated customers. Any differences between our estimates and actual collections are reflected in operations in the year payment is received. Differences may result in the amount and timing of our revenues for any period if actual performance varies from our estimates. Financing charge revenues are recognized when received.

Results of Operations

The following table sets forth for the periods indicated, the percentages of net sales represented by the respective financial items:

9

Net sales increased to $839.7 million in the first six months of 2004 from $702.0 million in the first six months of 2003, an increase of 20%. Net sales increased to $438.5 million in the three months ended July 3, 2004, from $350.5 million in the three months ended June 28, 2003, an increase of 25%. The growth primarily reflected the addition of new customers, new product introductions, additional sales to existing customers, and inflationary price increases.

Gross profit increased to $88.9 million in the first six months of 2004 from $78.1 million in the first six months of 2003, an increase of 14%. Gross profit as a percentage of net sales decreased in the first six months of 2004 to 10.6% from 11.1% in the first six months of 2003. Gross profit increased to $45.9 million in the three months ended July 3, 2004, from $37.8 million in the three months ended June 28, 2003, an increase of 21%. Gross profit as a percentage of net sales decreased in the three months ended July 3, 2004, to 10.5% from 10.8% in the three months ended June 28, 2003. The increases in gross profit reflected increased sales. The decreases in gross profit as a percentage of net sales were primarily attributable to the contraction on gross profit related to oncology distribution products and the change in sales mix, as lower margin products experienced increased sales. Competition continues to exert pressure on margins.

Selling, general and administrative (“SGA”) expense increased to $45.6 million in the first six months of 2004 from $37.5 million in the first six months of 2003, an increase of 21%. SGA expense as a percentage of net sales increased in the first six months of 2004 to 5.4% from 5.3% in the first six months of 2003. SGA expense increased to $23.4 million in the three months ended July 3, 2004, from $18.8 million in the three months ended June 28, 2003, an increase of 25%. SGA expense as a percentage of net sales decreased in the three months ended July 3, 2004 to 5.3% from 5.4% in the three months ended June 28, 2003. The increases in SGA expense reflected the growth in our business, costs related to new business relationships with drug manufacturers, increased costs attributable to providing more clinically oriented services, costs related to our Sarbanes-Oxley Section 404 internal control project, incremental costs of running multiple information systems as we prepare to bring the remaining modules of our new enterprise wide information technology system live and premium increases for health, property and liability insurance. The increase in SGA expense as a percentage of net sales in the first six months of 2004 compared to the first six months of 2003 resulted from costs related to new business relationships with drug manufacturers, increased costs attributable to providing more clinically oriented services, costs related to our Sarbanes-Oxley Section 404 internal control project and incremental costs of running multiple information systems as we prepare to bring the remaining modules of our new enterprise wide information technology system live. The decrease in SGA expense as a percentage of net sales in the three months ended July 3, 2004 compared to the three months ended June 28, 2003 resulted from spreading fixed costs over a larger sales base in the three months ended July 3, 2004. Management continually monitors SGA expense and remains focused on controlling these increases through improved technology and efficient asset management.

The restructuring charge of $1.3 million in the three-month and six-month periods ended July 3, 2004 related to facility consolidation and certain employee and lease termination costs. The Company consolidated its Carpinteria, CA location into its Monrovia, CA location and eliminated certain employee positions, which included another location.

Depreciation and amortization (“D&A”) increased to $2.8 million in the first six months of 2004 from $2.0 million in the first six months of 2003, an increase of 39%. D&A increased to $1.4 million in the three months ended July 3, 2004, from $1.1 million in the three months ended June 28, 2003, an increase of 32%. The increases in D&A were primarily the result of depreciation on newly acquired computer hardware and software, furniture and equipment, transportation equipment, telephone equipment and leasehold improvements.

Interest income decreased to $369,000 in the first six months of 2004 from $812,000 in the first six months of 2003, a decrease of 55%. Interest income decreased to $163,000 in the three months ended July 3, 2004 from $351,000 in the three months ended June 28, 2003, a decrease of 54%. In the first six months of 2004 we earned 1.30% on an average invested balance of $56.9 million. In the first six months of 2003 we earned 1.97%

10

on an average invested balance of $82.6 million. In the three months ended July 3, 2004 we earned 1.12% on an average invested balance of $58.4 million. In the three months ended June 28, 2003 we earned 1.68% on an average invested balance of $83.7 million. The decreases in interest income were due to the lower average invested balances and the lower interest rates earned. In the three-month and six-month periods ended July 3, 2004 and June 28, 2003 the interest income was primarily related to amounts earned by investing cash and funds received from operations, the secondary public offering of our Class B Common Stock and stock option exercises in overnight repurchase agreements with major financial institutions and in marketable securities.

The provision for income taxes in the three-month and six-month periods ended July 3, 2004 represented 38.0% and 37.8%, respectively, of earnings before income taxes. The provision for income taxes in the three-month and six-month periods ended June 28, 2003 represented 37.5% of earnings before income taxes.

Liquidity - Capital Resources.

Our principal capital requirements have been to fund working capital needs to support internal growth, for acquisitions and for capital expenditures. Our principal working capital needs are for inventory and accounts receivable. Management controls inventory levels in order to minimize carrying costs and maximize purchasing opportunities. We sell inventory to our customers on various payment terms. This requires significant working capital to finance inventory purchases and entails accounts receivable exposure in the event any of our major customers encounter financial difficulties. Although we monitor closely the creditworthiness of our customers, there can be no assurance that we will not incur some collection loss on accounts receivable in the future.

On July 3, 2004, we had cash and cash equivalents of $43.1 million, marketable securities of $7.7 million and working capital of $215.8 million. On February 27, 2004, we entered into an agreement with Suntrust Bank, as administrative agent, for an unsecured three year revolving credit facility for up to $150 million. We intend to use the available proceeds to fund acquisitions, repurchase shares of our Class B Common Stock, provide for working capital and capital expenditures, and for other general corporate purposes. The revolving credit facility requires us, among other things, to maintain a minimum consolidated net worth, a minimum interest coverage ratio and limits our leverage ratio. We were in compliance with these covenants as of July 3, 2004. On July 3, 2004, the principal amount outstanding under this facility was $5.0 million. We believe that the cash and cash equivalents, marketable securities, working capital, revolving credit facility and cash from operations will be sufficient to meet our working capital needs for at least one year.

Net cash provided by operating activities. Our operations generated $19.5 million in cash during the first six months of 2004. Receivables, net of acquisitions, increased $41.9 million during the first six months of 2004, primarily to support the increase in sales and due to the extension of credit terms to meet competitive conditions. Finished goods inventory, net of acquisitions, decreased $12.7 million during the first six months of 2004 partly due to our concerted effort to closely monitor inventory and maintain it at an optimal level and partly due to our taking advantage of purchasing opportunities during the fourth quarter of 2003 for certain inventory items that were sold during the first six months of 2004. The $12.6 million increase in accounts payable, net of acquisitions, was attributable to the timing of payments and credit terms negotiated with vendors. Other current assets and liabilities, net of acquisitions, increased cash by $6.5 million primarily due to an increase in income taxes payable and accrued expenses and a restructuring charge accrual. We anticipate that our operations may require cash to fund our growth.

Net cash provided by investing activities. During the first six months of 2004, we sold $7.6 million of marketable securities. Capital expenditures during the first six months of 2004 totaled $5.9 million. Primarily these purchases were for our new enterprise wide information technology system, computer hardware and software, telecommunications equipment, furniture and equipment and leasehold improvements. We expect that capital expenditures during the last six months of 2004 will be approximately $7 to $10 million and during 2005 will be approximately $12 to $15 million. We anticipate that these expenditures will relate primarily to our new enterprise wide information technology system, computer hardware and software, telecommunications equipment, furniture and equipment and leasehold improvements. During the first six months of 2004, other assets increased $15 million due to increasing our deposit with our wholesaler. During the first six months of 2004, investments increased $582,000 due to making an additional investment in Burrill Life Sciences Capital

11

Fund, L.P. During the first six months of 2004, we paid $14.7 million for the acquisition of certain assets of Partners In Care, the acquisition of the stock of Healthbridge and the 2001 acquisition of InfuRx because InfuRx achieved certain predetermined financial results during the year ended January 3, 2004.

Net cash used by financing activities. During the first six months of 2004, we received proceeds of $485,000 from stock option exercises and $156,000 from the employee stock purchase plan. Also during the first six months of 2004, we purchased treasury stock for $1.2 million and borrowed $5 million on our line of credit.

Off-Balance Sheet Arrangements and Contractual Obligations

There have been no material changes to off-balance sheet arrangements described in our Form 10-K for the fiscal year ended January 3, 2004. Also, there have been no material changes outside the ordinary course of business in our contractual obligations described in our Form 10-K for the fiscal year ended January 3, 2004, except that on July 3, 2004, the principal amount outstanding on our revolving credit facility was $5.0 million, as described above.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Our primary exposure to market risk consists of a decline in the market value of our investments in marketable debt securities as a result of potential changes in interest rates. Market risk was estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in interest rates on securities included in our portfolio, and given the short term maturities of all of our investments in interest-sensitive securities, this hypothetical fair value was not materially different from the period end carrying value.

Item 4. Controls and Procedures.

We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of our disclosure controls and procedures as of July 3, 2004 pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, our President and Chief Executive Officer and our Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures are effective.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended July 3, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

Sales of Unregistered Securities

The following information is furnished as to securities of the Company sold during the three-month period ended July 3, 2004 that were not registered under the Securities Act of 1933, as amended (the “Securities Act”):

On April 15, 2004, the Company issued 9,469 shares of Class B Common Stock to the former owners of Chesapeake Infusion LLC, dba InfuRx, in connection with its acquisition. This transaction was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof.

12

On May 17, 2004, the Company issued 1,875 shares of Class B Common Stock to its five non-employee Directors as the stock portion of their annual retainer.

Issuer Purchases of Equity Securities

Item 4. Submission of Matters to a Vote of Security Holders.

In addition, the following directors continue in office until the annual meeting of shareholders in the year indicated:

13

Item 6. Exhibits and Reports on Form 8-K.

On July 22, 2004, Priority Healthcare Corporation furnished, not filed, a Form 8-K attaching a press release announcing its operating and financial results for the quarter ended July 3, 2004.

14

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.

15