UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2004
or
o	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: 000-33217

 

NEIGHBORCARE, INC.

(Exact name of registrant as specified in its charter)

 

Pennsylvania		06-1132947
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
601 East Pratt Street, 3rd Floor Baltimore, Maryland		21202
(Address of principal executive offices)		(Zip code)

 

(410) 528-7300

(Registrant’s telephone number, including area code)

 

N/A

(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 ý           NO o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act).

 

YES ý           NO o

 

As of February 4, 2005, 44,121,407 shares of the registrant’s common stock were outstanding and 259,522 shares are to be issued in connection with the registrant’s joint plan of reorganization confirmed by the Bankruptcy Court on September 20, 2001.

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS.

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

 

YES ý           NO o

 

 

TABLE OF CONTENTS

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II: OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

As used herein, unless the context otherwise requires, “NeighborCare,” the “Company,” “we,” “our” or “us” refers to NeighborCare, Inc. and our subsidiaries.

 

Statements made in this report and in our other public filings and releases, which are not historical facts, contain “forward-looking” statements (as defined in the Private Securities Litigation Reform Act of 1995) that involve risks and uncertainties and are subject to change at any time. These forward-looking statements may include, but are not limited to:

 

•                  certain statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the notes to our consolidated financial statements, such as our ability to meet our liquidity needs, scheduled debt and interest payments, and expected future capital expenditure and business acquisition requirements; the expected effects of government regulation on our business including the Medicare Prescription Drug, Improvement and Modernization Act of 2003; our ability to successfully implement our strategic objectives, including the effects of the spin-off of Genesis HealthCare Corporation (“GHC”) and the achievement of certain performance improvement initiatives within our institutional pharmacy segment, in order to improve current pharmacy profitability; costs associated with an unsolicited offer to acquire the Company; and estimates in our significant accounting policies, including our allowance for doubtful accounts, the valuation of our deferred tax assets and the anticipated impact of long-lived asset impairments;

 

•                  certain statements in “Quantitative and Qualitative Disclosures About Market Risk;” and

 

•                  certain statements in “Legal Proceedings” regarding the effects of litigation.

 

The forward-looking statements involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control. You are cautioned that these statements are not guarantees of future performance, and that actual results and trends in the future may differ materially.

 

Factors that could cause actual results to differ materially include, but are not limited to the following:

 

•                  our ability, and the ability of our customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws;

 

•                  changes in the reimbursement rates or methods of payment from Medicare and Medicaid, or the implementation of other measures to reduce the reimbursement for our services and the impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003;

 

•                  changes in pharmacy legislation and payment formulas;

 

•                  the impact of federal and state regulations;

 

•                  competition in our businesses;

 

•                  the impact of Omnicare, Inc.’s unsolicited tender offer to acquire all of our outstanding common stock and nomination of an alternative slate of directors;

 

•                  competition for qualified management and pharmacy professionals;

 

•                  the impact of investigations and audits relating to alleged violations of federal and/or state regulations;

 

•                  changes in the acuity of patients, payor mix and payment methodologies;

 

 

•                  further consolidation of managed care organizations and other third party payors;

 

•                  the effect of the expiration or termination of certain service and supply contracts;

 

•                  changes in or our failure to satisfy pharmaceutical manufacturers’ rebate programs;

 

•                  an economic downturn or changes in the laws affecting our business in those markets in which we operate;

 

•                  the impact of acquisitions, and our ability to integrate acquired businesses, on our operations and finances;

 

•                  our ability to control operating costs and generate sufficient cash flow to meet operational and financial requirements;

 

•                  our ability, and the ability of our subsidiary guarantors, to fulfill debt obligations;

 

•                  our covenants and restrictions contained in financing agreements which limit our discretion in the operation of our business;

 

•                  our charter documents and the Pennsylvania Business Corporation Law of 1988, as amended, which could delay or prevent a change of control;

 

•                  income tax liabilities and indemnification obligations related to the spin-off of GHC; and

 

•                  acts of God or public authorities, war, civil unrest, terrorism, fire, floods, earthquakes and other matters beyond our control.

 

Certain of these risks are described in more detail in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004 filed with the Securities and Exchange Commission on December 10, 2004, as amended on Form 10-K/A filed with the Securities and Exchange Commission on December 14, 2004.

 

In addition to these factors and any risks and uncertainties specifically identified in the text surrounding forward-looking statements, any statements in this report or the reports and other documents filed by us with the SEC that warn of risks or uncertainties associated with future results, events or circumstances also identify factors that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements.

 

All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable securities law.

 

1

 

PART I:  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

NEIGHBORCARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands)

 

		December 31, 2004			September 30, 2004
ASSETS
Current assets
Cash and cash equivalents		$	21,092		$	81,923
Accounts receivable, net of allowance of $16,140 and $13,608, respectively		253,015			230,903
Inventories		73,873			64,111
Prepaid expenses and other current assets		41,026			40,046
Total current assets		389,006			416,983
Property, plant and equipment, net of accumulated depreciation of $68,165 and $61,904, respectively		91,207			84,215
Other long-term assets		20,735			19,353
Identifiable intangible assets, net		16,990			12,737
Goodwill		342,940			316,120
Total assets		$	860,878		$	849,408
LIABILITIES and SHAREHOLDERS’ EQUITY
Current liabilities
Current portion of long-term debt		$	22,150		$	4,263
Accounts payable and accrued expenses		96,029			116,965
Income taxes payable		8,838			4,747
Total current liabilities		127,017			125,975
Long-term debt excluding current portion		258,418			258,008
Deferred income taxes		62,607			62,607
Other long-term liabilities		8,131			8,158
Total liabilities		456,173			454,748
Minority interest		7,531			7,880
SHAREHOLDERS’ EQUITY		397,174			386,780
Total liabilities and shareholders’ equity		$	860,878		$	849,408

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

2

 

NEIGHBORCARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(unaudited, in thousands except per share amounts)

 

		Three Months Ended December 31,
		2004			2003
Net revenues		$	392,000		$	338,394
Cost of revenues		309,734			261,967
Gross profit		82,266			76,427
Selling, general and administrative		51,949			50,797
Depreciation and amortization		7,697			6,244
Strategic planning, severance and other operating items		519			40,664
Takeover defense expenses		772			—
Operating income (loss)		21,329			(21,278		)
Interest expense, net		4,031			5,654
Other expense		1,128			1,091
Income (loss) before income tax provision (benefit)		16,170			(28,023		)
Income tax provision (benefit)		6,468			(13,874		)
Income (loss) from continuing operations		9,702			(14,149		)
Income from discontinued operations, net of taxes		—			8,435
Net income (loss)		$	9,702		$	(5,714	)
Other comprehensive income:
Termination and fair value change of derivative instruments, net		—			4,402
Comprehensive income (loss)		$	9,702		$	(1,312	)
Per common share data
Basic
Income (loss) from continuing operations		$	0.22		$	(0.35	)
Income from discontinued operations		$	—		$	0.21
Net income (loss)		$	0.22		$	(0.14	)
Weighted average shares outstanding		43,809			40,397
Diluted
Income (loss) from continuing operations		$	0.22		$	(0.35	)
Income from discontinued operations		$	—		$	0.21
Net income (loss)		$	0.22		$	(0.14	)
Weighted average shares outstanding		44,545			40,397

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3

 

NEIGHBORCARE, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

		Three Months Ended December 31,
		2004			2003
Cash flows from operating activities
Net income (loss)		$	9,702		$	(5,714	)
Net charges included in operations not requiring funds		15,267			20,227
Changes in operating assets and liabilities, excluding the impact of business acquisitions
Change in accounts receivable, net		(20,132		)	(37,974		)
Change in accounts payable and accrued expenses		(18,434		)	84,618
Other, net		(8,867		)	(34,209		)
Net cash provided (used) by operating activities		(22,464		)	26,948
Cash flows from investing activities
Capital expenditures		(12,725		)	(9,573		)
Pharmacy business acquisitions		(39,889		)	—
Other, net		(2,004		)	(33,478		)
Net cash used by investing activities		(54,618		)	(43,051		)
Cash flows from financing activities
Repayment of long-term debt		(1,329		)	(555,378		)
Borrowings against revolving credit facility		17,000			—
Proceeds from issuance of long-term debt, net of debt issuance costs		—			458,337
Distributions of cash to GHC		—			(63,154		)
Funds received from GHC for debt financing		—			135,885
Other		580			448
Net cash provided (used) by financing activities		16,251			(23,862		)
Net decrease in cash and cash equivalents		$	(60,831	)	$	(39,965	)
Cash and cash equivalents at beginning of period		81,923			132,726
Cash and cash equivalents at end of period		$	21,092		$	92,761
Non-cash investing and financing activities
Distribution of net assets to GHC		—			$	(662,419	)
Conversion of preferred stock to common stock		—			(46,831		)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4

 

NeighborCare, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

1.                                      Background and Basis of Presentation

 

NeighborCare, Inc. (“NeighborCare” or the “Company”), formerly named Genesis Health Ventures, Inc., provides pharmacy services nationwide through its NeighborCare® integrated pharmacy operation that serves approximately 287,000 institutional beds in long-term care settings.  NeighborCare also operates 32 community-based retail pharmacies and a group purchasing organization.  Prior to December 1, 2003, the Company also operated an inpatient services business, which was then spun-off as Genesis HealthCare Corporation (GHC).  For additional information, see the Company’s Form 10-K, as amended, for the fiscal year ended September 30, 2004 (Form 10-K).

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared on a basis that is substantially consistent with the accounting principles applied in the Form 10-K.  Accordingly, certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Form 10-K.

 

In the opinion of NeighborCare’s management, the unaudited condensed consolidated financial statements include all necessary adjustments consisting of normal recurring accruals and adjustments for a fair presentation of the financial position and results of operations for the periods presented. Certain reclassifications have been made to the prior year’s financial statements to conform to the current year’s presentation.

 

2.                                      Significant Accounting Policies

 

Management’s Use of Estimates

 

An accounting policy is considered to be significant if it is important to the Company’s financial condition and results of operations, and requires significant judgment and estimates on the part of management in its application. Significant accounting estimates and the related assumptions are evaluated periodically as conditions warrant, and changes to such estimates are recorded as new information or changed conditions require revision. Application of certain accounting policies requires management’s significant judgments, often as the result of the need to make estimates of matters that are inherently uncertain. If actual results were to differ materially from the estimates made, the reported results could be materially affected. The Company’s significant estimates include allowance for doubtful accounts, allowance for inventories, revenue recognition and contractual allowances, and the valuation of long-lived assets.

 

Senior management has reviewed these significant accounting policies and estimates with the Company’s audit committee. During the current quarter, there were no material changes made to the estimates or methods by which estimates are derived with regard to the significant accounting policies of the Company. See the Form 10-K for more detail regarding the Company’s significant accounting policies.

 

Stock Based Compensation

 

As permitted by the Financial Accounting Standards Board (FASB) SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148), the Company applies the intrinsic value method as defined in APB Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for its stock option and restricted stock plans. Had the Company determined compensation cost of outstanding stock options based on the fair value at the grant date consistent with the provisions of SFAS 123 “Accounting for Stock Based Compensation,” the Company’s net income (loss) would have been changed to the pro forma amounts indicated below (in thousands):

 

5

 

		Three months ended December 31,
		2004			2003
Net income (loss) – as reported		$	9,702		$	(5,714	)
Add stock-based compensation expense included in reported net income, net of tax effect		601			126
Deduct stock-based compensation expense determined under the fair-value-based method for all awards, net of tax effect		(919		)	(2,049		)
Net income (loss)– pro forma		9,384			$	(7,637	)
Net income (loss) per share:
Basic–as reported		$	0.22		$	(0.14	)
Basic–pro forma		0.21			(0.19		)
Diluted–as reported		0.22			(0.14		)
Diluted–pro forma		0.21			(0.19		)

 

There were no stock options granted during the three months ended December 31, 2004.  The fair value of stock options granted during the three months ended December 31, 2003 was estimated at the grant date using the Black-Scholes option-pricing model with the following assumptions:

 

Volatility		60	%
Expected life (in years)		5.0
Rate of return		2.2	%
Dividend yield		0	%

 

On December 16, 2004, the FASB issued Statement No. 123R, “Share Based Payment” (SFAS 123R), which is a revision of SFAS 123, “Accounting for Stock-Based Compensation.”  SFAS 123R requires that all share-based payments to employees, including stock options, be recognized in the financial statements based on their fair values on the date of grant and eliminates the disclosure-only provisions permitted under SFAS 148.  SFAS 123R is effective for fiscal periods beginning after June 15, 2005 and the Company does not anticipate that the adoption of SFAS 123R will have a material impact on its results of operations for the current fiscal year.

 

3.                                      Acquisitions

 

In the ordinary course of business, the Company makes strategic acquisitions to enhance its geographical market presence and to create beneficial operating synergies through acquisitions in locations that it has an existing market presence. On December 1, 2004, the Company completed the acquisition of Belville Pharmacy Services, Inc. (“Belville”) by purchasing certain of the assets of Belville. Also on October 1, 2004, the Company acquired certain of the assets and assumed certain liabilities of Quest Total Care, L.P. (“Quest”). The aggregate cash purchase price for these acquisitions was approximately $39.9 million. These acquisitions were accounted for under the purchase method of accounting for business combinations in accordance with SFAS No. 141 “Business Combinations.”

 

Results of these completed acquisitions are included in the Company’s consolidated statements of operations from the date of the respective acquisition.  Pro-forma financial information has not been prepared because the acquisitions are not material to the consolidated operations and financial position of the Company.  The Company’s preliminary purchase price allocation, which is based on fair-value estimates, is as follows (in thousands):

 

Accounts receivable, net		$	7,067
Inventories		1,343
Property, plant and equipment		407
Goodwill		25,788
Identifiable intangible assets		5,433
Other assets		27
Total liabilities assumed		(176		)
Net assets acquired through acquisitions		$	39,889

 

The Company expects to complete its independent third-party valuation of Belville during the second quarter of fiscal 2005.

 

6

 

4.                                      Discontinued Operations

 

Effective December 1, 2003, NeighborCare completed its plan of disposition for GHC through a distribution of GHC common stock to NeighborCare’s shareholders of record as of October 15, 2003 in the form of a tax-free spin-off as described in Note 1. Under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144), discontinued businesses, including assets held for sale or distributed to shareholders, are removed from the results of continuing operations.  Consolidated interest expense in periods prior to the spin-off has been allocated to discontinued operations using a basis of net assets of each of the continuing and discontinued operating segments for the three months ended December 31, 2003.

 

The following table sets forth the components of income from discontinued operations for the three months ended December 31, 2003 (in thousands):

 

Net revenues of GHC		$	250,927
Net operating income of GHC		16,450
Interest expense allocation		2,467
Income tax expense		5,548
Income from discontinued operations, net of taxes		$	8,435

 

5.                                      Certain Significant Transactions and Events

 

Strategic Planning, Severance and Other Operating Items

 

NeighborCare has incurred costs that are directly attributable to the Company’s transforming to a pharmacy-based business and certain of its short-term strategic objectives. These costs are segregated in the unaudited condensed consolidated statements of operations as “Strategic planning, severance and other operating items.” A summary of these costs for the three months ended December 31, 2004 follows (in thousands):

 

		Accrued as of September 30, 2004			Three months Ended December 31, 2004						Accrued as of December 31, 2004
					Provision			Paid
Employee contract termination, transaction completion bonuses, severance and related costs		$	2,304		$	519		$	456		$	2,367
Strategic planning and other items		655			—			143			512
Total		$	2,959		$	519		$	599		$	2,879

 

Strategic planning, severance and other operating items for the three months ended December 31, 2004 are attributable to the consolidation of pharmacy operations.

 

Strategic planning, severance and other operating items for the three months ended December 31, 2003 relate primarily to legal, professional and other fees incurred to complete the spin-off of GHC of $17.4 million; costs incurred pursuant to the termination provisions of employment contracts and transaction completion bonuses with NeighborCare and GHC executives of $8.8 million; and costs incurred to extinguish long-term debt and related obligations in connection with the spin-off of $14.5 million. Debt extinguishment costs represent the write-off of unamortized deferred financing costs of $5.9 million, consent fees required to eliminate the Company’s commitments under GHC debt of $5.0 million and other debt-related settlements of $3.6 million.

 

Takeover Defense Expenses

 

On May 24, 2004, Omnicare, Inc. announced its intention to purchase all of the outstanding shares of NeighborCare, Inc. common stock for $30 per share in cash. On May 25, 2004, NeighborCare announced that its Board of Directors unanimously rejected the proposal. On June 3, 2004, Omnicare, Inc. announced its intention to commence a tender offer to purchase all of the outstanding shares of NeighborCare, Inc. common stock for $30 per share in cash. The tender offer formally commenced on June 4, 2004 and was originally stated to expire on July 7, 2004 but has been subsequently extended on several occasions, most recently to March 4, 2005. On June 14, 2004, NeighborCare, Inc. announced that the Board of Directors had unanimously recommended that shareholders reject

 

7

 

the tender offer and not tender shares pursuant to the offer. Further information relating to the tender offer, including the Board’s recommendation and reasons therefore, can be found in the Company’s Solicitation/Recommendation Statement on Schedule 14D-9 filed with the Securities and Exchange Commission on June 14, 2004, and in subsequent amendments filed with Securities and Exchange Commission.

 

The Company has incurred various expenses as a result of the tender offer including legal, investment banking and other fees.  During the three months ended December 31, 2004, $0.8 million of takeover defense expenses were incurred, $8.2 million were paid and $10.1 million remains accrued as of December 31, 2004. The Company anticipates that additional takeover defense expenses will continue to be incurred through the duration of the tender offer; however, the impact of these expenses cannot be reasonably estimated.

 

6.                                      Certain Significant Risks, Uncertainties and Business Concentrations

 

At December 31, 2004, the Company had contracts to provide services to approximately 287,000 residents in long-term care facilities in 34 states and the District of Columbia. Many of these contracts, as is typical in the industry, are for a period of one year but can be terminated by either party for any reason upon thirty to sixty days written notice. For the three months ended December 31, 2004, net revenues from GHC were 12% of total institutional pharmacy revenues.  Net revenues from HCR Manor Care, Inc. (“Manor Care”) in the three months ended December 31, 2004 and 2003 were 11% and 12%, respectively, of institutional pharmacy revenue. No other individual customer or market group represented more than 5% of the total revenues of the Company’s institutional pharmacy business.

 

 7.                                   Long-Term Debt

 

Long-term debt as of December 31, 2004 and September 30, 2004 consists of the following (in thousands):

 

		December 31, 2004				September 30, 2004
Senior Subordinated Notes due 2013		$		250,000		$	250,000
Borrowings under revolving credit facility		17,000				—
Capital lease obligations and other debt		13,568				12,271
Total debt		280,568				262,271
Less:
Current portion of long-term debt		(22,150			)	(4,263			)
Long-term debt		$	258,418			$		258,008

 

During the quarter ended December 31, 2003, the Company repaid substantially all of its existing long-term debt using the proceeds of the Company’s $250 million senior subordinated notes offering and GHC’s $225 million senior subordinated notes offering.

 

8.                                      Guarantor Subsidiaries and Condensed Consolidated Financial Statements

 

The Company’s $250 million senior subordinated notes due 2013 are fully and unconditionally guaranteed on a joint and several basis by certain 100% owned subsidiaries of the Company (Guarantors). Those subsidiaries that do not guarantee the notes consist of the joint ventures in which NeighborCare has a greater than 50% share in the equity and earnings thereof (Non-Guarantors). Separate financial statements of the guarantor subsidiaries have not been prepared because management believes it would not be material to investors. The following tables present the condensed consolidating financial statements of NeighborCare, Inc. (Parent), the guarantor subsidiaries and the non-guarantor subsidiaries:

 

8

 

Condensed Consolidating Balance Sheets

December 31, 2004

(in thousands)

 

		Parent				Guarantors				Non- Guarantors						Eliminations					Consolidated
Assets
Accounts receivable, net		$	177,184			$		216,616		$	17,723					$			(158,508	)	$	253,015
Other current assets		44,550				76,970				14,471						—					135,991
Property, plant and equipment, net		18,911				65,273				7,023						—					91,207
Investment in subsidiaries		23,056				1,454				—						(23,920				)	590
Goodwill		288,633				51,016				3,291						—					342,940
Other long-term assets		26,065				11,019				51						—					37,135
		$	578,399			$	422,348			$		42,559				$	(182,428			)	$			860,878
Liabilities and Shareholders’ Equity
Accounts payable and accrued expenses		$		61,818		$		192,772		$			8,785			$	(158,508			)	$	104,867
Current portion of long-term debt		21,646				—				504						—					22,150
Long-term debt less current portion		254,903				240				3,275						—					258,418
Other non-current liabilities		78,269				—				—						—					78,269
Shareholders’ equity		161,763				229,336				29,995						(23,920				)	397,174
		$		578,399		$	422,348			$				42,559		$		(182,428		)	$		860,878

 

Condensed Consolidating Balance Sheets

September 30, 2004

(in thousands)

 

		Parent			Guarantors			Non- Guarantors			Eliminations			Consolidated
Assets
Accounts receivable, net		$	146,197		$	195,364		$	18,365		$	(129,023	)	$	230,903
Other current assets		108,879			63,787			13,414			—			186,080
Property, plant and equipment, net		18,685			58,069			7,461			—			84,215
Investment in subsidiaries		20,209			1,381			—			(21,034		)	556
Goodwill		287,142			26,720			2,258			—			316,120
Other long-term assets		25,795			5,676			63			—			31,534
		$	606,907		$	350,997		$	41,561		$	(150,057	)	$	849,408
Liabilities and Shareholders’ Equity
Accounts payable and accrued expenses		$	82,876		$	155,346		$	12,513		$	(129,023	)	$	121,712
Current portion of long-term debt		4,263			—			—			—			4,263
Long-term debt less current portion		256,240			254			1,514			—			258,008
Other non-current liabilities		78,645			—			—			—			78,645
Shareholders’ equity		184,883			195,397			27,534			(21,034		)	386,780
		$	606,907		$	350,997		$	41,561		$	(150,057	)	$	849,408

 

9

 

Condensed Consolidating Statements of Operations

Three months ended

December 31, 2004

(in thousands)

 

		Parent			Guarantors			Non- Guarantors			Consolidated
Net revenues		$	—		$	353,564		$	38,436		$	392,000
Cost of revenues		—			281,589			28,145			309,734
Gross profit		—			71,975			10,291			82,266
Operating expenses		15,672			39,863			5,402			60,937
Interest expense (income), net		3,768			196			67			4,031
Other expense (income)		1,320			(192		)	—			1,128
Income (loss) before income tax provision		(20,760		)	32,108			4,822			16,170
Income tax provision		6,463			5			—			6,468
Net income (loss)		$	(27,223	)	$	32,103		$	4,822		$	9,702

 

Condensed Consolidating Statements of Operations

Three months ended

December 31, 2003

(in thousands)

 

		Parent			Guarantors			Non- Guarantors			Consolidated
Net revenues		$	—		$	302,051		$	36,343		$	338,394
Cost of revenues		—			234,848			27,119			261,967
Gross profit		—			67,203			9,224			76,427
Operating expenses		54,451			37,672			5,582			97,705
Interest expense (income), net		5,545			51			58			5,654
Other expense (income)		1,253			(162		)	—			1,091
Income (loss) before income tax provision (benefit)		(61,249		)	29,642			3,584			(28,023		)
Income tax provision (benefit)		(13,877		)	3			—			(13,874		)
Income (loss) from continuing operations		(47,372		)	29,639			3,584			(14,149		)
Income from discontinued operations		8,435			—			—			8,435
Net income (loss)		$	(38,937	)	$	29,639		$	3,584		$	(5,714	)

 

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Condensed Consolidating Statements of Cash Flows

Three months ended

December 31, 2004

(in thousands)

 

		Parent			Guarantors			Non- Guarantors			Consolidated
Cash flow from operating activities		$	(67,425	)	$	42,504		$	2,457		$	(22,464	)
Cash flow from investing activities		(49,678		)	(4,927		)	(13		)	(54,618		)
Cash flow from financing activities		16,394			(70		)	(73		)	16,251

 

Condensed Consolidating Statements of Cash Flows

Three months ended

December 31, 2003

(in thousands)

 

		Parent			Guarantors			Non- Guarantors			Consolidated
Cash flow from operating activities		$	(12,501	)	$	32,575		$	6,874		$	26,948
Cash flow from investing activities		(4,520		)	(3,899		)	(34,632		)	(43,051		)
Cash flow from financing activities		(33,258		)	(19		)	9,415			(23,862		)

 

9.                                      Earnings (Loss) Per Share

 

The following table sets forth the computation of basic and diluted earnings (loss) per share for the three months ended December 31, 2004 and 2003 (in thousands, except per share data):

 

		Three months ended
		December 31, 2004			December 31, 2003
Earnings:
Basic and diluted calculation:
Income (loss) from continuing operations		$	9,702		$	(14,149	)
Income from discontinued operations		—			8,435
Net income (loss)		$	9,702		$	(5,714	)
Shares:
Weighted average shares outstanding — basic		43,809			40,397
Dilutive effect of stock options and restricted stock		736			—
Weighted average shares outstanding — diluted		44,545			40,397
Per common share data:
Basic:
Income (loss) from continuing operations		$	0.22		$	(0.35	)
Income from discontinued operations		$	—		$	0.21
Net income (loss)		$	0.22		$	(0.14	)
Diluted:
Income (loss) from continuing operations		$	0.22		$	(0.35	)
Income from discontinued operations		$	—		$	0.21
Net income (loss)		$	0.22		$	(0.14	)

 

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Basic earnings per share is calculated by dividing earnings (numerator) by the weighted average number of shares of common stock outstanding during the respective reporting period (denominator). Included in the calculation of basic weighted average shares for the current quarter are approximately 259,522 shares to be issued in connection with the joint plan of reorganization confirmed by the bankruptcy court.

 

Diluted earnings per share is calculated in a manner consistent with basic earnings per share except, where applicable, the weighted average shares outstanding are increased to include additional shares from the assumed exercise of stock options and vesting of restricted stock awards. For the three months ended December 31, 2003, the Company reported a net loss from continuing operations for the period, thus the impact of including the effect of unexercised stock options and unvested restricted stock would be anti-dilutive.

 

10.                               Segment Information

 

The Company’s principal operating segments are identified by the types of products and services from which revenues are derived and are consistent with the reporting structure of the Company’s internal organization. The Company has two reportable segments: (1) institutional pharmacy business and (2) corporate and other.

 

The institutional pharmacy business provides prescription and non-prescription pharmaceuticals, infusion therapy and medical supplies and equipment to the elderly, chronically ill and disabled in long-term care facilities, including skilled nursing facilities, assisted living facilities, residential and independent living communities and other institutional healthcare facilities. The pharmacy services provided in these settings are tailored to meet the needs of the institutional customer. These services include highly specialized packaging and dispensing systems, computerized medical records processing and 24-hour emergency services. The Company also provides pharmacy consulting services to assure proper and effective drug therapy, including monitoring and reporting on prescription drug therapy and assisting the facility in compliance with applicable federal and state regulations.

 

Summarized financial information concerning the Company’s reportable segments is shown in the following table for the current quarter and same period last year. The “Corporate and Other” category of operations represents operating information of business units below the prescribed quantitative thresholds under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Revenues from these business units are primarily derived from the Company’s community-based professional pharmacy business, home infusion, respiratory and medical equipment business and long-term care group purchasing business (Tidewater). The “Corporate and Other” category also consists of the Company’s corporate general and administrative function, for which there is generally no revenue generated.

 

This approach to segment reporting is consistent with the Company’s internal financial reporting and the information used by the chief operating decision makers regarding the performance of the reportable and non-reportable segments. The accounting policies of the segments are the same as those of the consolidated organization.

 

		Institutional Pharmacy			Corporate and Other			Consolidated
		(in thousands)
Three months ended December 31, 2004
Net revenues		$	337,928		$	54,072		$	392,000
Gross profit		65,595			16,671			82,266
Operating income (loss)		33,051			(11,722		)	21,329
Three months ended December 31, 2003
Net revenues		$	281,792		$	56,602		$	338,394
Gross profit		58,114			18,313			76,427
Operating income (loss)		26,573			(47,851		)	(21,278		)
Total assets as of
December 31, 2004		$	255,226		$	605,652		$	860,878
September 30, 2004		217,969			631,439			849,408

 

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11.                               Income Taxes

 

The Company’s provision (benefit) for income taxes from continuing operations for the three months ended December 31, 2004 and 2003 was $6.5 million and ($13.9) million, respectively. The income tax benefit generated from the utilization of certain NOL carryforwards will be applied first as a reduction to goodwill and, thereafter, as a direct addition to paid in capital, pursuant to Statement of Position (SOP) No. 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code,” at such time as it is assured.

 

12.                               Preferred Stock Conversion

 

Effective December 16, 2003, the Company’s board of directors exercised its option for mandatory conversion of the Series A preferred stock, at a per share conversion price of $12.60 (as adjusted from $20.33 in connection with the spin-off), into 3,464,255 shares of NeighborCare, Inc. common stock pursuant to the terms of the Company’s amended and restated articles of incorporation. Prior to December 16, 2003, 38,377 shares of Series A preferred stock were voluntarily converted into 293,643 shares of the Company’s common stock.

 

13.                               Restricted Stock

 

On June 15, 2004, the Company’s shareholders approved the 2004 Performance Incentive Plan (the Plan).  The aggregate number of shares that may be issued under the Plan is 5,000,000.  As of December 31, 2004, 432,096 shares of restricted stock have been issued to NeighborCare employees under the Plan, of which 140,659 are fully vested and 50,661 have been surrendered to fulfill employee income tax obligations resulting from the grants.  These restricted stock grants were issued out of the treasury shares held as of the respective grant dates.  Restrictions on grants to employees typically vest ratably over three years from the date of grant such that the employee cannot sell or trade the restricted stock until it becomes vested.  In addition, as of December 31, 2004, 46,921 shares of restricted stock have been issued to members of the Company’s board of directors.  Restricted shares issued to current board members are restricted such that the holder cannot sell or trade the stock unless the seller’s holdings in NeighborCare stock exceed $285,000 after the sale or trade occurs.  The restrictions immediately lapse upon the holder’s termination of board membership.

 

15.                               Changes in Shareholders’ Equity

 

The rollforward of shareholders’ equity is as follows (in thousands):

 

Balance at September 30, 2004		$	386,780
Stock option exercises and stock-based compensation		692
Net income		9,702
Balance at December 31, 2004		$	397,174

 

16.                               Commitments and Contingencies

 

Financial Commitments

 

        Requests for providing commitments to extend financial guarantees and extend credit are reviewed and approved by senior management. Management regularly reviews all outstanding commitments, letters of credit and financial guarantees, and the results of these reviews are considered in assessing the need for any provisions for possible credit and guarantee losses.

 

        As of December 31, 2004, the Company had extended letters of credit of $5.2 million. The outstanding letters of credit reduce the Company’s $83.0 million borrowing availability under its $100.0 million revolving credit facility to $77.8 million.

 

Legal Proceedings

 

The Company is a party to litigation arising in the ordinary course of business. The Company accrues for legal proceedings when an unfavorable outcome is probable and reasonably estimable. With exception to the discussion which follows, the Company does not believe the results of such litigation, even if the outcome is unfavorable, would have a material adverse effect on its financial position. While the outcome of the cases discussed below could have a material effect if decided adversely, the Company’s management considers this result unlikely. See “Cautionary Statements Regarding Forward-Looking Statements.”

 

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The following reflects developments in legal proceedings during the reporting quarter.  For information regarding other Legal Proceedings, see the Company’s Form 10-K, as amended, for the fiscal year ended September 30, 2004.

 

U.S. ex rel Scherfel v. Genesis Health Ventures et al.

 

In this action, brought in United States District Court for the District of New Jersey on March 16, 2000, the plaintiff alleges that a pharmacy purchased by the Company failed to process Medicaid credits for returned medications. The allegations are vaguely alleged for other jurisdictions. While the action was under seal in United States District Court, the Company fully cooperated with the Department of Justice’s evaluation of the allegations. On or about March 2001, the Department of Justice declined to intervene in the suit and prosecute the allegations. The United States District Court action is no longer under seal but remains administratively stayed pending resolution of the bankruptcy issues.

 

The plaintiff filed a proof of claim in the Company’s bankruptcy proceedings initially for approximately $650 million and subsequently submitted an amended claim in the amount of approximately $325 million. The Company believes the allegations have no merit and objected to the proof of claim. In connection with an estimation of the proof of claim in the bankruptcy proceeding, the Company filed a motion for summary judgment urging that the claim be estimated at zero. On or about January 24, 2002, the United States Bankruptcy Court granted our motion and estimated the claim at zero.

 

On or about February 11, 2002, the plaintiff appealed the Bankruptcy Court’s granting of summary judgment to the United States District Court in Delaware and sought an injunction preventing the distribution of assets according to the plan of reorganization. The injunction was subsequently denied by the United States District Court for several reasons, including that the plaintiff was unlikely to succeed on the merits. When the injunction was denied by the United States District Court, the assets previously reserved for the plaintiff’s claim were distributed in accordance with the plan of reorganization. On March 27, 2003, the United States District Court denied the plaintiff’s appeal and upheld the summary judgment decision rendered by the United States Bankruptcy Court. The Third Circuit Court of Appeals affirmed the decision of the District Court on October 12, 2004, and the New Jersey District Court case was subsequently dismissed.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

As of December 31, 2004, NeighborCare, Inc. (formerly named Genesis Health Ventures, Inc) provided pharmacy services for approximately 287,000 beds in long-term care facilities in 34 states and the District of Columbia.  Our pharmacy operations consist of 70 institutional pharmacies (five are jointly owned), 32 community-based professional retail pharmacies (two are jointly owned) and 19 on-site pharmacies which are located in customers’ facilities and serve only customers of that facility.  In addition, we operate 17 home infusion, respiratory and medical equipment distribution centers (four are jointly owned) and Tidewater Healthcare Shared Services Group, Inc. (“Tidewater”), one of the largest long-term care group purchasing organizations in the country.  Prior to December 1, 2003, the Company also operated an inpatient services business, which was then spun off as Genesis HealthCare Corporation (“GHC”).

 

The following discussion provides management’s analysis of our financial condition and results of operations for the quarter ended December 31, 2004 and should be read in conjunction with the consolidated financial statements and notes thereto included herein and with our annual report on Form 10-K for the fiscal year ended September 30, 2004, as amended (the “Form 10-K”).

 

Key strategic issues facing our pharmacy operations include industry trends and regulatory changes such as increasing pharmaceutical costs, lower Medicaid reimbursement rates, consolidation within the industry, competitive pricing pressure, and the Medicare Modernization Act (the “MMA”).  Our near-term strategies to address these exposures are to drive down service and product cost while retaining and improving customer service levels, to grow our pharmacy operations through acquisitions and organically, and to leverage our core business activities to expand into adjacent businesses.  More detail on the MMA is provided under “—Laws Affecting Revenues” below and in our Form 10-K.  We also continue to face costs and uncertainties associated with Omnicare’s pending unsolicited tender offer for all of its outstanding shares.

 

Certain Transactions and Events

 

Strategic Planning, Severance and Other Operating Items

 

We have incurred costs that are directly attributable to the transformation to a pharmacy-based business and certain of our short-term strategic objectives. These costs are segregated in the unaudited condensed consolidated statements of operations as “Strategic planning, severance and other operating items.” A summary of these costs for the three months ended December 31, 2004 follows (in thousands):

 

		Accrued as of September 30, 2004			Three months Ended December 31, 2004						Accrued as of December 31, 2004
					Provision			Paid
Employee contract termination, transaction completion bonuses, severance and related costs		$	2,304		$	519		$	456		$	2,367
Strategic planning and other items		655			—			143			512
Total		$	2,959		$	519		$	599		$	2,879

 

Strategic planning, severance and other operating items for the three months ended December 31, 2004 relate primarily to the consolidation of our pharmacy operations.

 

Strategic planning, severance and other operating items for the three months ended December 31, 2003 relate primarily to legal, professional and other fees incurred to complete the spin-off of GHC of $17.4 million; costs incurred pursuant to the termination provisions of employment contracts and transaction completion bonuses with NeighborCare and GHC executives of $8.8 million; and costs incurred to extinguish long-term debt and related obligations in connection with the spin-off of $14.5 million.  Debt extinguishment costs represent the write-off of unamortized deferred financing costs of $5.9 million, consent fees required to eliminate the Company’s commitments under GHC debt of $5.0 million and other debt-related settlements of $3.6 million.

 

Omnicare, Inc. Tender Offer

 

On May 24, 2004, Omnicare, Inc. announced its intention to purchase all of the outstanding shares of our common stock for

 

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$30 per share in cash. On May 25, 2004, we announced that our Board of Directors unanimously rejected the proposal. On June 3, 2004, Omnicare, Inc. announced its intention to commence a tender offer to purchase all of the outstanding shares of our common stock for $30 per share in cash. The tender offer formally commenced on June 4, 2004 and was originally stated to expire on July 7, 2004 but has been subsequently extended, most recently to March 4, 2005. On June 14, 2004, we announced that our Board of Directors had unanimously recommended that shareholders reject the tender offer and not tender shares pursuant to the offer. On December 23, 2004, Omnicare, Inc. nominated three directors to our eight member Board of Directors.  Further information relating to these matters can be found in our Solicitation/Recommendation Statement on Schedule 14D-9 filed with the Securities and Exchange Commission on June 14, 2004, and in subsequent amendments we have filed with the Securities and Exchange Commission.

 

These events may have an adverse effect on our business and results of operations. For example, the tender offer may impact our ability to attract and retain customers, management personnel and pharmacy professionals. We will also continue to incur advisory fees and other expenses which will negatively impact our results of operations.

 

We have incurred various expenses as a result of the tender offer including legal, investment banking and other fees.  During the three months ended December 31, 2004, $0.8 million of takeover defense expenses were incurred, $8.2 million were paid and $10.1 million remains accrued as of December 31, 2004. We anticipate that additional takeover defense expenses will continue to be incurred through the duration of the tender offer; however, the impact of these expenses cannot be reasonably estimated.

 

Acquisitions

 

In the ordinary course of business, we make strategic acquisitions to enhance our geographical market presence and to create beneficial operating synergies through acquisitions in locations we have an existing market presence. On December 1, 2004, we completed the acquisition of Belville Pharmacy Services, Inc. (“Belville”) by purchasing certain of the assets of Belville. Also on October 1, 2004, we acquired certain assets and assumed certain liabilities of Quest Total Care, L.P. (“Quest”). The aggregate cash purchase price for these acquisitions was approximately $39.9 million. These acquisitions were accounted for under the purchase method for accounting for business combinations in accordance with SFAS No. 141 “Business Combinations.”

 

Results of these completed acquisitions are included in our consolidated statements of operations from the date of acquisition.  Our preliminary purchase price allocations, which were based upon fair-value estimates, is as follows (in thousands):

 

Accounts receivable, net		$	7,067
Inventories		1,343
Property, plant and equipment		407
Goodwill		25,788
Intangible assets		5,433
Other assets		27
Total liabilities assumed		(176		)
Net assets acquired through acquisitions		$	39,889

 

We expect to complete our independent third-party valuation of Belville during the second quarter of fiscal 2005.

 

Discontinued Operations

 

On December 1, 2003, we completed the plan of disposition of GHC through a distribution of GHC common stock to our shareholders of record as of October 15, 2003 in the form of a tax-free spin-off as previously described.

 

The following table sets forth the components of net income (loss) from discontinued operations for the three months ended December 31, 2003 (in thousands):

 

Net revenues of GHC		$	250,927
Net operating income of GHC		16,450
Interest expense allocation		2,467
Income tax expense		5,548
Net income from discontinued operations		$	8,435

 

Consolidated interest expense in periods prior to the spin-off has been allocated to discontinued operations using a basis of net assets of each of the continuing and discontinued operating segments for the three months ended December 31, 2003.

 

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