On July 11, 2006, the Attorney General’s Office in Michigan provided the Company’s legal counsel with information concerning its investigation relating to certain billing issues under the Michigan Medicaid program at Specialized Pharmacy Services, a subsidiary of the Company located in Michigan. On October 5, 2006, the Company entered into a voluntary settlement agreement and a two-year Corporate Integrity Agreement with the State of Michigan to resolve the Michigan Attorney General’s investigation relating to certain billing issues under the Michigan Medicaid program at Specialized Pharmacy Services. Under the terms of the settlement agreement, the Company paid the State of Michigan approximately $43 million, with an additional amount of approximately $6 million to be paid over the following three years. The Company also reached an agreement in principle with the State of Michigan to resolve claims relating to billing by Specialized Pharmacy Services for drugs provided to hospice patients for a settlement amount of approximately $3.5 million. On October 26, 2007, the Company entered into settlement agreements with the federal government and the State of Michigan to resolve these hospice claims. Under the terms of the October 26, 2007 settlement agreements, the Company paid the federal government and the State of Michigan an aggregate amount of approximately $3.5 million. In connection with the settlements, the November 9, 2006 Corporate Integrity Agreement with the Department of Health and Human Services Office of the Inspector General was also amended to cover certain hospice billing matters. The settlement agreements do not include any finding of wrongdoing or any admission of liability. The Company recorded a special litigation charge of $54.0 million pretax ($46.7 million aftertax) in its financial results for 2006 based on the terms of the settlement agreement. The Corporate Integrity Agreement with the State of Michigan requires that the Company and Specialized Pharmacy Services maintain Specialized Pharmacy Services’ compliance program in accordance with the terms of the Corporate Integrity Agreement. The agreement contains specific requirements regarding compliance with Medicaid policies governing access to pharmacy facilities and records, unit dose billing agreements, consumption billing, hospice patient terminal illness prescriptions and prescriptions dispensed after a patient’s death. The requirements of the Corporate Integrity Agreement have resulted in increased costs to maintain Specialized Pharmacy Services’ compliance program and could result in greater scrutiny by Michigan
regulatory authorities. Violations of the Corporate Integrity Agreement could subject the Company to significant monetary and/or administrative penalties.
On February 2 and February 13, 2006, respectively, two substantially similar putative class action lawsuits, entitledIndiana State Dist. Council of Laborers & HOD Carriers Pension & Welfare Fund v. Omnicare, Inc., et al., No. 2:06cv26 (“HOD Carriers”), andChi v. Omnicare, Inc., et al., No. 2:06cv31 (“Chi”), were filed against Omnicare and two of its officers in the United States District Court for the Eastern District of Kentucky purporting to assert claims for violation of §§10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeking, among other things, compensatory damages and injunctive relief. The complaints, which purported to be brought on behalf of all open-market purchasers of Omnicare common stock from August 3, 2005 through January 27, 2006, alleged that Omnicare had artificially inflated its earnings by engaging in improper generic drug substitution and that defendants had made false and misleading statements regarding the Company’s business and prospects. On April 3, 2006, plaintiffs in theHOD Carriers case formally moved for consolidation and the appointment of lead plaintiff and lead counsel pursuant to the Private Securities Litigation Reform Act of 1995. On May 22, 2006, that motion was granted, the cases were consolidated, and a lead plaintiff and lead counsel were appointed. On July 20, 2006, plaintiffs filed a consolidated amended complaint, adding a third officer as a defendant and new factual allegations primarily relating to revenue recognition, the valuation of receivables and the valuation of inventories. On October 31, 2006, plaintiffs moved for leave to file a second amended complaint, which was granted on January 26, 2007, on the condition that no further amendments would be permitted absent extraordinary circumstances. Plaintiffs thereafter filed their second amended complaint on January 29, 2007. The second amended complaint (i) expands the putative class to include all purchasers of Omnicare common stock from August 3, 2005 through July 27, 2006, (ii) names two members of the Company’s board of directors as additional defendants, (iii) adds a new plaintiff and a new claim for violation of Section 11 of the Securities Act of 1933 based on alleged false and misleading statements in the registration statement filed in connection with the Company’s December 2005 public offering, (iv) alleges that the Company failed to timely disclose its contractual dispute with UnitedHealth, and (v) alleges that the Company failed to timely record certain special litigation reserves. The defendants filed a motion to dismiss the second amended complaint on March 12, 2007, claiming that plaintiffs had failed adequately to plead loss causation, scienter or any actionable misstatement or omission. That motion was fully briefed as of May 1, 2007. In response to certain arguments relating to the individual claims of the named plaintiffs that were raised in defendants’ pending motion to dismiss, plaintiffs filed a motion to add, or in the alternative, to intervene an additional named plaintiff, Alaska Electrical Pension Fund, on July 27, 2007. On October 12, 2007, the court issued an opinion and order dismissing the case and denying plaintiffs’ motion to add an additional named plaintiff. On November 9, 2007, plaintiffs filed a notice of appeal with the United States Court of Appeals for the Sixth Circuit with respect to the dismissal of their case. That appeal is fully briefed and oral argument has been scheduled for September 18, 2008.
On February 13, 2006, two substantially similar shareholder derivative actions, entitledIsak v. Gemunder, et al., Case No. 06-CI-390, andFragnoli v. Hutton, et al., Case No. 06-CI-389, were filed in Kentucky State Circuit Court, Kenton Circuit, against the members of Omnicare’s board
22
of directors, individually, purporting to assert claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment arising out of the Company’s alleged violations of federal and state health care laws based upon the same purportedly improper generic drug substitution that is the subject of the federal purported class action lawsuits. The complaints seek, among other things, damages, restitution and injunctive relief. TheIsak andFragnoli actions were later consolidated by agreement of the parties. On January 12, 2007, the defendants filed a motion to dismiss the consolidated action on the grounds that the dismissal of the substantially identical shareholder derivative action,Irwinv. Gemunder, et al., 2:06cv62, by the United States District Court for the Eastern District of Kentucky on November 20, 2006 should be given preclusive effect and thus bars re-litigation of the issues already decided inIrwin. Instead of opposing that motion, on March 16, 2007, the plaintiffs filed an amended consolidated complaint, which continues to name all of the directors as defendants and asserts the same claims, but attempts to bolster those claims by adding nearly all of the substantive allegations from the most recent complaint in the federal securities class action (seediscussion ofHOD Carriers above) and an amended complaint inIrwin that added the same factual allegations that were added to the consolidated amended complaint in the HOD Carriers action. On April 16, 2007, defendants filed a supplemental memorandum of law in further support of their pending motion to dismiss contending that the amended complaint should be dismissed on the same grounds previously articulated for dismissal, namely, the preclusive effect of the dismissal of theIrwin action. That motion has been fully briefed, oral argument was held on August 21, 2007, and the court reserved decision.
The Company believes the above-described purported class and derivative actions are without merit and will be vigorously defended.
The three and six months ended June 30, 2008 included a $16.0 million pretax charge ($10.1 million after taxes) and a $37.7 million pretax charge ($23.1 million after taxes), respectively, and the three and six months ended June 30, 2007 included a $9.0 million pretax charge ($5.5 million after taxes) and a $15.9 million pretax charge ($9.8 million after taxes), respectively, reflected in the “Litigation and other related professional fees” line of the Consolidated Statements of Income, primarily for litigation-related professional expenses in connection with the Company’s lawsuit against United, certain other large customer disputes, the administrative subpoenas from the United States Attorney’s Office, District of Massachusetts, the purported class and derivative actions, the investigation by the federal government and certain states relating to drug substitutions, the Company’s response to subpoenas it received relating to other legal proceedings to which the Company is not a party, and the inquiry conducted by the Attorney General’s Office in Michigan relating to certain billing issues under the Michigan Medicaid program.
During 2006, the Company experienced certain quality control and product recall issues, as well as fire damage, at one of its repackaging facilities, Heartland Repack Services (“Heartland”). As a precautionary measure, the Company voluntarily and temporarily suspended operations at Heartland. During the time that the Heartland facility was closed, the Company conducted certain environmental tests at the facility. Based on the results of these tests, which showed very low levels of beta lactam residue, and the time and expense associated with completing the necessary remediation procedures, as well as the short remaining term on the lease for the current
23
facility, the Company decided not to reopen the Heartland facility. The Company continues to work to address and resolve all issues, and restore centralized repackaging to full capacity. In order to temporarily replace the capacity of the Heartland facility, the Company ramped up production in its other repackaging facility, as well as onsite in its individual pharmacies for use by their patients. As a result, the Company has been and continues to be able to meet the needs of all of its client facilities and their residents. Addressing these issues served to increase costs and as a result, the three months ended June 30, 2008 included special charges of approximately $1.7 million pretax (approximately $1.5 million and approximately $0.2 million was recorded in the cost of sales and operating expenses sections of the Consolidated Statements of Income, respectively) ($1.1 million after taxes) for costs associated with the quality control, product recall and fire damage issues at Heartland (“Heartland Matters”). The associated costs for the six months ended June 30, 2008 totaled $3.6 million pretax ($3.1 million and $0.5 million was recorded in the cost of sales and operating expenses sections of the Consolidated Statements of Income, respectively) ($2.2 million after taxes). The three months ended June 30, 2007 included special charges of approximately $4.9 million pretax ($4.0 million and $0.9 million was recorded in the cost of sales and operating expenses sections of the Consolidated Statements of Income, respectively) ($3.0 million after taxes) for costs associated with the Heartland Matters. The associated costs for the six months ended June 30, 2007 totaled $10.7 million pretax ($8.3 million and $2.4 million was recorded in the cost of sales and operating expenses sections of the Consolidated Statements of Income, respectively) ($6.6 million after taxes). The Company maintains product recall, property and casualty and business interruption insurance, and the extent of insurance recovery for these expenses continues to be reviewed by its outside advisors. As of June 30, 2008, no receivables for insurance recoveries have been recorded by the Company. Further, in order to replace the repackaging capacity of the Heartland facility, on February 27, 2007, Omnicare entered into an agreement for the Repackaging Services division of Cardinal Health to serve as the contract repackager for pharmaceutical volumes previously repackaged at the Heartland facility. The agreement initially extends through October 2010.
Although the Company cannot know with certainty the ultimate outcome of the matters described in the preceding paragraphs, there can be no assurance that the resolution of these matters will not have a material adverse impact on the Company’s consolidated results of operations, financial position or cash flows or, in the case of the investigations regarding certain drug substitutions and the matters relating to the Heartland facility, that these matters will be resolved in an amount that would not exceed the amount of the pretax charges recorded by the Company.
As part of its ongoing operations, the Company is subject to various inspections, audits, inquiries and similar actions by third parties, as well as governmental/regulatory authorities responsible for enforcing the laws and regulations to which the Company is subject. The Company is also involved in various legal actions arising in the normal course of business. These matters are continuously being evaluated and, in many cases, are being contested by the Company and the outcome is not predictable. Consequently, an estimate of the possible loss or range of loss associated with certain actions cannot be made. Although occasional adverse outcomes (or settlements) may occur and could possibly have an adverse effect on the results of operations and cash flows in any one accounting period, outside of the matters described in the preceding paragraphs, the Company is not aware of any such matters whereby it is presently believed that
24
the final disposition will have a material adverse affect on the Company’s overall consolidated financial position.
The Company indemnifies the directors and officers of the Company for certain liabilities that might arise from the performance of their job responsibilities for the Company. Additionally, in the normal course of business, the Company enters into contracts that contain a variety of representations and warranties and which provide general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this involves the resolution of claims made, or future claims that may be made, against the Company, its directors and/or officers, the outcomes of which is unknown and not currently predictable. Accordingly, no liabilities have been recorded for the indemnifications.
Note 12 - Segment Information
Based on the “management approach,” as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” Omnicare has two operating segments. The Company’s larger segment is Pharmacy Services. Pharmacy Services primarily provides distribution of pharmaceuticals, related pharmacy consulting and other ancillary services, data management services, medical supplies, and distribution and patient assistance services for specialty pharmaceuticals. The Company’s customers are primarily skilled nursing, assisted living, hospice and other providers of healthcare services in 47 states in the United States, the District of Columbia and in Canada at June 30, 2008. The Company’s other segment is CRO Services, which provides comprehensive product development and research services to client companies in pharmaceutical, biotechnology, medical devices and diagnostics industries in 30 countries around the world at June 30, 2008, including the United States. Certain reclassification of prior-year depreciation and amortization amounts have been made to conform with the current-year presentation.
25
The table below presents information about the segments as of and for the three and six months ended June 30, 2008 and 2007, and should be read in conjunction with the paragraph that follows (in thousands):
| | | | | | | | | | | | | |
| | Three months ended June 30, | |
| |
| |
2008: | | Pharmacy
Services | | CRO
Services | | Corporate and
Consolidating | | Consolidated
Totals | |
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | 1,496,521 | | $ | 53,631 | | $ | — | | $ | 1,550,152 | |
Depreciation and amortization | | | (20,692 | ) | | (450 | ) | | (7,006 | ) | | (28,148 | ) |
Restructuring and other related charges | | | (9,222 | ) | | (600 | ) | | (962 | ) | | (10,784 | ) |
Litigation and other related professional fees | | | (16,022 | ) | | — | | | — | | | (16,022 | ) |
Heartland matters | | | (1,740 | ) | | — | | | — | | | (1,740 | ) |
Operating income (expense) | | | 117,516 | | | 3,800 | | | (28,957 | ) | | 92,359 | |
Total assets | | | 6,915,425 | | | 194,286 | | | 372,469 | | | 7,482,180 | |
Capital expenditures | | | (14,220 | ) | | (1,728 | ) | | (81 | ) | | (16,029 | ) |
| | | | | | | | | | | | | |
2007: | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | 1,498,918 | | $ | 50,239 | | $ | — | | $ | 1,549,157 | |
Depreciation and amortization | | | (21,269 | ) | | (477 | ) | | (6,740 | ) | | (28,486 | ) |
Restructuring and other related charges | | | (5,004 | ) | | (252 | ) | | (994 | ) | | (6,250 | ) |
Litigation and other related professional fees | | | (9,010 | ) | | — | | | — | | | (9,010 | ) |
Heartland matters | | | (4,911 | ) | | — | | | — | | | (4,911 | ) |
Operating income (expense) | | | 144,274 | | | 2,904 | | | (26,208 | ) | | 120,970 | |
Total assets | | | 7,001,157 | | | 181,252 | | | 287,811 | | | 7,470,220 | |
Capital expenditures | | | (9,629 | ) | | (388 | ) | | (627 | ) | | (10,644 | ) |
26
| | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2008: | | Pharmacy
Services | | CRO
Services | | Corporate and
Consolidating | | Consolidated
Totals | |
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | 3,006,327 | | $ | 102,804 | | $ | — | | $ | 3,109,131 | |
Depreciation and amortization | | | (40,931 | ) | | (889 | ) | | (15,843 | ) | | (57,663 | ) |
Restructuring and other related charges | | | (14,318 | ) | | (1,374 | ) | | (1,540 | ) | | (17,232 | ) |
Litigation and other related professional fees | | | (37,664 | ) | | — | | | — | | | (37,664 | ) |
Heartland matters | | | (3,633 | ) | | — | | | — | | | (3,633 | ) |
Operating income (expense) | | | 226,751 | | | 6,468 | | | (56,616 | ) | | 176,603 | |
Total assets | | | 6,915,425 | | | 194,286 | | | 372,469 | | | 7,482,180 | |
Capital expenditures | | | (26,144 | ) | | (2,070 | ) | | (254 | ) | | (28,468 | ) |
| | | | | | | | | | | | | |
2007: | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | 3,028,561 | | $ | 97,661 | | $ | — | | $ | 3,126,222 | |
Depreciation and amortization | | | (42,880 | ) | | (954 | ) | | (13,374 | ) | | (57,208 | ) |
Restructuring and other related charges | | | (9,756 | ) | | (2,070 | ) | | (3,598 | ) | | (15,424 | ) |
Litigation and other related professional fees | | | (15,917 | ) | | — | | | — | | | (15,917 | ) |
Heartland matters | | | (10,703 | ) | | — | | | — | | | (10,703 | ) |
Operating income (expense) | | | 279,864 | | | 3,634 | | | (52,842 | ) | | 230,656 | |
Total assets | | | 7,001,157 | | | 181,252 | | | 287,811 | | | 7,470,220 | |
Capital expenditures | | | (17,100 | ) | | (662 | ) | | (1,163 | ) | | (18,925 | ) |
In accordance with Emerging Issues Task Force (“EITF”) Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred” (“EITF No. 01-14”), Omnicare included in its reported CRO segment net sales amount, for the three and six month periods ended June 30, 2008, reimbursable out-of-pockets totaling $8.8 million and $16.2 million, respectively, and $8.2 million and $15.4 million for the three and six months ended June 30, 2007, respectively.
Note 13 - Guarantor Subsidiaries
The Company’s 6.125% senior subordinated notes due 2013, the 6.75% senior subordinated notes due 2013 and the 6.875% senior subordinated notes due 2015 are fully and unconditionally guaranteed on an unsecured, joint and several basis by certain wholly-owned subsidiaries of the Company (the “Guarantor Subsidiaries”). The following condensed consolidating financial data illustrates the composition of Omnicare, Inc. (“Parent”), the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries as of June 30, 2008 and December 31, 2007 for the balance sheets, the three and six months ended June 30, 2008 and 2007 for the statements of income, and the statements of cash flows for the six months ended June 30, 2008 and 2007. Management believes separate complete financial statements of the respective Guarantor Subsidiaries would not provide information that would be necessary for evaluating the sufficiency of the Guarantor Subsidiaries, and thus are not presented. No consolidating/eliminating adjustment column is presented for the condensed consolidating statements of cash flows since there were no significant consolidating/eliminating adjustment amounts during the periods presented.
27
Note 13 - Guarantor Subsidiaries (Continued)
Summary Consolidating Statements of Income - Unaudited
(in thousands)
| | | | | | | | | | | | | | | | |
| | Three months ended June 30, | |
| |
| |
2008: | | Parent | | Guarantor
Subsidiaries | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | 1,488,742 | | $ | 61,410 | | $ | — | | $ | 1,550,152 | |
Cost of sales | | | — | | | 1,119,065 | | | 47,396 | | | — | | | 1,166,461 | |
Heartland matters | | | — | | | 1,560 | | | — | | | — | | | 1,560 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | 368,117 | | | 14,014 | | | — | | | 382,131 | |
Selling, general and administrative expenses | | | 2,349 | | | 225,988 | | | 8,682 | | | — | | | 237,019 | |
Provision for doubtful accounts | | | — | | | 24,751 | | | 1,016 | | | — | | | 25,767 | |
Restructuring and other related charges | | | — | | | 10,560 | | | 224 | | | — | | | 10,784 | |
Litigation and other related professional fees | | | — | | | 16,022 | | | — | | | — | | | 16,022 | |
Heartland matters | | | — | | | 180 | | | — | | | — | | | 180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (2,349 | ) | | 90,616 | | | 4,092 | | | — | | | 92,359 | |
Investment income | | | 817 | | | 1,142 | | | — | | | — | | | 1,959 | |
Interest expense | | | (34,846 | ) | | (271 | ) | | (823 | ) | | — | | | (35,940 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (36,378 | ) | | 91,487 | | | 3,269 | | | — | | | 58,378 | |
Income tax (benefit) expense | | | (13,668 | ) | | 34,001 | | | 1,240 | | | — | | | 21,573 | |
Equity in net income of subsidiaries | | | 59,515 | | | — | | | — | | | (59,515 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | $ | 36,805 | | $ | 57,486 | | $ | 2,029 | | $ | (59,515 | ) | $ | 36,805 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
2007: | | | | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | 1,491,712 | | $ | 57,445 | | $ | — | | $ | 1,549,157 | |
Cost of sales | | | — | | | 1,107,178 | | | 42,931 | | | — | | | 1,150,109 | |
Heartland matters | | | — | | | 4,015 | | | — | | | — | | | 4,015 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | 380,519 | | | 14,514 | | | — | | | 395,033 | |
Selling, general and administrative expenses | | | 2,140 | | | 215,310 | | | 10,558 | | | — | | | 228,008 | |
Provision for doubtful accounts | | | — | | | 29,457 | | | 442 | | | — | | | 29,899 | |
Restructuring and other related charges | | | — | | | 6,250 | | | — | | | — | | | 6,250 | |
Litigation and other related professional fees | | | — | | | 9,010 | | | — | | | — | | | 9,010 | |
Heartland matters | | | — | | | 896 | | | — | | | — | | | 896 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (2,140 | ) | | 119,596 | | | 3,514 | | | — | | | 120,970 | |
Investment income | | | 764 | | | 1,338 | | | — | | | — | | | 2,102 | |
Interest expense | | | (40,600 | ) | | (293 | ) | | (825 | ) | | — | | | (41,718 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (41,976 | ) | | 120,641 | | | 2,689 | | | — | | | 81,354 | |
Income tax (benefit) expense | | | (16,474 | ) | | 47,529 | | | 1,058 | | | — | | | 32,113 | |
Equity in net income of subsidiaries | | | 74,743 | | | — | | | — | | | (74,743 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | $ | 49,241 | | $ | 73,112 | | $ | 1,631 | | $ | (74,743 | ) | $ | 49,241 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
28
Note 13 - Guarantor Subsidiaries (Continued)
Summary Consolidating Statements of Income - Unaudited
(in thousands)
| | | | | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2008: | | Parent | | Guarantor
Subsidiaries | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | 2,987,427 | | $ | 121,704 | | $ | — | | $ | 3,109,131 | |
Cost of sales | | | — | | | 2,250,679 | | | 93,545 | | | — | | | 2,344,224 | |
Heartland matters | | | — | | | 3,134 | | | — | | | — | | | 3,134 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | 733,614 | | | 28,159 | | | — | | | 761,773 | |
Selling, general and administrative expenses | | | 4,297 | | | 450,983 | | | 18,336 | | | — | | | 473,616 | |
Provision for doubtful accounts | | | — | | | 53,802 | | | 2,357 | | | — | | | 56,159 | |
Restructuring and other related charges | | | — | | | 17,008 | | | 224 | | | — | | | 17,232 | |
Litigation and other related professional fees | | | — | | | 37,664 | | | — | | | — | | | 37,664 | |
Heartland matters | | | — | | | 499 | | | — | | | — | | | 499 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (4,297 | ) | | 173,658 | | | 7,242 | | | — | | | 176,603 | |
Investment income | | | 1,391 | | | 3,179 | | | — | | | — | | | 4,570 | |
Interest expense | | | (69,831 | ) | | (1,426 | ) | | (1,739 | ) | | — | | | (72,996 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (72,737 | ) | | 175,411 | | | 5,503 | | | — | | | 108,177 | |
Income tax (benefit) expense | | | (28,164 | ) | | 67,461 | | | 2,131 | | | — | | | 41,428 | |
Equity in net income of subsidiaries | | | 111,322 | | | — | | | — | | | (111,322 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | $ | 66,749 | | $ | 107,950 | | $ | 3,372 | | $ | (111,322 | ) | $ | 66,749 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
2007: | | | | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | 3,011,730 | | $ | 114,492 | | $ | — | | $ | 3,126,222 | |
Cost of sales | | | — | | | 2,255,878 | | | 85,224 | | | — | | | 2,341,102 | |
Heartland matters | | | — | | | 8,311 | | | — | | | — | | | 8,311 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | 747,541 | | | 29,268 | | | — | | | 776,809 | |
Selling, general and administrative expenses | | | 4,273 | | | 429,377 | | | 19,967 | | | — | | | 453,617 | |
Provision for doubtful accounts | | | — | | | 57,919 | | | 884 | | | — | | | 58,803 | |
Restructuring and other related charges | | | — | | | 14,514 | | | 910 | | | — | | | 15,424 | |
Litigation and other related professional fees | | | — | | | 15,917 | | | — | | | — | | | 15,917 | |
Heartland matters | | | — | | | 2,392 | | | — | | | — | | | 2,392 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (4,273 | ) | | 227,422 | | | 7,507 | | | — | | | 230,656 | |
Investment income | | | 1,335 | | | 2,688 | | | — | | | — | | | 4,023 | |
Interest expense | | | (81,606 | ) | | (569 | ) | | (1,591 | ) | | — | | | (83,766 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (84,544 | ) | | 229,541 | | | 5,916 | | | — | | | 150,913 | |
Income tax (benefit) expense | | | (32,735 | ) | | 89,129 | | | 2,291 | | | — | | | 58,685 | |
Equity in net income of subsidiaries | | | 144,037 | | | — | | | — | | | (144,037 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | $ | 92,228 | | $ | 140,412 | | $ | 3,625 | | $ | (144,037 | ) | $ | 92,228 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
29
Note 13 - Guarantor Subsidiaries (Continued)
| | | | | | | | | | | | | | | | |
Condensed Consolidating Balance Sheets |
(in thousands) |
| | | | | | | | | | | | | | | | |
As of June 30, 2008 (Unaudited): | | Parent | | Guarantor
Subsidiaries | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
| |
ASSETS | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 135,886 | | $ | 52,742 | | $ | 20,102 | | $ | — | | $ | 208,730 | |
Restricted cash | | | — | | | 15,019 | | | — | | | — | | | 15,019 | |
Accounts receivable, net (including intercompany) | | | — | | | 1,316,705 | | | 35,701 | | | (4,364 | ) | | 1,348,042 | |
Unbilled receivables, CRO | | | — | | | 28,509 | | | — | | | — | | | 28,509 | |
Inventories | | | — | | | 388,240 | | | 11,844 | | | — | | | 400,084 | |
Deferred income tax benefits, net-current | | | — | | | 132,763 | | | 96 | | | (3,352 | ) | | 129,507 | |
Other current assets | | | 1,608 | | | 198,006 | | | 4,487 | | | — | | | 204,101 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 137,494 | | | 2,131,984 | | | 72,230 | | | (7,716 | ) | | 2,333,992 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Properties and equipment, net | | | — | | | 193,909 | | | 9,756 | | | — | | | 203,665 | |
Goodwill | | | — | | | 4,274,581 | | | 103,232 | | | — | | | 4,377,813 | |
Identifiable intangible assets, net | | | — | | | 308,400 | | | 5,278 | | | — | | | 313,678 | |
Other noncurrent assets | | | 48,181 | | | 204,593 | | | 258 | | | — | | | 253,032 | |
Investment in subsidiaries | | | 5,920,359 | | | — | | | — | | | (5,920,359 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 6,106,034 | | $ | 7,113,467 | | $ | 190,754 | | $ | (5,928,075 | ) | $ | 7,482,180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | |
Current liabilities (including intercompany) | | $ | 28,906 | | $ | 543,505 | | $ | 18,731 | | $ | (4,364 | ) | $ | 586,778 | |
Long-term debt, notes and convertible debentures | | | 2,712,882 | | | 3,159 | | | 50,022 | | | — | | | 2,766,063 | |
Deferred income tax liabilities, net-noncurrent | | | 85,325 | | | 407,148 | | | 9,789 | | | (3,352 | ) | | 498,910 | |
Other noncurrent liabilities | | | 9,618 | | | 350,296 | | | 1,212 | | | — | | | 361,126 | |
Stockholders’ equity | | | 3,269,303 | | | 5,809,359 | | | 111,000 | | | (5,920,359 | ) | | 3,269,303 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 6,106,034 | | $ | 7,113,467 | | $ | 190,754 | | $ | (5,928,075 | ) | $ | 7,482,180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
30
Note 13 - Guarantor Subsidiaries (Continued)
| | | | | | | | | | | | | | | | |
Condensed Consolidating Balance Sheets - (Continued) |
(in thousands) |
| | | | | | | | | | | | | | | | |
As of December 31, 2007: | | Parent | | Guarantor
Subsidiaries | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
| |
ASSETS | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 171,779 | | $ | 70,088 | | $ | 32,581 | | $ | — | | $ | 274,448 | |
Restricted cash | | | — | | | 3,155 | | | — | | | — | | | 3,155 | |
Accounts receivable, net (including intercompany) | | | — | | | 1,348,504 | | | 30,386 | | | (2,602 | ) | | 1,376,288 | |
Unbilled receivables, CRO | | | — | | | 24,855 | | | — | | | — | | | 24,855 | |
Inventories | | | — | | | 436,639 | | | 11,544 | | | — | | | 448,183 | |
Deferred income tax benefits, net-current | | | 878 | | | 125,474 | | | — | | | (113 | ) | | 126,239 | |
Other current assets | | | 1,336 | | | 196,474 | | | 5,172 | | | — | | | 202,982 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 173,993 | | | 2,205,189 | | | 79,683 | | | (2,715 | ) | | 2,456,150 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Properties and equipment, net | | | — | | | 188,340 | | | 11,109 | | | — | | | 199,449 | |
Goodwill | | | — | | | 4,238,547 | | | 103,622 | | | — | | | 4,342,169 | |
Identifiable intangible assets, net | | | — | | | 318,255 | | | 5,382 | | | — | | | 323,637 | |
Other noncurrent assets | | | 52,135 | | | 219,906 | | | 333 | | | — | | | 272,374 | |
Investment in subsidiaries | | | 5,939,714 | | | — | | | — | | | (5,939,714 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 6,165,842 | | $ | 7,170,237 | | $ | 200,129 | | $ | (5,942,429 | ) | $ | 7,593,779 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | |
Current liabilities (including intercompany) | | $ | 33,105 | | $ | 600,095 | | $ | 21,562 | | $ | (2,602 | ) | $ | 652,160 | |
Long-term debt, notes and convertible debentures | | | 2,764,510 | | | 4,505 | | | 51,736 | | | — | | | 2,820,751 | |
Deferred income tax liabilities, net-noncurrent | | | 68,534 | | | 372,110 | | | 9,258 | | | (113 | ) | | 449,789 | |
Other noncurrent liabilities | | | 7,990 | | | 370,352 | | | 1,034 | | | — | | | 379,376 | |
Stockholders’ equity | | | 3,291,703 | | | 5,823,175 | | | 116,539 | | | (5,939,714 | ) | | 3,291,703 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 6,165,842 | | $ | 7,170,237 | | $ | 200,129 | | $ | (5,942,429 | ) | $ | 7,593,779 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
31
Note 13 - Guarantor Subsidiaries (Continued)
| | | | | | | | | | | | | |
Condensed Consolidating Statements of Cash Flows - Unaudited |
(in thousands) |
| | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2008: | | Parent | | Guarantor
Subsidiaries | | Non-Guarantor
Subsidiaries | | Omnicare, Inc.
and
Subsidiaries | |
|
|
|
|
|
|
|
|
| |
Cash flows from operating activities: | | | | | | | | | | | | | |
Net cash flows from operating activities | | $ | (20,886 | ) | $ | 263,011 | | $ | (13,513 | ) | $ | 228,612 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | | |
Acquisition of businesses, net of cash received | | | — | | | (90,988 | ) | | — | | | (90,988 | ) |
Capital expenditures | | | — | | | (28,271 | ) | | (197 | ) | | (28,468 | ) |
Transfer of cash to trusts for employee health and severance costs, net of payments out of the trust | | | — | | | (11,589 | ) | | — | | | (11,589 | ) |
Other | | | — | | | (6 | ) | | — | | | (6 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in investing activities | | | — | | | (130,854 | ) | | (197 | ) | �� | (131,051 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | | |
Borrowings on line of credit facilities and term A loan | | | 59,000 | | | — | | | — | | | 59,000 | |
Payments on line of credit facilities and term A loan | | | (109,000 | ) | | — | | | — | | | (109,000 | ) |
Payments on long-term borrowings and obligations | | | (1,606 | ) | | — | | | — | | | (1,606 | ) |
Change in cash overdraft balance | | | (4,032 | ) | | 426 | | | — | | | (3,606 | ) |
Payments for Omnicare common stock repurchases | | | (100,165 | ) | | — | | | — | | | (100,165 | ) |
(Payments) for stock awards and exercise of stock options, net of stock tendered in payment | | | (3,803 | ) | | — | | | — | | | (3,803 | ) |
Excess tax benefits from stock-based compensation | | | 82 | | | — | | | — | | | 82 | |
Dividends paid | | | (5,412 | ) | | — | | | — | | | (5,412 | ) |
Other | | | 149,929 | | | (149,929 | ) | | — | | | — | |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in financing activities | | | (15,007 | ) | | (149,503 | ) | | — | | | (164,510 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Effect of exchange rate changes on cash | | | — | | | — | | | 1,231 | | | 1,231 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Net (decrease) in cash and cash equivalents | | | (35,893 | ) | | (17,346 | ) | | (12,479 | ) | | (65,718 | ) |
Cash and cash equivalents at beginning of period | | | 171,779 | | | 70,088 | | | 32,581 | | | 274,448 | |
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents at end of period | | $ | 135,886 | | $ | 52,742 | | $ | 20,102 | | $ | 208,730 | |
| |
|
| |
|
| |
|
| |
|
| |
32
Note 13 - Guarantor Subsidiaries (Continued)
| | | | | | | | | | | | | |
Condensed Consolidating Statements of Cash Flows - (Continued) - Unaudited |
(in thousands) |
| | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2007: | | Parent | | Guarantor
Subsidiaries | | Non-Guarantor
Subsidiaries | | Omnicare, Inc.
and
Subsidiaries | |
|
|
|
|
|
|
|
|
| |
Cash flows from operating activities: | | | | | | | | | | | | | |
Net cash flows from operating activities | | $ | (29,750 | ) | $ | 257,935 | | $ | 7,742 | | $ | 235,927 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | | |
Acquisition of businesses, net of cash received | | | — | | | (69,299 | ) | | — | | | (69,299 | ) |
Capital expenditures | | | — | | | (18,179 | ) | | (746 | ) | | (18,925 | ) |
Transfer of cash to trusts for employee health and severance costs, net of payments out of the trust | | | — | | | (10,501 | ) | | — | | | (10,501 | ) |
Other | | | — | | | (98 | ) | | (8 | ) | | (106 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in investing activities | | | — | | | (98,077 | ) | | (754 | ) | | (98,831 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | | |
Borrowings on line of credit facilities and term A loan | | | 74,000 | | | — | | | — | | | 74,000 | |
Payments on line of credit facilities and term A loan | | | (174,000 | ) | | — | | | — | | | (174,000 | ) |
Payments on long-term borrowings and obligations | | | (3,631 | ) | | — | | | — | | | (3,631 | ) |
Change in cash overdraft balance | | | (9,372 | ) | | (2,272 | ) | | — | | | (11,644 | ) |
(Payments) for stock awards and exercise of stock options, net of stock tendered in payment | | | (8,132 | ) | | — | | | — | | | (8,132 | ) |
Excess tax benefits from stock-based compensation | | | 4,079 | | | — | | | — | | | 4,079 | |
Dividends paid | | | (5,482 | ) | | — | | | — | | | (5,482 | ) |
Other | | | 187,469 | | | (187,469 | ) | | — | | | — | |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows from financing activities | | | 64,931 | | | (189,741 | ) | | — | | | (124,810 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Effect of exchange rate changes on cash | | | — | | | — | | | 942 | | | 942 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 35,181 | | | (29,883 | ) | | 7,930 | | | 13,228 | |
Cash and cash equivalents at beginning of period | | | 43,494 | | | 74,262 | | | 20,278 | | | 138,034 | |
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents at end of period | | $ | 78,675 | | $ | 44,379 | | $ | 28,208 | | $ | 151,262 | |
| |
|
| |
|
| |
|
| |
|
| |
33
Note 13 - Guarantor Subsidiaries (Continued)
The Company’s 3.25% convertible senior debentures due 2035 are fully and unconditionally guaranteed on an unsecured basis by Omnicare Purchasing Company, LP, a wholly-owned subsidiary of the Company (the “Guarantor Subsidiary”). The following condensed consolidating financial data illustrates the composition of Omnicare, Inc. (“Parent”), the Guarantor Subsidiary and the Non-Guarantor Subsidiaries as of June 30, 2008 and December 31, 2007 for the balance sheets, the three and six months ended June 30, 2008 and 2007 for the statements of income, and the statements of cash flows for the six months ended June 30, 2008 and 2007. Management believes separate complete financial statements of the respective Guarantor Subsidiary would not provide information that would be necessary for evaluating the sufficiency of the Guarantor Subsidiary, and thus are not presented. The Guarantor Subsidiary does not have any material net cash flows in the condensed consolidating statements of cash flows. No consolidating/eliminating adjustments column is presented for the condensed consolidating statements of cash flows since there were no significant consolidating/eliminating adjustment amounts during the periods presented.
34
Summary Consolidating Statements of Income - Unaudited
(in thousands)
| | | | | | | | | | | | | | | | |
| | Three months ended June 30, | |
| |
|
|
2008: | | Parent | | Guarantor
Subsidiary | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | — | | $ | 1,550,152 | | $ | — | | $ | 1,550,152 | |
Cost of sales | | | — | | | — | | | 1,166,461 | | | — | | | 1,166,461 | |
Heartland matters | | | — | | | — | | | 1,560 | | | — | | | 1,560 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | — | | | 382,131 | | | — | | | 382,131 | |
Selling, general and administrative expenses | | | 2,349 | | | 346 | | | 234,324 | | | — | | | 237,019 | |
Provision for doubtful accounts | | | — | | | — | | | 25,767 | | | — | | | 25,767 | |
Restructuring and other related charges | | | — | | | — | | | 10,784 | | | — | | | 10,784 | |
Litigation and other related professional fees | | | — | | | — | | | 16,022 | | | — | | | 16,022 | |
Heartland matters | | | — | | | — | | | 180 | | | — | | | 180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (2,349 | ) | | (346 | ) | | 95,054 | | | — | | | 92,359 | |
Investment income | | | 817 | | | — | | | 1,142 | | | — | | | 1,959 | |
Interest expense | | | (34,846 | ) | | — | | | (1,094 | ) | | — | | | (35,940 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (36,378 | ) | | (346 | ) | | 95,102 | | | — | | | 58,378 | |
Income tax (benefit) expense | | | (13,668 | ) | | (130 | ) | | 35,371 | | | — | | | 21,573 | |
Equity in net income of subsidiaries | | | 59,515 | | | — | | | — | | | (59,515 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | 36,805 | | $ | (216 | ) | $ | 59,731 | | $ | (59,515 | ) | $ | 36,805 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
2007: | | | | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | — | | $ | 1,549,157 | | $ | — | | $ | 1,549,157 | |
Cost of sales | | | — | | | — | | | 1,150,109 | | | — | | | 1,150,109 | |
Heartland matters | | | — | | | — | | | 4,015 | | | — | | | 4,015 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | — | | | 395,033 | | | — | | | 395,033 | |
Selling, general and administrative expenses | | | 2,140 | | | 270 | | | 225,598 | | | — | | | 228,008 | |
Provision for doubtful accounts | | | — | | | — | | | 29,899 | | | — | | | 29,899 | |
Restructuring and other related charges | | | — | | | — | | | 6,250 | | | — | | | 6,250 | |
Litigation and other related professional fees | | | — | | | — | | | 9,010 | | | — | | | 9,010 | |
Heartland matters | | | — | | | — | | | 896 | | | — | | | 896 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (2,140 | ) | | (270 | ) | | 123,380 | | | — | | | 120,970 | |
Investment income | | | 764 | | | — | | | 1,338 | | | — | | | 2,102 | |
Interest expense | | | (40,600 | ) | | — | | | (1,118 | ) | | — | | | (41,718 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (41,976 | ) | | (270 | ) | | 123,600 | | | — | | | 81,354 | |
Income tax (benefit) expense | | | (16,474 | ) | | (105 | ) | | 48,692 | | | — | | | 32,113 | |
Equity in net income of subsidiaries | | | 74,743 | | | — | | | — | | | (74,743 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | 49,241 | | $ | (165 | ) | $ | 74,908 | | $ | (74,743 | ) | $ | 49,241 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
35
Note 13 - Guarantor Subsidiaries (Continued)
Summary Consolidating Statements of Income - Unaudited
(in thousands)
| | | | | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
|
|
2008: | | Parent | | Guarantor
Subsidiary | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | — | | $ | 3,109,131 | | $ | — | | $ | 3,109,131 | |
Cost of sales | | | — | | | — | | | 2,344,224 | | | — | | | 2,344,224 | |
Heartland matters | | | — | | | — | | | 3,134 | | | — | | | 3,134 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | — | | | 761,773 | | | — | | | 761,773 | |
Selling, general and administrative expenses | | | 4,297 | | | 646 | | | 468,673 | | | — | | | 473,616 | |
Provision for doubtful accounts | | | — | | | — | | | 56,159 | | | — | | | 56,159 | |
Restructuring and other related charges | | | — | | | — | | | 17,232 | | | — | | | 17,232 | |
Litigation and other related professional fees | | | — | | | — | | | 37,664 | | | — | | | 37,664 | |
Heartland matters | | | — | | | — | | | 499 | | | — | | | 499 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (4,297 | ) | | (646 | ) | | 181,546 | | | — | | | 176,603 | |
Investment income | | | 1,391 | | | — | | | 3,179 | | | — | | | 4,570 | |
Interest expense | | | (69,831 | ) | | — | | | (3,165 | ) | | — | | | (72,996 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (72,737 | ) | | (646 | ) | | 181,560 | | | — | | | 108,177 | |
Income tax (benefit) expense | | | (28,164 | ) | | (250 | ) | | 69,842 | | | — | | | 41,428 | |
Equity in net income of subsidiaries | | | 111,322 | | | — | | | — | | | (111,322 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | 66,749 | | $ | (396 | ) | $ | 111,718 | | $ | (111,322 | ) | $ | 66,749 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
2007: | | | | | | | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales | | $ | — | | $ | — | | $ | 3,126,222 | | $ | — | | $ | 3,126,222 | |
Cost of sales | | | — | | | — | | | 2,341,102 | | | — | | | 2,341,102 | |
Heartland matters | | | — | | | — | | | 8,311 | | | — | | | 8,311 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Gross profit | | | — | | | — | | | 776,809 | | | — | | | 776,809 | |
Selling, general and administrative expenses | | | 4,273 | | | 541 | | | 448,803 | | | — | | | 453,617 | |
Provision for doubtful accounts | | | — | | | — | | | 58,803 | | | — | | | 58,803 | |
Restructuring and other related charges | | | — | | | — | | | 15,424 | | | — | | | 15,424 | |
Litigation and other related professional fees | | | — | | | — | | | 15,917 | | | — | | | 15,917 | |
Heartland matters | | | — | | | — | | | 2,392 | | | — | | | 2,392 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income (loss) | | | (4,273 | ) | | (541 | ) | | 235,470 | | | — | | | 230,656 | |
Investment income | | | 1,335 | | | — | | | 2,688 | | | — | | | 4,023 | |
Interest expense | | | (81,606 | ) | | — | | | (2,160 | ) | | — | | | (83,766 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) before income taxes | | | (84,544 | ) | | (541 | ) | | 235,998 | | | — | | | 150,913 | |
Income tax (benefit) expense | | | (32,735 | ) | | (209 | ) | | 91,629 | | | — | | | 58,685 | |
Equity in net income of subsidiaries | | | 144,037 | | | — | | | — | | | (144,037 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | 92,228 | | $ | (332 | ) | $ | 144,369 | | $ | (144,037 | ) | $ | 92,228 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
36
Note 13 - Guarantor Subsidiaries (Continued)
Condensed Consolidating Balance Sheets
(in thousands)
| | | | | | | | | | | | | | | | |
As of June 30, 2008 (Unaudited): | | Parent | | Guarantor
Subsidiary | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 135,886 | | $ | — | | $ | 72,844 | | $ | — | | $ | 208,730 | |
Restricted cash | | | — | | | — | | | 15,019 | | | — | | | 15,019 | |
Accounts receivable, net (including intercompany) | | | — | | | 56 | | | 1,348,042 | | | (56 | ) | | 1,348,042 | |
Unbilled receivables, CRO | | | — | | | — | | | 28,509 | | | — | | | 28,509 | |
Inventories | | | — | | | — | | | 400,084 | | | — | | | 400,084 | |
Deferred income tax benefits, net-current | | | — | | | — | | | 132,859 | | | (3,352 | ) | | 129,507 | |
Other current assets | | | 1,608 | | | — | | | 202,493 | | | — | | | 204,101 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 137,494 | | | 56 | | | 2,199,850 | | | (3,408 | ) | | 2,333,992 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Properties and equipment, net | | | — | | | 29 | | | 203,636 | | | — | | | 203,665 | |
Goodwill | | | — | | | — | | | 4,377,813 | | | — | | | 4,377,813 | |
Identifiable intangible assets, net | | | — | | | — | | | 313,678 | | | — | | | 313,678 | |
Other noncurrent assets | | | 48,181 | | | 19 | | | 204,832 | | | — | | | 253,032 | |
Investment in subsidiaries | | | 5,920,359 | | | — | | | — | | | (5,920,359 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 6,106,034 | | $ | 104 | | $ | 7,299,809 | | $ | (5,923,767 | ) | $ | 7,482,180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | |
Current liabilities (including intercompany) | | $ | 28,906 | | $ | 16 | | $ | 557,912 | | $ | (56 | ) | $ | 586,778 | |
Long-term debt, notes and convertible debentures | | | 2,712,882 | | | — | | | 53,181 | | | — | | | 2,766,063 | |
Deferred income tax liabilities, net-noncurrent | | | 85,325 | | | — | | | 416,937 | | | (3,352 | ) | | 498,910 | |
Other noncurrent liabilities | | | 9,618 | | | — | | | 351,508 | | | — | | | 361,126 | |
Stockholders’ equity | | | 3,269,303 | | | 88 | | | 5,920,271 | | | (5,920,359 | ) | | 3,269,303 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 6,106,034 | | $ | 104 | | $ | 7,299,809 | | $ | (5,923,767 | ) | $ | 7,482,180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
37
Note 13 - Guarantor Subsidiaries (Continued)
Condensed Consolidating Balance Sheets - (Continued)
(in thousands)
| | | | | | | | | | | | | | | | |
As of December 31, 2007: | | Parent | | Guarantor
Subsidiary | | Non-
Guarantor
Subsidiaries | | Consolidating/
Eliminating
Adjustments | | Omnicare,
Inc. and
Subsidiaries | |
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 171,779 | | $ | — | | $ | 102,669 | | $ | — | | $ | 274,448 | |
Restricted cash | | | — | | | — | | | 3,155 | | | — | | | 3,155 | |
Accounts receivable, net (including intercompany) | | | — | | | 43 | | | 1,376,288 | | | (43 | ) | | 1,376,288 | |
Unbilled receivables, CRO | | | — | | | — | | | 24,855 | | | — | | | 24,855 | |
Inventories | | | — | | | — | | | 448,183 | | | — | | | 448,183 | |
Deferred income tax benefits, net-current | | | 878 | | | — | | | 125,361 | | | — | | | 126,239 | |
Other current assets | | | 1,336 | | | — | | | 201,646 | | | — | | | 202,982 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 173,993 | | | 43 | | | 2,282,157 | | | (43 | ) | | 2,456,150 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Properties and equipment, net | | | — | | | 28 | | | 199,421 | | | — | | | 199,449 | |
Goodwill | | | — | | | — | | | 4,342,169 | | | — | | | 4,342,169 | |
Identifiable intangible assets, net | | | — | | | — | | | 323,637 | | | — | | | 323,637 | |
Other noncurrent assets | | | 52,135 | | | 19 | | | 220,220 | | | — | | | 272,374 | |
Investment in subsidiaries | | | 5,939,714 | | | — | | | — | | | (5,939,714 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 6,165,842 | | $ | 90 | | $ | 7,367,604 | | $ | (5,939,757 | ) | $ | 7,593,779 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | |
Current liabilities (including intercompany) | | $ | 33,105 | | $ | — | | $ | 619,098 | | $ | (43 | ) | $ | 652,160 | |
Long-term debt, notes and convertible debentures | | | 2,764,510 | | | — | | | 56,241 | | | — | | | 2,820,751 | |
Deferred income tax liabilities, net-noncurrent | | | 68,534 | | | — | | | 381,255 | | | — | | | 449,789 | |
Other noncurrent liabilities | | | 7,990 | | | — | | | 371,386 | | | — | | | 379,376 | |
Stockholders’ equity | | | 3,291,703 | | | 90 | | | 5,939,624 | | | (5,939,714 | ) | | 3,291,703 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 6,165,842 | | $ | 90 | | $ | 7,367,604 | | $ | (5,939,757 | ) | $ | 7,593,779 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
38
Note 13 - Guarantor Subsidiaries (Continued)
Condensed Consolidating Statements of Cash Flows - Unaudited
(in thousands)
| | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2008: | | Parent | | Guarantor
Subsidiary | | Non-Guarantor
Subsidiaries | | Omnicare, Inc.
and
Subsidiaries | |
|
|
|
|
|
|
|
|
| |
Cash flows from operating activities: | | | | | | | | | | | | | |
Net cash flows from operating activities | | $ | (20,886 | ) | $ | — | | $ | 249,498 | | $ | 228,612 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | | |
Acquisition of businesses, net of cash received | | | — | | | — | | | (90,988 | ) | | (90,988 | ) |
Capital expenditures | | | — | | | — | | | (28,468 | ) | | (28,468 | ) |
Transfer of cash to trusts for employee health and severance costs, net of payments out of the trust | | | — | | | — | | | (11,589 | ) | | (11,589 | ) |
Other | | | — | | | — | | | (6 | ) | | (6 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in investing activities | | | — | | | — | | | (131,051 | ) | | (131,051 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | | |
Borrowings on line of credit facilities and term A loan | | | 59,000 | | | — | | | — | | | 59,000 | |
Payments on line of credit facilities and term A loan | | | (109,000 | ) | | — | | | — | | | (109,000 | ) |
Payments on long-term borrowings and obligations | | | (1,606 | ) | | — | | | — | | | (1,606 | ) |
Change in cash overdraft balance | | | (4,032 | ) | | — | | | 426 | | | (3,606 | ) |
Payments for Omnicare common stock repurchases | | | (100,165 | ) | | — | | | — | | | (100,165 | ) |
(Payments) for stock awards and exercise of stock options, net of stock tendered in payment | | | (3,803 | ) | | — | | | — | | | (3,803 | ) |
Excess tax benefits from stock-based compensation | | | 82 | | | — | | | — | | | 82 | |
Dividends paid | | | (5,412 | ) | | — | | | — | | | (5,412 | ) |
Other | | | 149,929 | | | — | | | (149,929 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in financing activities | | | (15,007 | ) | | — | | | (149,503 | ) | | (164,510 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Effect of exchange rate changes on cash | | | — | | | — | | | 1,231 | | | 1,231 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Net (decrease) in cash and cash equivalents | | | (35,893 | ) | | — | | | (29,825 | ) | | (65,718 | ) |
Cash and cash equivalents at beginning of period | | | 171,779 | | | — | | | 102,669 | | | 274,448 | |
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents at end of period | | $ | 135,886 | | $ | — | | $ | 72,844 | | $ | 208,730 | |
| |
|
| |
|
| |
|
| |
|
| |
39
Note 13 - Guarantor Subsidiaries (Continued)
Condensed Consolidating Statements of Cash Flows - (Continued) - Unaudited
(in thousands)
| | | | | | | | | | | | | |
| | Six months ended June 30, | |
| |
| |
2007: | | Parent | | Guarantor
Subsidiary | | Non-Guarantor
Subsidiaries | | Omnicare, Inc.
and
Subsidiaries | |
|
|
|
|
|
|
|
|
| |
Cash flows from operating activities: | | | | | | | | | | | | | |
Net cash flows from operating activities | | $ | (29,750 | ) | $ | — | | $ | 265,677 | | $ | 235,927 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | | |
Acquisition of businesses, net of cash received | | | — | | | — | | | (69,299 | ) | | (69,299 | ) |
Capital expenditures | | | — | | | — | | | (18,925 | ) | | (18,925 | ) |
Transfer of cash to trusts for employee health and severance costs, net of payments out of the trust | | | — | | | — | | | (10,501 | ) | | (10,501 | ) |
Other | | | — | | | — | | | (106 | ) | | (106 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows used in investing activities | | | — | | | — | | | (98,831 | ) | | (98,831 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | | |
Borrowings on line of credit facilities and term A loan | | | 74,000 | | | — | | | — | | | 74,000 | |
Payments on line of credit facilities and term A loan | | | (174,000 | ) | | — | | | — | | | (174,000 | ) |
Payments on long-term borrowings and obligations | | | (3,631 | ) | | — | | | — | | | (3,631 | ) |
Change in cash overdraft balance | | | (9,372 | ) | | — | | | (2,272 | ) | | (11,644 | ) |
(Payments) for stock awards and exercise of stock options, net of stock tendered in payment | | | (8,132 | ) | | — | | | — | | | (8,132 | ) |
Excess tax benefits from stock-based compensation | | | 4,079 | | | — | | | — | | | 4,079 | |
Dividends paid | | | (5,482 | ) | | — | | | — | | | (5,482 | ) |
Other | | | 187,469 | | | — | | | (187,469 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
Net cash flows from financing activities | | | 64,931 | | | — | | | (189,741 | ) | | (124,810 | ) |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Effect of exchange rate changes on cash | | | — | | | — | | | 942 | | | 942 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 35,181 | | | — | | | (21,953 | ) | | 13,228 | |
Cash and cash equivalents at beginning of period | | | 43,494 | | | — | | | 94,540 | | | 138,034 | |
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents at end of period | | $ | 78,675 | | $ | — | | $ | 72,587 | | $ | 151,262 | |
| |
|
| |
|
| |
|
| |
|
| |
40
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (“MD&A”)
The following discussion should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information appearing elsewhere in this report. In addition, see “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Regarding Forward-Looking Information.” The reader should also refer to the Consolidated Financial Statements and notes thereto and MD&A, including critical accounting policies, for the year ended December 31, 2007, which appear in the Company’s Annual Report on Form 10-K, (“Omnicare’s 2007 Annual Report”), which was filed with the Securities and Exchange Commission on February 28, 2008.
|
Overview of Three and Six Months Ended June 30, 2008 and Results of Operations |
|
Omnicare, Inc. (“Omnicare” or the “Company”) is a leading geriatric pharmaceutical services company. Omnicare is the nation’s largest provider of pharmaceuticals and related pharmacy and ancillary services to long-term healthcare institutions. Omnicare’s clients include primarily skilled nursing facilities (“SNFs”), assisted living facilities, retirement centers, independent living communities, hospitals, hospice, and other healthcare settings and service providers. At June 30, 2008, Omnicare served long-term care facilities as well as chronic care and other settings comprising approximately 1,438,000 beds, including approximately 70,000 patients served by the patient assistance programs of its specialty pharmacy services business. The comparable number at June 30, 2007 was approximately 1,449,000 (including approximately 60,000 patients served by patient assistance programs). Omnicare provides its pharmacy services in 47 states in the United States, the District of Columbia and Canada at June 30, 2008. As well, Omnicare provides operational software and support systems to long-term care pharmacy providers across the United States. Omnicare’s pharmacy services also include distribution and patient assistance services for specialty pharmaceuticals. Omnicare provides comprehensive product development and research services for the pharmaceutical, biotechnology, medical device and diagnostic industries in 30 countries worldwide.
The following summary table presents consolidated net sales and results of operations of Omnicare for the three and six months ended June 30, 2008 and 2007 (in thousands, except per share amounts). In accordance with the Securities and Exchange Commission (“SEC”) release entitled “Conditions for Use of Non-GAAP Financial Measures,” the Company has disclosed in this MD&A, with the exception of EBITDA (discussed below), only those measures that are in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”).
41
| | | | | | | | | | | | | |
| | Three months ended
June 30, | | Six months ended
June 30, | |
| |
| |
| |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | |
Net sales | | $ | 1,550,152 | | $ | 1,549,157 | | $ | 3,109,131 | | $ | 3,126,222 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Net income | | $ | 36,805 | | $ | 49,241 | | $ | 66,749 | | $ | 92,228 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Earnings per share: | | | | | | | | | | | | | |
Basic | | $ | 0.31 | | $ | 0.41 | | $ | 0.56 | | $ | 0.77 | |
| |
|
| |
|
| |
|
| |
|
| |
Diluted | | $ | 0.31 | | $ | 0.41 | | $ | 0.56 | | $ | 0.76 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
EBITDA(a) | | $ | 120,507 | | $ | 149,456 | | $ | 234,266 | | $ | 287,864 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
EBITDA reconciliation to net cash flows from operating activities: | | | | | | | | | | | | | |
EBITDA(a) | | $ | 120,507 | | $ | 149,456 | | $ | 234,266 | | $ | 287,864 | |
(Subtract)/Add: | | | | | | | | | | | | | |
Interest expense, net of investment income | | | (33,981 | ) | | (39,616 | ) | | (68,426 | ) | | (79,743 | ) |
Income tax provision | | | (21,573 | ) | | (32,113 | ) | | (41,428 | ) | | (58,685 | ) |
Changes in assets and liabilities, net of effects from acquisition of businesses | | | (24,464 | ) | | (68,655 | ) | | 3,972 | | | (7,736 | ) |
Provision for doubtful accounts | | | 25,767 | | | 29,899 | | | 56,159 | | | 58,803 | |
Deferred tax provision | | | 20,092 | | | 22,167 | | | 44,069 | | | 35,424 | |
| |
|
| |
|
| |
|
| |
|
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Net cash flows from operating activities | | $ | 86,348 | | $ | 61,138 | | $ | 228,612 | | $ | 235,927 | |
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(a) “EBITDA” represents earnings before interest (net of investment income), income taxes, depreciation and amortization. Omnicare uses EBITDA primarily as an indicator of the Company’s ability to service its debt, and believes that certain investors find EBITDA to be a useful financial measure for the same purpose. However, EBITDA does not represent net cash flows from operating activities, as defined by U.S. GAAP, and should not be considered as a substitute for operating cash flows as a measure of liquidity. The Company’s calculation of EBITDA may differ from the calculation of EBITDA by others.
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Three Months Ended June 30, 2008 vs. 2007 |
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Total net sales for the three months ended June 30, 2008 increased to $1,550.2 million from $1,549.2 million in the comparable prior-year period. Net income for the three months ended June 30, 2008 was $36.8 million versus $49.2 million earned in the comparable 2007 period. Diluted earnings per share for the three months ended June 30, 2008 were $0.31 versus $0.41 in the same prior-year period. EBITDA totaled $120.5 million for the three months ended June 30, 2008 as compared with $149.5 million for the same period of 2007.
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The Company continues to be impacted by the unilateral reduction in April 2006 by UnitedHealth Group, Inc. and its Affiliates (“United”) in the reimbursement rates paid by United to Omnicare by switching to its PacifiCare pharmacy network contract for services rendered by Omnicare to beneficiaries of United’s drug benefit plans under the Medicare Part D program. The differential in reimbursement rates that resulted from United’s action, as compared with reimbursement rates under the originally negotiated contract, reduced sales and operating profit in the second quarter of 2008 by approximately $24 million (approximately $15 million aftertax), and cumulatively since April 2006 by approximately $246 million (approximately $153 million aftertax). This matter is currently the subject of litigation initiated by Omnicare and is before the federal court in the Northern District of Illinois. See further discussion at the “Legal Proceedings” section at Part II, Item 1 of this Filing.
Net sales for the quarter were favorably impacted primarily by drug price inflation, increased use of certain higher acuity drugs and biologic agents, and acquisitions, as well as increased CRO Services revenues. Partially offsetting these factors was the unfavorable sales impact of a lower number of beds served, combined with a year-over-year shift in mix towards assisted living, the increased availability and utilization of generic drugs, reductions in reimbursement and/or utilization for certain drugs as well as competitive pricing issues, and lower revenues reported from copays and rejects under Part D as well as from certain matters currently in litigation. See discussion of sales and operating profit results in more detail at the “Pharmacy Services Segment” and “CRO Services Segment” captions below.
The Company’s consolidated gross profit of $382.1 million decreased $12.9 million for the three months ended June 30, 2008, from the same prior-year period amount of $395.0 million. Gross profit as a percentage of total net sales of 24.7% in the three months ended June 30, 2008, was lower than the 25.5% experienced during the comparable 2007 period. Gross profit was unfavorably affected in the 2008 period largely due to the aforementioned factors that reduced net sales, primarily the lower net number of beds served, competitive pricing issues and the reductions in reimbursement and/or utilization for certain drugs. Partially offsetting these factors were the increased availability and utilization of higher margin generic drugs, the continued integration of prior-period acquisitions, the favorable effect of drug price inflation, lower incremental costs associated with the closure of the Company’s Heartland repackaging facility as further described below, and, purchasing improvements.
Omnicare’s consolidated selling, general and administrative (“operating”) expenses for the three months ended June 30, 2008 of $237.0 million were higher than the comparable prior-year amount of $228.0 million by $9.0 million. Operating expenses as a percentage of net sales amounted to 15.3% in the second quarter of 2008, representing an increase from the 14.7% experienced in the comparable prior-year period. Operating expenses for the quarter ended June 30, 2008 were unfavorably impacted largely by increases in employee benefit costs and increased operating costs associated with recent acquisitions. Partially offsetting the increased operating expenses were the favorable impact of the Company’s continued integration of prior-year acquisitions, purchasing improvements and productivity enhancements.
The provision for doubtful accounts for the three months ended June 30, 2008 was $25.8 million versus $29.9 million in the comparable prior-year period, lower by $4.1 million due to improved collections and recovery of previously uncollected copays and rejects.
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Investment income for the three months ended June 30, 2008 of $2.0 million was modestly lower than the $2.1 million earned in the comparable prior-year period, primarily due to lower interest rates versus the prior year.
Interest expense for the three months ended June 30, 2008 of $35.9 million is lower than the $41.7 million in the comparable prior-year period, primarily due to lower debt outstanding resulting from payments aggregating $150 million on the Company’s senior term A loan facility, maturing on July 28, 2010 (the “Term Loans”) during the second quarter of 2007 through the first six months of 2008, and lower interest rates on variable rate loans.
The effective income tax rate was 37.0% for the three months ended June 30, 2008, as compared to the second quarter of 2007 rate of 39.5%. The year-over-year decrease in the effective tax rate is largely attributable to the favorable impact of a change in filing methodology for a state taxing jurisdiction in the second quarter of 2008. The effective tax rates in 2008 and 2007 are higher than the federal statutory rate largely as a result of the impact of state and local income taxes and various nondeductible expenses.
Special Items:
The three months ended June 30, 2008 included the following charges, which primarily impacted the Pharmacy Services segment. Management believes that these special items are either infrequent occurrences or otherwise not related to Omnicare’s ordinary course of business:
(i) Operating income included restructuring and other related charges of approximately $10.8 million pretax ($6.7 million aftertax), relating to the implementation of the “Omnicare Full Potential” Plan, a major initiative primarily designed to re-engineer the pharmacy operating model to increase efficiency and enhance customer growth. See further discussion at the “Restructuring and Other Related Charges” note of the Notes to Consolidated Financial Statements and the “Restructuring and Other Related Charges” section of this MD&A.
(ii) During 2006, the Company experienced certain quality control and product recall issues, as well as fire damage, at one of its repackaging facilities, Heartland Repack Services (“Heartland”), as described in further detail at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements (the “Heartland Matters”). In addressing and resolving these Heartland Matters, the Company continues to experience increased costs and as a result, the three months ended June 30, 2008 included special charges of $1.7 million pretax (approximately $1.5 million and $0.2 million was recorded in the cost of sales and operating expense sections of the Consolidated Statements of Income, respectively) ($1.1 million aftertax) for these increased costs. The Company maintains product recall, property and casualty and business interruption insurance, and the extent of insurance recovery for these expenses continues to be reviewed by its outside advisors. As of June 30, 2008, no receivables for insurance recoveries have been recorded by the Company.
(iii) Operating income included special litigation and other related professional fees of $16.0 million pretax ($10.1 million aftertax) for litigation-related professional expenses primarily in connection with the Company’s lawsuit against United, certain other large customer disputes, the
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investigation by the United States Attorney’s Office, District of Massachusetts, the purported class and derivative actions, the investigation by the federal government and certain states relating to drug substitutions, and the Company’s response to subpoenas it received relating to other legal proceedings to which the Company is not a party. With respect to these proceedings to which the Company is a party, see further discussion at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
The three months ended June 30, 2007 included the following charges, which primarily impacted the Pharmacy Services segment. Management believes that these special items are either infrequent occurrences or otherwise not related to Omnicare’s ordinary course of business:
(i) Operating income included restructuring and other related charges of approximately $6.3 million pretax ($3.8 million aftertax), $7.8 million of which related to the implementation of the “Omnicare Full Potential” Plan, a major initiative primarily designed to re-engineer the pharmacy operating model to increase efficiency and enhance customer growth, partially offset by a ($1.6) million credit adjustment to the previously disclosed consolidation and productivity initiatives related, in part, to the integration of the NeighborCare, Inc. (“NeighborCare”) acquisition and other related activities. See further discussion at the “Restructuring and Other Related Charges” note of the Notes to Consolidated Financial Statements and the “Restructuring and Other Related Charges” section of this MD&A.
(ii) During the three months ended June 30, 2007, special charges relating to the aforementioned Heartland Matters of $4.9 million pretax (approximately $4.0 million and $0.9 million was recorded in the cost of sales and operating expense sections of the Consolidated Statements of Income, respectively) ($3.0 million aftertax) were recorded associated with these increased costs. As previously disclosed, the Company maintains product recall, property and casualty, and business interruption insurance, and the extent of insurance recovery for these expenses continues to be reviewed by its outside advisors. As of June 30, 2007, no receivables for insurance recoveries were recorded by the Company.
(iii) Operating income included a special litigation charge of $9.0 million pretax ($5.5 million aftertax) for litigation-related professional expenses primarily in connection with the investigation by the United States Attorney’s Office, District of Massachusetts, the purported class and derivative actions, the Company’s lawsuit against United, the inquiry conducted by the Attorney General’s office in Michigan relating to certain billing issues under the Michigan Medicaid program, the investigation by the federal government and certain states relating to drug substitutions and the Company’s response to subpoenas it received relating to other legal proceedings to which the Company is not a party. With respect to these proceedings to which the Company is a party, see further discussion at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
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Pharmacy Services Segment
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Net sales | | $ | 1,496,521 | | $ | 1,498,918 | |
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Operating income | | $ | 117,516 | | $ | 144,274 | |
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Three Months Ended June 30, 2008 vs. 2007
Omnicare’s Pharmacy Services segment recorded sales of $1,496.5 million for the three months ended June 30, 2008, down modestly from the 2007 amount of $1,498.9 million by $2.4 million, or 0.2%. At June 30, 2008, Omnicare served long-term care facilities as well as chronic care and other settings comprising approximately 1,438,000 beds, including approximately 70,000 patients served by the patient assistance programs of its specialty pharmacy business. The comparable number at June 30, 2007 was approximately 1,449,000 (including approximately 60,000 patients served by patient assistance programs). Pharmacy Services sales were unfavorably impacted by a lower number of beds served, as well as the impact of a bed mix shift toward assisted living, which typically has lower penetration rates than skilled nursing facilities, the increased availability and utilization of generic drugs, reductions in reimbursement and/or utilization of certain drugs as well as competitive pricing issues, and lower revenues reported from copays and rejects under Part D as well as from certain matters currently in litigation. Largely offsetting these factors was the favorable impact of drug price inflation, increased use of certain higher acuity drugs and biologic agents, and acquisitions. While the Company is focused on reducing its costs to mitigate the impact of drug pricing and reimbursement issues, there can be no assurance that such issues or other pricing and reimbursement pressures will not adversely impact the Pharmacy Services segment.
Operating income of the Pharmacy Services segment was $117.5 million in the second quarter of 2008, a $26.8 million decrease as compared with the $144.3 million earned in the comparable period of 2007. As a percentage of the segment’s sales, operating income was 7.9% for the second quarter of 2008, compared with 9.6% in 2007. The 2008 quarter was unfavorably affected primarily by the operating income effect of certain of the aforementioned reductions in sales, as well as the year-over-year impact of the previously mentioned special items. Operating income in 2008 was favorably impacted largely by the increased availability and utilization of higher margin generic drugs, drug price inflation, lower bad debt expense and purchasing improvements, as well as the Company’s continued integration of prior-period acquisitions and productivity enhancements.
The Company derives a significant portion of its revenues directly or indirectly from government-sponsored programs, principally the federal Medicare program and to a lesser extent state Medicaid programs. As part of ongoing operations, the Company and its customers are subject to regulatory changes in the level of reimbursement received from the Medicare and Medicaid programs. Since 1997, Congress has passed a number of federal laws that have effected major changes in the healthcare system and payments to certain providers.
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The Balanced Budget Act of 1997 (the “BBA”) mandated a prospective payment system (“PPS”) for Medicare-eligible residents of skilled nursing facilities (“SNFs”). Under PPS, Medicare pays SNFs a fixed fee per patient per day based upon the acuity level of the resident, covering substantially all items and services furnished during a Medicare-covered stay, including pharmacy services. PPS initially resulted in a significant reduction of reimbursement to SNFs. Congress subsequently sought to restore some of the reductions in reimbursement resulting from PPS. One provision gave SNFs a temporary rate increase for certain specific high-acuity patients beginning April 1, 2000, and ending when the Centers for Medicare & Medicaid Services (“CMS”) implemented a refined patient classification system under PPS. For several years, CMS did not implement such refinements, thus continuing the additional rate increase for certain high-acuity patients through federal fiscal year 2005.
On August 4, 2005, CMS issued its final SNF PPS rule for fiscal year 2006. Under the rule, CMS added nine patient classification categories to the PPS patient classification system, thus triggering the expiration of the high-acuity payments add-ons. However, CMS estimated that the rule would have a slightly positive financial impact on SNFs in fiscal year 2006 because the $1.02 billion reduction from the expiration of the add-on payments would be more than offset by a $510 million increase in the nursing case-mix weight for all of the resource utilization group categories and a $530 million increase associated with various updates to the payment rates (including updates to the wage and market basket indexes), resulting in a $20 million overall increase in payments for fiscal year 2006. The new patient classification refinements became effective on January 1, 2006, and the market basket increase became effective October 1, 2005. On July 31, 2006, CMS issued the update to the SNF PPS rates for fiscal year 2007. Effective October 1, 2006, SNFs received the full 3.1 percent market basket increase to rates, increasing payments to SNFs by approximately $560 million for fiscal year 2007. On August 3, 2007, CMS published its final SNF PPS update for fiscal year 2008. Effective October 1, 2007, SNFs received a 3.3 percent market basket increase, which increases Medicare payments to SNFs by approximately $690 million in fiscal year 2008. The final rule also includes several policy and payment provisions, including rebasing the market basket, which currently reflects data from fiscal 1997, to a base year of fiscal year 2004; revisions to the calculation of the SNF market basket (including revising the pharmacy component); changing the threshold for forecast error adjustments from the current 0.25 percentage point to 0.5 percentage point; and continuing a special adjustment made to cover the additional services required by nursing home residents with HIV/AIDS. On May 1, 2008, CMS released its proposed SNF PPS update for fiscal year 2009. Among other things, the proposed rule would recalibrate case mix weights, resulting in an overall 3.3 percent reduction in Medicare payments. Most of the decrease would be offset by a 3.1 percent market basket increase, but if the rule were adopted as proposed, SNFs would experience a net reduction in Medicare payments of $60 million, or approximately 0.3 percent. The rule was subject to public comment until June 30, 2008, and a final rule will be issued this summer. While the fiscal year 2007 and 2008 SNF PPS rates do not decrease payments to SNFs, the potential loss of revenues associated with the proposed fiscal year 2009 changes to SNF payments or other potential reimbursement changes could, in the future, have an adverse effect on the financial condition of the Company’s SNF clients which could, in turn, adversely affect the timing or level of their payments to Omnicare.
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Moreover, on February 8, 2006, the President signed into law the Deficit Reduction Act (“DRA”), which will reduce net Medicare and Medicaid spending by approximately $11 billion over five years. Among other things, the legislation reduces Medicare SNF bad debt payments by 30 percent for those individuals who are not dually eligible for Medicare and Medicaid. This provision is expected to reduce payments to SNFs by $100 million over five years (fiscal years 2006-2010). On February 4, 2008, the Bush Administration released its fiscal year 2009 budget proposal, which includes legislative and administrative proposals that would reduce Medicare spending by approximately $12.2 billion in fiscal year 2009 and $178 billion over five years. Among other things, the budget would provide no annual update for SNFs in 2009 through 2011 and a -0.65 percent adjustment to the update annually thereafter. In addition, the budget would apply a “sequester” of -0.4 percent to all Medicare provider payments when general fund contributions exceed 45 percent of program spending. The sequester order would increase each year by -0.4 percent until general revenue funding is brought back to 45 percent. The budget also would move toward site-neutral post-hospital payments to limit perceived inappropriate incentives for five conditions commonly treated in both SNFs and inpatient rehabilitation facilities. The Administration also proposes to achieve savings by issuing regulations to adjust for case mix distribution in the SNF payment system. CMS included this provision in its proposed SNF prospective payment system update for fiscal year 2009, released May 1, 2008. CMS estimates that the recalibration would result in an overall 3.3 percent reduction in Medicare payments in fiscal year 2009, although the proposed rule would partially offset the case mix recalibration payment decrease with a 3.1 percent market basket increase. In addition, the budget proposal would eliminate all bad debt reimbursements for unpaid beneficiary cost-sharing over four years. Many provisions of the proposed Bush budget would require Congressional action to implement. Separately, on August 1, 2007, the House of Representatives approved H.R. 3162, the Children’s Health and Medicare Protection Act of 2007, that included a number of Medicare policy changes, including a freeze in fiscal year 2008 SNF PPS rates at fiscal year 2007 levels. Note that while the version of the bill that ultimately passed Congress did not include Medicare provisions impacting SNF reimbursement, Congress may yet consider these and other proposals in the future that would further restrict Medicare funding for SNFs.
In December 2003, Congress enacted the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), which included a major expansion of the Medicare prescription drug benefit under a new Medicare Part D.
Under the Medicare Part D prescription drug benefit, Medicare beneficiaries may enroll in prescription drug plans offered by private entities (or in a “fallback” plan offered on behalf of the government through a contractor, to the extent private entities fail to offer a plan in a given area), which provide coverage of outpatient prescription drugs (collectively, “Part D Plans”). Part D Plans include both plans providing the drug benefit on a stand-alone basis and Medicare Advantage plans providing drug coverage as a supplement to an existing medical benefit under that Medicare Advantage plan, most commonly a health maintenance organization plan. Medicare beneficiaries generally have to pay a premium to enroll in a Part D Plan, with the premium amount varying from plan to plan, although CMS provides various federal subsidies to Part D Plans to reduce the cost to beneficiaries. Effective January 1, 2006, Medicare beneficiaries who are also entitled to benefits under a state Medicaid program (so-called “dual eligibles”) have their prescription drug costs covered by the new Medicare drug benefit. Many
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nursing home residents Omnicare serves are dual eligibles, whose drug costs were previously covered by state Medicaid programs. In 2007, approximately 42% of Omnicare’s revenue was derived from beneficiaries covered under the federal Medicare Part D program.
CMS provides premium and cost-sharing subsidies to Part D Plans with respect to dual eligible residents of nursing homes. Such dual eligibles are not required to pay a premium for enrollment in a Part D Plan, so long as the premium for the Part D Plan in which they are enrolled is at or below the premium subsidy, nor are they required to meet deductibles or pay copayment amounts. Further, all dual eligibles who do not affirmatively enroll in a Part D Plan are automatically enrolled into a Prescription Drug Plan (“PDP”) by CMS on a random basis from among those PDPs meeting CMS criteria for low-income premiums in the PDP region. As is the case for any nursing home beneficiary, such dual eligible beneficiaries may select a different Part D Plan at any time through the Part D enrollment process. In sum, dual eligible residents of nursing homes are entitled to have their prescription drug costs covered by a Part D Plan, provided that the prescription drugs which they are taking are either on the Part D Plan’s formulary, or an exception to the plan’s formulary is granted. CMS requires the formularies of Part D Plans to include the types of drugs most commonly needed by Medicare beneficiaries and to offer an exceptions process to provide coverage for medically necessary drugs.
Pursuant to the final Part D rule, effective January 1, 2006, the Company obtains reimbursement for drugs it provides to enrollees of a given Part D Plan in accordance with the terms of agreements negotiated between it and that Part D Plan. The Company has entered into such agreements with nearly all Part D Plan sponsors under which it will provide drugs and associated services to their enrollees. The Company continues to have ongoing discussions with Part D Plans in the ordinary course. Moreover, the Company may, as appropriate, renegotiate agreements. Further, the proportion of the Company’s Part D business serviced under specific agreements may change over time. Consequently, there can be no assurance that the reimbursement terms which currently apply to the Company’s Part D business will not change. In addition, as expected in the transition to a new program of this magnitude, certain administrative and payment issues have arisen, resulting in higher operating expenses, as well as outstanding gross accounts receivable (net of allowances for contractual adjustments, and prior to any allowance for doubtful accounts), particularly for copays. As of June 30, 2008, copays outstanding from Part D Plans were approximately $27 million relating to 2006 and 2007. The Company is pursuing solutions, including legal actions against certain Part D payors, to collect outstanding copays, as well as certain rejected claims. Participants in the long-term care pharmacy industry continue to address these issues with CMS and the Part D Plans and attempt to develop solutions. However, until all administrative and payment issues are fully resolved, there can be no assurance that the impact of the Part D drug benefit on the Company’s results of operations, financial position or cash flows will not change based on the outcome of any unforeseen future developments.
The MMA does not change the manner in which Medicare pays for drugs for Medicare beneficiaries covered under a Medicare Part A stay. The Company continues to receive reimbursement for drugs provided to such residents from the SNFs, in accordance with the terms of the agreements it has negotiated with each SNF. The Company also continues to receive reimbursement from the state Medicaid programs, albeit to a greatly reduced extent, for those
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Medicaid beneficiaries not eligible for the Part D program, including those under age 65, and for certain drugs specifically excluded from Medicare Part D.
CMS has issued subregulatory guidance on many aspects of the final Part D rule, including the provision of pharmaceutical services to long-term care residents. CMS has also expressed some concerns about pharmacies’ receipt of discounts, rebates and other price concessions from drug manufacturers. Specifically, in a finalized “Call Letter” for the 2007 calendar year, CMS indicated that beginning in 2007, Part D sponsors must have policies and systems in place, as part of their drug utilization management programs, to protect beneficiaries and reduce costs when long-term care pharmacies are subject to incentives to move market share through access/performance rebates from drug manufacturers. For the purposes of managing and monitoring drug utilization, especially where such rebates exist, CMS instructs Part D Plan sponsors to require pharmacies to disclose to the Part D Plan sponsor any discounts, rebates and other direct or indirect remuneration designed to directly or indirectly influence or impact utilization of Part D drugs. CMS stated that Plan sponsors should provide assurances that such information will remain confidential. CMS has issued subregulatory guidelines specifying the information that CMS is requiring from Plan sponsors with respect to rebates paid to long-term care pharmacies. CMS has also issued reporting requirements for 2008 which, among other things, require disclosure of rebates provided to long-term care pharmacies at a more detailed level. The Company has agreed with various Plan sponsors and their agents with respect to the format, terms and conditions for providing such information and the Company intends to continue to work with other sponsors with respect to providing such information.
On July 15, 2008, Congress enacted into law H.R. 6331, the “Medicare Improvements for Patients and Providers Act of 2008,” by overriding the President’s veto of the bill. The new law includes further reforms to the Part D program. Among other things, from and after January 1, 2010, the law requires that long-term care pharmacies have between 30 and 90 days to submit claims to a Part D Plan. Commencing January 1, 2009, the law also requires Part D Plan sponsors to update the prescription drug pricing data they use to pay pharmacies no less frequently than every seven days. The law also expands the number of Medicare beneficiaries who will be entitled to premium and cost-sharing subsidies by modifying previous income and asset requirements, eliminates late enrollment penalties for beneficiaries entitled to these subsidies, and limits the sales and marketing activities in which Part D Plan sponsors may engage, among other things.
Moreover, CMS continues to issue guidance on and make revisions to the Part D program. The Company is continuing to monitor issues relating to implementation of the Part D benefit, and until further agency guidance is known and until all administrative and payment issues associated with the transition to this massive program are fully resolved, there can be no assurance that the impact of the final rule or the outcome of other potential developments relating to its implementation on our business, results of operations, financial position or cash flows will not change based on the outcome of any unforeseen future developments.
The MMA also changed the Medicare payment methodology and conditions for coverage of certain items of durable medical equipment prosthetics, orthotics, and supplies (“DMEPOS”) under Medicare Part B. Approximately 1% of the Company’s revenue is derived from
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beneficiaries covered under Medicare Part B. The changes include a temporary freeze in annual increases in payments for durable medical equipment from 2004 through 2008, new clinical conditions for payment, quality standards (applied by CMS-approved accrediting organizations), and competitive bidding requirements. On April 10, 2007, CMS issued a final rule establishing the Medicare competitive bidding program. Only suppliers that are winning bidders will be eligible to provide competitively-bid items to Medicare beneficiaries in the selected areas. Enteral nutrients, equipment and supplies and oxygen equipment and supplies were among the 10 categories of DMEPOS included in the first round of the competitive bidding program.
In mid-2007 CMS conducted a first round of bidding for these 10 DMEPOS product categories in 10 competitive bidding areas, and CMS began announcing winning bidders in March 2008. In light of concerns about implementation of the bidding program, including CMS’ disqualification of many bids based upon bidders’ submission of allegedly incomplete financial documentation and the potential adverse impact on beneficiary access to certain types of DMEPOS, Congress has, through the enactment into law on July 15, 2008 of H.R. 6331, the “Medicare Improvements for Patients and Providers Act of 2008,” terminated the contracts awarded by CMS in the first round of competitive bidding, required that new bidding be conducted for the first round, and required certain reforms to the bidding process. Among other things, the law requires CMS to rebid those areas in 2009, with bidding for round two delayed until 2011. The delay will be financed by reducing Medicare fee schedule payments for all items covered by round one bidding program by 9.5 percent nationwide beginning January 1, 2009, followed by a 2 percent increase in 2014 (with certain exceptions). The legislation also includes a series of procedural improvements to the bidding process, including requiring CMS to notify bidders about paperwork discrepancies and providing suppliers with an opportunity to submit proper documentation, and it requires contracting suppliers to disclose all subcontracting relationships to CMS. The Company intends to participate in the new bidding process for round one, and is assessing the potential impact of the fee schedule reductions on its business.
CMS requires all existing DMEPOS suppliers to submit proof of accreditation by a deemed accreditation organization by September 30, 2009, although suppliers in the competitive bidding regions and new suppliers have been subject to earlier accreditation deadlines. The Medicare Improvements for Patients and Providers Act of 2008 codifies the requirement that all suppliers be accredited by October 1, 2009 and extends the accreditation requirement to companies that subcontract with contract suppliers under the competitive bidding program. The Company intends to comply with all accreditation requirements for DMEPOS suppliers by the applicable deadline.
With respect to Medicaid, the BBA repealed the “Boren Amendment” federal payment standard for Medicaid payments to nursing facilities, giving states greater latitude in setting payment rates for such facilities. The law also granted states greater flexibility to establish Medicaid managed care programs without the need to obtain a federal waiver. Although these waiver programs generally exempt institutional care, including nursing facilities and institutional pharmacy services, some states do use managed care principles in their long-term care programs. Likewise, the DRA includes several changes to the Medicaid program designed to rein in program spending. These include, among others, strengthening the Medicaid asset transfer restrictions for persons seeking to qualify for Medicaid long-term care coverage, which could, due to the timing of the
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penalty period, increase facilities’ exposure to uncompensated care. This provision is expected to reduce Medicaid spending by an estimated $2.4 billion over five years. The law also gives states greater flexibility to expand access to home and community based services by allowing states to provide these services as an optional benefit without undergoing the waiver approval process, and includes a new demonstration to encourage states to provide long-term care services in a community setting to individuals who currently receive Medicaid services in nursing homes. Together, these provisions could increase state funding for home and community-based services, while prompting states to cut funding for nursing facilities. No assurances can be given that state Medicaid programs ultimately will not change the reimbursement system for long-term care or pharmacy services in a way that adversely impacts the Company.
The DRA also changed the so-called federal upper limit payment rules for multiple source prescription drugs covered under Medicaid. Like the current upper limit, it only applies to drug ingredient costs and does not include dispensing fees, which will continue to be determined by the states. First, the DRA redefined a multiple source drug subject to the upper limit rules to be a covered outpatient drug that has at least one other drug product that is therapeutically equivalent. Thus, the federal upper limit is triggered when there are two or more therapeutic equivalents, instead of three or more as was previously the case. Second, effective January 1, 2007, the DRA changed the federal upper payment limit from 150 percent of the lowest published price for a drug (which is usually the average wholesale price) to 250 percent of the lowest average manufacturer price (“AMP”). Congress expected these DRA provisions to reduce federal and state Medicaid spending by $8.4 billion over five years. On July 17, 2007, CMS issued a final rule with comment period to implement changes to the upper limit rules. Among other things, the final rule: established a new federal upper limit calculation for multiple source drugs based on 250 percent of the lowest AMP in a drug class; required CMS to post AMP amounts on its web site; and established a uniform definition for AMP. Additionally, the final rule provided that sales of drugs to long-term care pharmacies for supply to nursing homes and assisted living facilities (as well as associated discounts, rebates or other price concessions) are not to be taken into account in determining AMP where such sales can be identified with adequate documentation, and that any AMPs which are not at least 40% of the next highest AMP will not be taken into account in determining the upper limit amount (the so-called “outlier” test). However, on December 19, 2007, the United States District Court for the District of Columbia issued a preliminary injunction that enjoins CMS from implementing provisions of the July 17, 2007 rule to the extent that it affects Medicaid reimbursement rates for retail pharmacies under the Medicaid program. The order also enjoins CMS from posting AMP data on a public website or disclosing it to states. As a result of this preliminary injunction, CMS did not post AMPs or new upper limit prices in late December 2007 based upon the July 17, 2007 final rule despite its earlier planned timetable, and the schedule for states to implement the new upper limits will be delayed until further notice. Separately, on March 14, 2008, CMS published an interim final rule with comment period revising the Medicaid rebate definition of multiple source drug set forth in the July 17, 2007 final rule. In short, the effect of the rule will be that federal upper limits apply in all states unless the state finds that a particular generic drug is not available within that state. While the rule’s effective date is April 14, 2008, it is subject to public comment. CMS also notes that the regulation is subject to the injunction by the United States District Court for the District of Columbia to the extent that it may affect Medicaid reimbursement rates for pharmacies. Most recently, on July 15, 2008, Congress enacted into law over the President’s veto H.R. 6331, the “Medicare Improvements for Patients
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and Providers Act of 2008”. The new law delays the adoption of the DRA’s new federal upper limit payment rules for Medicaid based on AMP for multiple source drugs and prevents CMS from publishing AMP data until October 1, 2009. With the advent of Medicare Part D, the Company’s revenues from state Medicaid programs are substantially lower than has been the case previously. However, some of the Company’s agreements with Part D Plans and other payors have incorporated the Medicaid upper limit rules into the pricing mechanisms for prescription drugs. Until the litigation regarding the final rule is resolved and new upper limit amounts are published by CMS, the Company cannot predict the impact of the final rule on the Company’s business. There can be no assurance, however, that the changes under the DRA or other efforts by payors to limit reimbursement for certain drugs will not have an adverse impact on the Company’s business.
The Medicare Improvements for Patients and Providers Act of 2008 also seeks to promote e-prescribing by providing incentive payments for physicians and other practitioners paid under the Medicare physician fee schedule who are “successful electronic prescribers.” Specifically, successful electronic prescribers are to receive a 2 percent bonus during 2009 and 2010, a 1 percent bonus for 2011 and 2012 and a 0.5 percent bonus for 2013; practitioners who are not successful electronic prescribers are penalized by a 1 percent reduction from the current fee schedule in 2012, a 1.5 percent reduction in 2013, and thereafter a 2 percent reduction. The requirements for a practitioner to qualify as a successful electronic prescriber are to be specified by CMS, and may relate to either the submission of a minimum number of e-prescriptions under Medicare Part D, or to simply having a qualifying e-prescribing system and reporting whether it was used under an existing program for reporting certain physician quality measures for at least 50 percent of applicable encounters. Numerous details relating to this provision, including the timetable for adoption, will need to be specified by CMS. The Company is closely monitoring developments related to this initiative, and will seek to make available to practitioners systems under which they may submit prescriptions to the Company’s pharmacies electronically so as to enable them to qualify for the incentive payments.
President Bush’s fiscal year 2009 budget proposal includes a series of proposals impacting Medicaid, including legislative and administrative changes that would reduce Medicaid payments by more than $18 billion over five years. Among other things, the proposed budget would further reduce the federal upper limit reimbursement for multiple source drugs to 150 percent of the AMP and replace the “best price” component of the Medicaid drug rebate formula with a budget-neutral flat rebate. Many of the proposed policy changes would require Congressional approval to implement. While the Company has endeavored to adjust to these types of funding pressures in the past, there can be no assurance that these or future changes in Medicaid payments to nursing facilities, pharmacies, or managed care systems, or their potential impact on payments under agreements with Part D Plans, will not have an adverse impact on its business.
Two recent actions at the federal level could impact Medicaid payments to nursing facilities. The Tax Relief and Health Care Act of 2006 modified several Medicaid policies including, among other things, reducing the limit on Medicaid provider taxes from 6 percent to 5.5 percent from January 1, 2008 through September 30, 2011. The Bush Administration had been expected to issue regulations calling for deeper cuts in this funding. On February 22, 2008, CMS published a final rule that implements this legislation, and makes other clarifications to the
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standards for determining the permissibility of provider tax arrangements. On June 30, 2008, President Bush signed into law a supplemental appropriations bill (P.L. 110-252) that imposes a moratorium on implementation of certain provisions of this rule until April 1, 2009. Second, on January 18, 2007, CMS published a proposed rule designed to ensure that Medicaid payments to governmentally-operated nursing facilities and certain other health care providers are based on actual costs and that state financing arrangements are consistent with the Medicaid statute. CMS estimates that the rule, if finalized, would save $120 million during the first year and $3.87 billion over five years. On May 29, 2007, CMS published a final rule to implement this provision, but Congress blocked the rule for one year in an emergency fiscal year 2007 spending bill, H.R. 2206. The supplemental appropriations bill, P.L. 110-252, further extends the moratorium on implementation of the rule through April 1, 2009.
On October 4, 2006, the plaintiffs inNew England Carpenters Health Benefits Fund et al. v. First DataBank, Inc. and McKesson Corporation, CA No. 1:05-CV-11148-PBS (United District Court for the District of Massachusetts) and defendant First DataBank, Inc. (“First DataBank”) entered into a settlement agreement relating to First DataBank’s publication of average wholesale price (“AWP”). AWP is a pricing benchmark that is widely used to calculate a portion of the reimbursement payable to pharmacy providers for the drugs and biologicals they provide, including under State Medicaid programs, Medicare Part D Plans and certain of the Company’s contracts with long-term care facilities. The settlement agreement would have required First DataBank to cease publishing AWP two years after the settlement became effective unless a competitor of First DataBank was then publishing AWP, and would have required that First DataBank modify the manner in which it calculates AWP for over 8,000 distinct drugs (“NDCs”) from 125% of the drug’s wholesale acquisition cost (“WAC”) price established by manufacturers to 120% of WAC until First DataBank ceased publishing same. In a related case,District Council 37 Health and Security Plan v. Medi-Span,CA No. 1:07-CV-10988-PBS (United States District Court for the District of Massachusetts), in which Medi-Span is accused of misrepresenting pharmaceutical prices by relying on and publishing First DataBank’s price list, the parties entered into a similar settlement agreement. The Court granted preliminary approval of both agreements, however on January 22, 2008, the court held a hearing on a motion for final approval of the proposed settlements, and after hearing various objections to the proposed settlements indicated that it would not approve the settlements as proposed. The parties filed amendments to the proposed settlements on March 19, 2008, and at a status hearing held that day, the Court asked the parties to further revise the amended settlements. On May 29, 2008, the plaintiffs and First DataBank filed a new settlement that included a reduction in the number of NDCs to which a new mark-up over WAC would apply (20% vs. 25%) from over 8,000 to 1,356, and removed the provision requiring that AWP no longer be published in the future. First DataBank also agreed to contribute $2 million to a settlement fund and for legal fees. First DataBank, independent of the settlement, announced that it would, of its own volition, reduce to 20% the markup on all drugs with a mark-up higher than 20% and stop publishing AWP within two years after the changes in mark-up are implemented. On June 3, 2008, the Court granted preliminary approval to the revised settlement, and on July 23, 2008 the Court approved the process for class notification. The matter is still subject to opposition by others, a fairness hearing which has been scheduled for December 17, 2008, and final approval.
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The Company is monitoring these cases for further developments and evaluating potential implications and/or actions that may be required, including any adverse effect on the Company’s reimbursement for drugs and biologicals and any actions that may be taken to offset or otherwise mitigate such impact. There can be no assurance, however, that the First DataBank settlement, if approved, or actions, if any, by the government or private health insurance programs relating to AWP would not have an adverse impact on the Company’s reimbursement for drugs and biologicals and have implications for the use of AWP as a benchmark from which pricing in the pharmaceutical industry is negotiated, which could adversely affect the Company.
Longer term, funding for federal and state healthcare programs must consider the aging of the population and the growth in enrollees as eligibility is expanded; the escalation in drug costs owing to higher drug utilization among seniors and the introduction of new, more efficacious but also more expensive medications; the impact of the Medicare Part D program; and the long-term financing of the Medicare and Medicaid programs. Given competing national priorities, it remains difficult to predict the outcome and impact on the Company of any changes in healthcare policy relating to the future funding of the Medicare and Medicaid programs.
Demographic trends indicate that demand for long-term care will increase well into the middle of this century as the elderly population grows significantly. Moreover, those over 65 consume a disproportionately high level of healthcare services, including prescription drugs, when compared with the under-65 population. There is widespread consensus that appropriate pharmaceutical care is generally considered the most cost-effective form of treatment for the chronic ailments afflicting the elderly and also one that is able to improve the quality of life. These trends not only support long-term growth for the geriatric pharmaceutical industry but also containment of healthcare costs and the well-being of the nation’s growing elderly population.
In order to fund this growing demand, the Company anticipates that the government and the private sector will continue to review, assess and possibly alter healthcare delivery systems and payment methodologies. While it cannot at this time predict the ultimate effect of the Medicare Part D drug benefit or any further initiatives on Omnicare’s business, management believes that the Company’s expertise in geriatric pharmaceutical care and pharmaceutical cost management position Omnicare to help meet the challenges of today’s healthcare environment. Further, while volatility can occur from time to time in the contract research business owing to factors such as the success or failure of its clients’ compounds, the timing or budgetary constraints of its clients, or consolidation within our client base, new drug discovery remains an important priority of drug manufacturers. Drug manufacturers, in order to optimize their research and development efforts, will continue to turn to contract research organizations to assist them in accelerating drug research development and commercialization.
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CRO Services Segment
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| | Three months ended
June 30, | |
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| | 2008 | | 2007 | |
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Revenues | | $ | 53,631 | | $ | 50,239 | |
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Operating income | | $ | 3,800 | | $ | 2,904 | |
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Three Months Ended June 30, 2008 vs. 2007
Omnicare’s CRO Services segment recorded revenues of $53.6 million for the three months ended June 30, 2008, which increased by $3.4 million, or 6.8% from the $50.2 million recorded in the same prior-year period. In accordance with Emerging Issues Task Force (“EITF”) Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred” (“EITF No. 01-14”), the Company included $8.8 million and $8.2 million of reimbursable out-of-pockets in its CRO Services segment reported revenue and direct cost amounts for the three months ended June 30, 2008 and 2007, respectively. Revenues for 2008 were higher than in the same prior-year period primarily due to the commencement and ramp-up of projects that were awarded in 2007 and in the first six months of 2008, exceeding project terminations and cancellations.
Operating income in the CRO Services segment was $3.8 million in the second quarter of 2008 compared with $2.9 million in 2007, an increase of $0.9 million or 30.9%. As a percentage of the segment’s revenue, operating income was 7.1% in the second quarter of 2008 compared with 5.8% in the same period of 2007. This increase is primarily attributable to the favorable impact of the increase in revenues discussed above, combined with operating expense control. Backlog at June 30, 2008 was $337.4 million, representing an increase of $23.1 million from the December 31, 2007 backlog of $314.3 million, and an increase of $21.9 million from the June 30, 2007 backlog of $315.5 million.
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Six Months Ended June 30, 2008 vs. 2007 |
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Total net sales for the six months ended June 30, 2008 decreased to $3,109.1 million from $3,126.2 million in the comparable prior-year period. Net income for the six months ended June 30, 2008 was $66.7 million versus $92.2 million earned in the comparable 2007 period. Diluted earnings per share for the six months ended June 30, 2008 were $0.56 versus $0.76 in the same prior-year period. EBITDA totaled $234.3 million for the six months ended June 30, 2008 as compared with $287.9 million for the same period of 2007.
The Company continues to be impacted by the unilateral reduction in April 2006 by United in the reimbursement rates paid by United to Omnicare by switching to its PacifiCare pharmacy network contract for services rendered by Omnicare to beneficiaries of United’s drug benefit plans under the Medicare Part D program. The differential in reimbursement rates that resulted from United’s action, as compared with
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reimbursement rates under the originally negotiated contract, reduced sales and operating profit in the first six months of 2008 by approximately $47 million (approximately $29 million aftertax), and cumulatively since April 2006 by approximately $246 million (approximately $153 million aftertax). This matter is currently the subject of litigation initiated by Omnicare and is before the federal court in the Northern District of Illinois. See further discussion at the “Legal Proceedings” section at Part II, Item 1 of this Filing.
Net sales for the first six months were unfavorably impacted by a lower number of beds served, combined with a year-over-year shift in mix towards assisted living, the increased availability and utilization of generic drugs, reductions in reimbursement and/or utilization for certain drugs as well as competitive pricing issues, and lower revenues reported from copays and rejects under Part D as well as from certain matters currently in litigation. Partially offsetting these factors was the favorable impact of drug price inflation, increased use of certain higher acuity drugs and biologic agents, acquisitions, and year-over-year growth in CRO Services revenues. See discussion of sales and operating profit results in more detail at the “Pharmacy Services Segment” and “CRO Services Segment” captions below.
The Company’s consolidated gross profit of $761.8 million decreased $15.0 million for the six months ended June 30, 2008, from the same prior-year period amount of $776.8 million. Gross profit as a percentage of total net sales of 24.5% in the six months ended June 30, 2008, was modestly lower than the 24.8% experienced during the comparable 2007 period. Gross profit was unfavorably impacted in the 2008 period largely as a result of the gross profit impact of the aforementioned reduction in net sales, primarily the lower net number of beds served, and the reductions in reimbursement. Largely offsetting these factors was the increased availability and utilization of higher margin generic drugs, the continued integration of prior-period acquisitions, the favorable effect of drug price inflation, purchasing improvements and lower incremental costs associated with the closure of the Company’s Heartland repackaging facility as further described below.
Omnicare’s operating expenses for the six months ended June 30, 2008 of $473.6 million were higher than the comparable prior-year amount of $453.6 million by $20.0 million. Operating expenses as a percentage of net sales amounted to 15.2% in the first half of 2008, representing an increase from the 14.5% experienced in the comparable prior-year period. Operating expenses for the six months ended June 30, 2008 were unfavorably impacted largely by increases in employee benefit costs and increased operating costs associated with recent acquisitions. Partially offsetting the increased operating expenses were the favorable impact of the Company’s continued integration of prior-year acquisitions, purchasing improvements and productivity enhancements.
The provision for doubtful accounts for the six months ended June 30, 2008 of $56.2 million was modestly lower than the comparable prior year amount of $58.8 million.
Investment income for the six months ended June 30, 2008 of $4.6 million was marginally higher than the $4.0 million earned in the comparable prior-year period, primarily due to higher average invested balances versus the prior year.
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Interest expense for the six months ended June 30, 2008 of $73.0 million is lower than the $83.8 million in the comparable prior-year period, primarily due to lower debt outstanding resulting from payments aggregating $200 million on the Term Loans throughout 2007 and the first six months of 2008 and lower interest rates on variable rate loans.
The effective income tax rate was 38.3% for the six months ended June 30, 2008, as compared to the rate of 38.9% for the same prior year period. The effective tax rates in 2008 and 2007 are higher than the federal statutory rate largely as a result of the impact of state and local income taxes and various nondeductible expenses.
Special Items:
The six months ended June 30, 2008 included the following charges, which primarily impacted the Pharmacy Services segment. Management believes that these special items are either infrequent occurrences or otherwise not related to Omnicare’s ordinary course of business:
(i) Operating income included restructuring and other related charges of approximately $17.2 million pretax ($10.6 million aftertax), relating to the implementation of the “Omnicare Full Potential” Plan, a major initiative primarily designed to re-engineer the pharmacy operating model to increase efficiency and enhance customer growth. See further discussion at the “Restructuring and Other Related Charges” note of the Notes to Consolidated Financial Statements and the “Restructuring and Other Related Charges” section of this MD&A.
(ii) During the six months ended June 30, 2008, special charges relating to the aforementioned Heartland Matters of $3.6 million pretax (approximately $3.1 million and $0.5 million was recorded in the cost of sales and operating expense sections of the Consolidated Statements of Income, respectively) ($2.2 million aftertax) were recorded associated with these increased costs. As previously disclosed, the Company maintains product recall, property and casualty, and business interruption insurance, and the extent of insurance recovery for these expenses continues to be reviewed by its outside advisors. As of June 30, 2008, no receivables for insurance recoveries were recorded by the Company.
(iii) Operating income included special litigation and other related professional fees of $37.7 million pretax ($23.1 million aftertax) for litigation-related professional expenses primarily in connection with the Company’s lawsuit against United, certain other large customer disputes, the investigation by the United States Attorney’s Office, District of Massachusetts, the purported class and derivative actions, the investigation by the federal government and certain states relating to drug substitutions, and the Company’s response to subpoenas it received relating to other legal proceedings to which the Company is not a party. With respect to these proceedings to which the Company is a party, see further discussion at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
The six months ended June 30, 2007 included the following charges, which primarily impacted the Pharmacy Services segment. Management believes that these special items are either infrequent occurrences or otherwise not related to Omnicare’s ordinary course of business:
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(i) Operating income included restructuring and other related charges of approximately $15.4 million pretax ($9.5 million aftertax), $17.0 million of which related to the implementation of the “Omnicare Full Potential” Plan, a major initiative primarily designed to re-engineer the pharmacy operating model to increase efficiency and enhance customer growth, partially offset by a ($1.6) million credit adjustment to the previously disclosed consolidation and productivity initiatives related, in part, to the integration of the NeighborCare acquisition and other related activities. See further discussion at the “Restructuring and Other Related Charges” note of the Notes to Consolidated Financial Statements and the “Restructuring and Other Related Charges” section of this MD&A.
(ii) During the six months ended June 30, 2007, special charges relating to the aforementioned Heartland Matters of $10.7 million pretax (approximately $8.3 million and $2.4 million was recorded in the cost of sales and operating expense sections of the Consolidated Statements of Income, respectively) ($6.6 million aftertax) were recorded associated with these increased costs. As previously disclosed, the Company maintains product recall, property and casualty, and business interruption insurance, and the extent of insurance recovery for these expenses continues to be reviewed by its outside advisors. As of June 30, 2007, no receivables for insurance recoveries were recorded by the Company.
(iii) Operating income included a special litigation charge of $15.9 million pretax ($9.8 million aftertax) for litigation-related professional expenses in connection with the investigation by the United States Attorney’s Office, District of Massachusetts, the purported class and derivative actions, the Company’s lawsuit against United, the inquiry conducted by the Attorney General’s office in Michigan relating to certain billing issues under the Michigan Medicaid program, the investigation by the federal government and certain states relating to drug substitutions and the Company’s response to subpoenas it received relating to other legal proceedings to which the Company is not a party. With respect to these proceedings to which the Company is a party, see further discussion at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
Pharmacy Services Segment
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| | Six months ended
June 30, | |
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| | 2008 | | 2007 | |
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Net sales | | $ | 3,006,327 | | $ | 3,028,561 | |
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Operating income | | $ | 226,751 | | $ | 279,864 | |
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| |
Six Months Ended June 30, 2008 vs. 2007
Omnicare’s Pharmacy Services segment recorded sales of $3,006.3 million for the six months ended June 30, 2008, down from the 2007 amount of $3,028.6 million by approximately $22.3
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million, or 0.7%. At June 30, 2008, Omnicare served long-term care facilities as well as chronic care and other settings comprising approximately 1,438,000 beds, including approximately 70,000 patients served by the patient assistance programs of its specialty pharmacy business. The comparable number at December 31, 2007 was approximately 1,449,000 (including approximately 57,000 specialty pharmacy patients) and 1,449,000 (including approximately 60,000 patients served by patient assistance programs) at June 30, 2007. Pharmacy Services sales were unfavorably impacted by a lower number of beds served, as well as the impact of a bed mix shift toward assisted living, which typically has lower penetration rates than skilled nursing facilities, the increased availability and utilization of generic drugs, reductions in reimbursement and/or utilization of certain drugs as well as competitive pricing issues,and lower revenues reported from copays and rejects under Part D as well as from certain matters currently in litigation. Partially offsetting these factors was the favorable impact of drug price inflation, increased use of certain higher acuity drugs and biologic agents, and acquisitions. While the Company is focused on reducing its costs to mitigate the impact of drug pricing and reimbursement issues, there can be no assurance that such issues or other pricing and reimbursement pressures will not adversely impact the Pharmacy Services segment.
Operating income of the Pharmacy Services segment was $226.8 million in the first six months of 2008, a $53.1 million decrease as compared with the $279.9 million earned in the comparable period of 2007. As a percentage of the segment’s sales, operating income was 7.5% for the first six months of 2008, compared with 9.2% in 2007. The 2008 quarter was unfavorably impacted primarily by the operating income effect of the aforementioned reductions in sales as well as the year-over-year impact of the previously mentioned special items. Operating income in 2008 was favorably impacted largely by the increased availability and utilization of higher margin generic drugs, the Company’s continued integration of prior-period acquisitions and productivity enhancements, drug price inflation, lower bad debt expense, and purchasing improvements.
CRO Services Segment
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| | Six months ended
June 30, | |
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| | 2008 | | 2007 | |
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Revenues | | $ | 102,804 | | $ | 97,661 | |
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Operating income | | $ | 6,468 | | $ | 3,634 | |
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Six Months Ended June 30, 2008 vs. 2007
Omnicare’s CRO Services segment recorded revenues of $102.8 million for the six months ended June 30, 2008, which increased by $5.1 million, or 5.3% from the $97.7 million recorded in the same prior-year period. In accordance with EITF No. 01-14, the Company included $16.2 million and $15.4 million of reimbursable out-of-pockets in its CRO Services segment reported revenue and direct cost amounts for the six months ended June 30, 2008 and 2007, respectively. Revenues for 2008 were higher than in the same prior-year period primarily due to the
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commencement and ramp-up of projects that were awarded in 2007 and in the first six months of 2008, exceeding project terminations and cancellations.
Operating income in the CRO Services segment was $6.5 million in the first six months of 2008 compared with $3.6 million in 2007, an increase of $2.8 million. As a percentage of the segment’s revenue, operating income was 6.3% in the first six months of 2008 compared with 3.7% in the same period of 2007. This increase is primarily attributable to the favorable impact of the increase in revenues discussed above and the favorable year-over-year impact of special items.
Restructuring and Other Related Charges
Omnicare Full Potential Program
In 2006, the Company commenced the implementation of the “Omnicare Full Potential” Plan, a major initiative primarily designed to re-engineer the Company’s pharmacy operating model to increase efficiency and enhance customer growth. The Omnicare Full Potential Plan is expected to optimize resources across the entire organization by implementing best practices, including the realignment and right-sizing of functions, and a “hub-and-spoke” model whereby certain key administrative and production functions will be transferred to regional support centers (“hubs”) specifically designed and managed to perform these tasks, with local pharmacies (“spokes”) focusing on time-sensitive services and customer-facing processes.
This program is expected to be completed over a multi-year period and is estimated to generate pretax savings in the range of $100 million to $120 million annually upon completion of the initiative. It is anticipated that approximately one-half of these savings will be realized in cost of sales, with the remainder being realized in operating expenses. The program is estimated to result in total pretax restructuring and other related charges of approximately $93 million over this implementation period. The charges primarily include severance pay, employment agreement buy-outs, excess lease costs and professional fees, as well as other related costs. The Company recorded restructuring and other related charges for the Omnicare Full Potential Plan of approximately $11 million and $17 million pretax (approximately $7 million and $11 million aftertax) during the three and six months ended June 30, 2008, respectively, and approximately $29 million pretax during the year ended December 31, 2007 (approximately $8 million and $17 million pretax in the three and six months ended June 30, 2007, respectively). The Omnicare Full Potential Plan initiatives required cumulative restructuring and other related charges of approximately $64 million before taxes through the second quarter of 2008. The remainder of the overall restructuring and other related charges will be recognized and disclosed prospectively, as various phases of the project are finalized and implemented. Incremental capital expenditures related to this program are expected to total approximately $50 million to $55 million over the implementation period. Through March 31, 2008, the Company had eliminated approximately 1,200 positions in completing its initial phase of the program. The remainder of the program is expected to result in a net reduction of approximately 1,000 positions (1,700 positions eliminated net of new positions filled in different geographic locations as well as to perform new functions required by the hub-and-spoke model of operations). The foregoing
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reductions do not include additional savings expected from lower levels of overtime and reduced temporary labor.
While the Company is working diligently to achieve the estimated savings as discussed above, there can be no assurances as to the ultimate outcome of the program, including the related timing thereof, due to the inherent risks associated with the implementation of a project of this magnitude and the related new technologies. Specifically, the potential inability to successfully mitigate implementation risks, including but not necessarily limited to, dependence on third-party suppliers and consultants for the timely delivery of technology as well as its performance at expected capacities, compliance with federal, state and local regulatory requirements, reliance on information technology and telecommunications support, timely completion of facility lease transactions and/or leasehold improvements, and the ability to obtain adequate staffing levels, individually or in the aggregate could affect the overall success of the program from a savings and/or timing standpoint.
See further discussion at the “Restructuring and Other Related Charges” note of the Notes to Consolidated Financial Statements.
2005 Program
In connection with the previously disclosed consolidation plans and other productivity initiatives to streamline pharmacy services (related, in part, to the NeighborCare acquisition) and contract research organization operations, including maximizing workforce and operating asset utilization, and producing a more cost-efficient, operating infrastructure (the “2005 Program”), the Company had liabilities of $5.3 million at December 31, 2007, of which $0.8 million was utilized in the six months ended June 30, 2008. The remaining liabilities of $4.5 million at June 30, 2008 represent amounts not yet paid relating to actions taken in connection with the program (primarily lease payments) and will be settled as these matters are finalized. As previously disclosed, the Company recorded a credit to restructuring and other related charges of approximately ($1.6) million pretax (approximately ($1.0) million aftertax) during the three and six months ended June 30, 2007 in connection with the finalization of certain liabilities under the 2005 program.
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Financial Condition, Liquidity and Capital Resources |
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Cash and cash equivalents and restricted cash at June 30, 2008 were $223.7 million compared with $277.6 million at December 31, 2007 (including restricted cash amounts of $15.0 million and $3.2 million, respectively).
The Company generated positive net cash flows from operating activities of $228.6 million during the six months ended June 30, 2008, compared with net cash flows from operating activities of $235.9 million during the six months ended June 30, 2007. Compared to the same prior-year period, cash flow from operating activities was unfavorably impacted largely by the year-over-year trend in accounts payable on operating cash flows.
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Net cash used by investing activities was $131.1 million and $98.8 million for the six months ended June 30, 2008 and 2007, respectively. Acquisitions of businesses, primarily funded by operating cash flows, required outlays of $91.0 million (including amounts payable pursuant to acquisition agreements relating to pre-2008 acquisitions) in the first six months of 2008. Acquisitions of businesses during the first six months of 2007 required $69.3 million of cash payments (including amounts payable pursuant to acquisition agreements relating to pre-2007 acquisitions) which were primarily funded by operating cash flows. Omnicare’s capital requirements, in addition to the payment of debt and dividends, are primarily comprised of its acquisition program and capital expenditures, largely relating to investments in the Company’s information technology systems and the implementation of the “Omnicare Full Potential” Plan.
Net cash used in financing activities was $164.5 million for the six months ended June 30, 2008 as compared to $124.8 million for the comparable prior-year period. During the first six months of 2008 and 2007, the Company paid down $50 million and $100 million, respectively, on the Company’s senior term A loan facility, maturing on July 28, 2010. Borrowings on the revolving credit facility totaled approximately $59 million during the first six months of 2008 and were completely repaid prior to the end of the period.
At June 30, 2008, there were no outstanding borrowings under the $800 million revolving credit facility, and $400 million in borrowings were outstanding under the senior term A loan facility due 2010. As of June 30, 2008, the Company had approximately $27 million outstanding relating to standby letters of credit, substantially all of which are subject to automatic annual renewals.
On May 23, 2008, the Company’s Board of Directors declared a quarterly cash dividend of 2.25 cents per common share for an indicated annual rate of 9 cents per common share for 2008, which is consistent with the annual dividends per share actually paid in 2007. Aggregate dividends paid of $5.4 million during the six month periods ended June 30, 2008 were relatively consistent with those paid in the comparable prior-year period.
On March 27, 2008, the Company announced that its Board of Directors authorized a new program to repurchase, from time to time, shares of Omnicare's outstanding common stock having an aggregate value of up to $100 million, depending on market conditions and other factors. In the three months ended June 30, 2008, the Company repurchased approximately 4.1 million shares at a cost of approximately $100 million. Accordingly, as of June 30, 2008 the Company had utilized the full amount of share repurchase authority and successfully completed the program. These repurchases were made in open market or privately negotiated transactions in compliance with Securities and Exchange Commission Rule 10b-18 and other applicable legal requirements. On June 30, 2008, Omnicare had approximately 118.2 million shares of common stock outstanding.
There were no known material commitments and contingencies outstanding at June 30, 2008, other than the contractual obligations summarized in the “Disclosures About Aggregate Contractual Obligations and Off-Balance Sheet Arrangements” section below; certain acquisition-related payments potentially due in the future, including deferred payments, indemnification payments and payments originating from earnout and other provisions that may become payable; as well as the matters discussed in the “Commitments and Contingencies” note
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of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
The Company believes that net cash flows from operating activities, credit facilities and other short- and long-term debt financings will be sufficient to satisfy its future working capital needs, acquisition contingency commitments, debt servicing, capital expenditures and other financing requirements for the foreseeable future. Additionally, the Company believes that external sources of financing are available, although no assurances can be given regarding the Company’s ability to obtain additional financing in the future.
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Disclosures About Aggregate Contractual Obligations and Off-Balance Sheet Arrangements
Aggregate Contractual Obligations:
The following summarizes the Company’s aggregate contractual obligations as of June 30, 2008, and the effect such obligations are expected to have on the Company’s liquidity and cash flows in future periods (in thousands):
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| | Total | | Less Than 1
Year | | 1-3 Years | | 4-5 Years | | After 5 Years | |
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Debt obligations(a) | | $ | 2,772,000 | | $ | — | | $ | 449,500 | | $ | 250,000 | | $ | 2,072,500 | |
Capital lease obligations(a) | | | 6,500 | | | 2,819 | | | 2,844 | | | 440 | | | 397 | |
Operating lease obligations | | | 158,363 | | | 42,811 | | | 57,601 | | | 27,006 | | | 30,945 | |
Purchase obligations(b) | | | 82,664 | | | 64,899 | | | 11,220 | | | 6,545 | | | — | |
Other current obligations(c) | | | 336,094 | | | 336,094 | | | — | | | — | | | — | |
Other long-term obligations(d) | | | 361,126 | | | — | | | 322,389 | | | 28,841 | | | 9,896 | |
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Subtotal | | | 3,716,747 | | | 446,623 | | | 843,554 | | | 312,832 | | | 2,113,738 | |
Future interest relating to debt and capital lease obligations(e) | | | 1,684,979 | | | 132,596 | | | 244,634 | | | 223,144 | | | 1,084,605 | |
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Total contractual cash obligations | | $ | 5,401,726 | | $ | 579,219 | | $ | 1,088,188 | | $ | 535,976 | | $ | 3,198,343 | |
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(a) The noted obligation amounts represent the principal portion of the associated debt obligations. Details of the Company’s outstanding debt instruments can be found in the “Debt” note of the Notes to Consolidated Financial Statements.
(b) Purchase obligations primarily consist of open inventory purchase orders, as well as obligations for other goods and services, at period end.
(c) Other current obligations primarily consist of accounts payable at period end.
(d) Other long-term obligations are largely comprised of pension and excess benefit plan obligations, acquisition-related liabilities, as well as accruals relating to uncertain tax positions.
(e) Represents estimated future pretax interest costs based on the stated fixed interest rate of the debt, or the variable interest rate in effect at period end for variable interest rate debt. The estimated future interest costs presented in this table do not include any amounts potentially payable associated with the contingent interest and interest reset provisions of the Company’s convertible debentures. To the extent that any debt would be paid off by Omnicare prior to the stated due date or refinanced, the estimated future interest costs would change accordingly. Further, these analyses do not consider the effects of potential changes in the Company’s credit rating.
As of June 30, 2008, the Company had approximately $27 million outstanding relating to standby letters of credit, substantially all of which are subject to automatic annual renewals.
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Off-Balance Sheet Arrangements:
As of June 30, 2008, the Company had two unconsolidated entities, Omnicare Capital Trust I, a statutory trust formed by the Company (the “Old Trust”) and Omnicare Capital Trust II (the “New Trust”), which were established for the purpose of facilitating the offerings of the 4.00% Trust Preferred Income Equity Redeemable Securities due 2033 (the “Old Trust PIERS”) and the Series B 4.00% Trust Preferred Income Equity Redeemable Securities (the “New Trust PIERS”), respectively. For financial reporting purposes, the Old Trust and New Trust are treated as equity method investments of the Company. The Old Trust and New Trust are 100%-owned finance subsidiaries of the Company. The Company has fully and unconditionally guaranteed the securities of the Old Trust and New Trust. The Old 4.00% Debentures issued by the Company to the Old Trust and the New 4.00% Debentures issued by the Company to the New Trust in connection with the issuance of the Old Trust PIERS and the New Trust PIERS, respectively, are presented as a single line item in Omnicare’s Consolidated Balance Sheets and debt footnote disclosures. Additionally, the related disclosures concerning the Old Trust PIERS and the New Trust PIERS, the guarantees, and the Old 4.00% Debentures and New 4.00% Debentures are included in the “Debt” note of the Notes to Consolidated Financial Statements in Omnicare’s 2007 Annual Report. Omnicare records interest payable to the Old Trust and New Trust as interest expense in its Consolidated Statements of Income.
As of June 30, 2008, the Company had no other unconsolidated entities, or any financial partnerships, such as entities often referred to as structured finance or special purpose entities, which might have been established for the purpose of facilitating off-balance sheet arrangements.
Critical Accounting Policies
Allowance for Doubtful Accounts
Collection of accounts receivable from customers is the Company’s primary source of operating cash flow and is critical to Omnicare’s operating performance, cash flows and financial condition. Omnicare’s primary collection risk relates to facility, private pay and Part D customers. The Company provides a reserve for accounts receivable considered to be at increased risk of becoming uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. Omnicare establishes this allowance for doubtful accounts using the specific identification approach, and considering such factors as historical collection experience (i.e., payment history and credit losses) and creditworthiness, specifically identified credit risks, aging of accounts receivable by payor category, current and expected economic conditions and other relevant factors. Management reviews this allowance for doubtful accounts on an ongoing basis for appropriateness. Judgment is used to assess the collectability of account balances and the economic ability of customers to pay.
The Company computes and monitors its accounts receivable days sales outstanding (“DSO”), a non-GAAP measure, in order to evaluate the liquidity and collection patterns of its accounts receivable. DSO is calculated by averaging the beginning and end of quarter accounts receivable, less contractual allowances and the allowance for doubtful accounts, to derive
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“average accounts receivable” and dividing average accounts receivable by the sales amount (excluding reimbursable out-of-pockets) for the related quarter. The resultant percentage is multiplied by 92 days to derive the DSO amount. Omnicare’s DSO approximated 81 days at June 30, 2008, which was lower than the December 31, 2007 DSO of approximately 84 days, largely attributable to the Company’s late 2007 increase in its provision for doubtful accounts. As previously disclosed, the Company has experienced on-going administrative and payment issues associated with the Medicare Part D implementation, resulting in outstanding gross accounts receivable (net of allowances for contractual adjustments, and prior to any allowance for doubtful accounts), particularly for copays. As of June 30, 2008, copays outstanding from Part D Plans were approximately $27 million relating to 2006 and 2007. The Company is pursuing solutions, including legal actions against certain Part D payors, to collect outstanding copays, as well as certain rejected claims. Unfavorably impacting the overall DSO, as well as increases in the 181 days and over past due accounts receivable balance, is the aging in accounts receivable relating to several of the Company’s larger nursing home chain customers, and the continued aging of copays and rejected claims. On July 11, 2007, the Company commenced legal action against a group of its customers for, among other things, the collection of past-due receivables that are owed to the Company. Specifically, approximately $93 million (excluding interest and prior to any allowance for doubtful accounts) is owed to the Company by this group of customers as of June 30, 2008, of which approximately $84 million is past due based on applicable payment terms (a significant portion of which is not reserved based on the relevant facts and circumstances). The $93 million represents approximately 5 days of the overall DSO at June 30, 2008. Until all administrative and payment issues relating to the Part D Drug Benefit as well as the aforementioned legal action against a group of Omnicare’s customers are fully resolved, there can be no assurance that the impact of these matters on the Company’s results of operations, financial position or cash flows will not change based on the outcome of any unforeseen future developments.
The allowance for doubtful accounts as of June 30, 2008 was $342.7 million, compared with $334.1 million at December 31, 2007. The allowance for doubtful accounts represented 20.3% and 19.5% of gross receivables (net of contractual allowances) as of June 30, 2008 and December 31, 2007, respectively. Unforeseen future developments could lead to changes in the Company’s provision for doubtful accounts levels and future allowance for doubtful accounts percentages, which could materially impact the overall financial results, financial position or cash flows of the Company. For example, a one percentage point increase in the allowance for doubtful accounts as a percentage of gross receivables (net of allowances for contractual adjustments, and prior to allowances for doubtful accounts) as of June 30, 2008 would result in an increase to the provision for doubtful accounts and related allowance for doubtful accounts on the balance sheet of approximately $16.9 million pretax.
The following table is an aging of the Company’s June 30, 2008 and December 31, 2007 gross accounts receivable (net of allowances for contractual adjustments, and prior to allowances for doubtful accounts), aged based on payment terms and categorized based on the four primary overall types of accounts receivable characteristics (in thousands):
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| | | | | | | | | | |
| | June 30, 2008 | |
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| | Current and
0-180 Days
Past Due | | 181 Days and
Over
Past Due | | Total | |
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Medicare (Part D and Part B), Medicaid and Third-Party payors | | $ | 362,223 | | $ | 185,925 | | $ | 548,148 | |
Facility payors | | | 510,055 | | | 359,028 | | | 869,083 | |
Private Pay payors | | | 120,451 | | | 129,544 | | | 249,995 | |
CRO | | | 23,502 | | | — | | | 23,502 | |
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Total gross accounts receivable (net of contractual allowance adjustments) | | $ | 1,016,231 | | $ | 674,497 | | $ | 1,690,728 | |
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| | December 31, 2007 | |
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| | Current and
0-180 Days
Past Due | | 181 Days and
Over
Past Due | | Total | |
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Medicare (Part D and Part B), Medicaid and Third-Party payors | | $ | 390,663 | | $ | 167,116 | | $ | 557,779 | |
Facility payors | | | 527,879 | | | 347,551 | | | 875,430 | |
Private Pay payors | | | 126,480 | | | 124,958 | | | 251,438 | |
CRO | | | 25,702 | | | — | | | 25,702 | |
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Total gross accounts receivable (net of contractual allowance adjustments) | | $ | 1,070,724 | | $ | 639,625 | | $ | 1,710,349 | |
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Fair Value
On January 1, 2008, the Company partially adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines a hierarchy which prioritizes the inputs in fair value measurements. “Level 1” measurements are measurements using quoted prices in active markets for identical assets or liabilities. “Level 2” measurements use significant other observable inputs. “Level 3” measurements are measurements using significant unobservable inputs which require a company to develop its own assumptions. In recording the fair value of assets and liabilities, companies must use the most reliable measurement available. The impact to the Company’s consolidated results of operations, financial position and cash flows upon partial adoption of SFAS 157 was not material. The Company elected to partially defer adoption of SFAS 157 related to goodwill and indefinite-lived intangible assets in accordance with Financial Accounting Standards Board (“FASB”) Staff Position 157-2.
See further discussion at the “Fair Value” note of the Notes to Consolidated Financial Statements.
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Legal Contingencies
The status of certain legal proceedings has been updated at the “Commitments and Contingencies” note of the Notes to Consolidated Financial Statements, and the “Legal Proceedings” section at Part II, Item 1 of this Filing.
Recently Issued Accounting Standards
Information pertaining to recently issued accounting standards is further discussed at the “Recently Issued Accounting Standards” section of the “Interim Financial Data, Description of Business and Summary of Significant Accounting Policies” note of the Notes to Consolidated Financial Statements of this Filing.
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Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Regarding Forward-Looking Information |
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In addition to historical information, this report contains certain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, all statements regarding the intent, belief or current expectations regarding the matters discussed or incorporated by reference in this document (including statements as to “beliefs,” “expectations,” “anticipations,” “intentions” or similar words) and all statements which are not statements of historical fact. Such forward-looking statements, together with other statements that are not historical, are based on management’s current expectations and involve known and unknown risks, uncertainties, contingencies and other factors that could cause results, performance or achievements to differ materially from those stated. The most significant of these risks and uncertainties are described in the Company’s Form 10-K, Form 10-Q and Form 8-K reports filed with the Securities and Exchange Commission and include, but are not limited to: overall economic, financial, political and business conditions; trends in the long-term healthcare, pharmaceutical and contract research industries; the ability to attract new clients and service contracts and retain existing clients and service contracts; the ability to consummate pending acquisitions; trends for the continued growth of the Company’s businesses; trends in drug pricing; delays and reductions in reimbursement by the government and other payors to customers and to the Company; the overall financial condition of the Company’s customers and the ability of the Company to assess and react to such financial condition of its customers; the ability of vendors and business partners to continue to provide products and services to the Company; the continued successful integration of acquired companies; the continued availability of suitable acquisition candidates; the ability to attract and retain needed management; competition for qualified staff in the healthcare industry; the demand for the Company’s products and services; variations in costs or expenses; the ability to implement productivity, consolidation and cost reduction efforts and to realize anticipated benefits; the ability of clinical research projects to produce revenues in future periods; the potential impact of legislation, government regulations, and other government action and/or executive orders, including those relating to Medicare Part D, including its implementing regulations and any subregulatory guidance, reimbursement and drug pricing policies and changes in the interpretation and application of such policies; government budgetary pressures and shifting priorities; federal and
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state budget shortfalls; efforts by payors to control costs; changes to or termination of the Company’s contracts with Medicare Part D plan sponsors or to the proportion of the Company’s Part D business covered by specific contracts; the outcome of litigation; potential liability for losses not covered by, or in excess of, insurance; the impact of differences in actuarial assumptions and estimates as compared to eventual outcomes; events or circumstances which result in an impairment of assets, including but not limited to, goodwill; market conditions; the outcome of audit, compliance, administrative, regulatory, or investigatory reviews; volatility in the market for the Company’s stock and in the financial markets generally; access to adequate capital and financing; changes in international economic and political conditions and currency fluctuations between the U.S. dollar and other currencies; changes in tax laws and regulations; changes in accounting rules and standards; and costs to comply with our Corporate Integrity Agreements. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, the Company’s actual results, performance or achievements could differ materially from those expressed in, or implied by, such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except as otherwise required by law, the Company does not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Omnicare’s primary market risk exposure relates to variable interest rate risk through its borrowings. Accordingly, market risk loss is primarily defined as the potential loss in earnings due to higher interest rates on variable-rate debt of the Company. The modeling technique used by Omnicare for evaluating interest rate risk exposure involves performing sensitivity analysis on the variable-rate debt, assuming a change in interest rates of 100 basis-points. The Company’s debt obligations at June 30, 2008 include $400.0 million outstanding under the variable-rate Senior term A loan, due 2010, at an interest rate of 4.23% at June 30, 2008 (a 100 basis-point change in the interest rate would increase or decrease pretax interest expense by approximately $4.0 million per year); $49.5 million borrowed on a variable-rate term loan, due 2010, at an interest rate of 6.26% at June 30, 2008 (a 100 basis-point change in the interest rate would increase or decrease pretax interest expense by approximately $0.5 million per year); $250.0 million outstanding under its fixed-rate 6.125% Senior Notes, due 2013; $225.0 million outstanding under its fixed-rate 6.75% Senior Notes, due 2013; $525 million outstanding under its fixed-rate 6.875% Senior Notes, due 2015; $345.0 million outstanding under its fixed-rate 4.00% Convertible Debentures, due 2033; and $977.5 million outstanding under its fixed-rate 3.25% Convertible Debentures, due 2035 (with an optional repurchase right of holders on December 15, 2015). In connection with its offering of $250.0 million of 6.125% Senior Notes during 2003, the Company entered into a Swap Agreement on all $250.0 million of its aggregate principal amount of the 6.125% Senior Notes. Under the Swap Agreement, which hedges against exposure to long-term U.S. dollar interest rates, the Company receives a fixed rate of 6.125% and pays a floating rate based on LIBOR with a maturity of six months, plus a spread of 2.27%. The estimated LIBOR-based floating rate (including the 2.27% spread) was 5.40% at June 30, 2008 (a 100 basis-point change in the interest rate would increase or decrease pretax
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interest expense by approximately $2.5 million per year). The Swap Agreement, which matches the terms of the 6.125% Senior Notes, is designated and accounted for as a fair value hedge. The Company is accounting for the Swap Agreement in accordance with SFAS No. 133, as amended, so changes in the fair value of the Swap Agreement are offset by changes in the recorded carrying value of the related 6.125% Senior Notes. The fair value of the Swap Agreement is recorded as a noncurrent asset or (liability), with an offsetting increase or (decrease), respectively, to the book carrying value of the related 6.125% Senior Notes, and amounted to approximately $(9.6) million at the end of the 2008 second quarter. Additionally, at June 30, 2008, the fair value of Omnicare’s variable rate debt facilities approximated the carrying value, as the effective interest rates fluctuate with changes in market rates.
The fair value of the Company’s fixed-rate debt facilities is based on quoted market prices and is summarized as follows (in thousands):
Fair Value of Financial Instruments
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| | June 30, 2008 | | December 31, 2007 | |
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Financial Instrument: | | Book Value | | Market Value | | Book Value | | Market Value | |
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6.125% senior subordinated notes, due 2013, gross | | | $ | 250,000 | | | | $ | 233,800 | | | | $ | 250,000 | | | | $ | 230,000 | | |
6.75% senior subordinated notes, due 2013 | | | | 225,000 | | | | | 212,700 | | | | | 225,000 | | | | | 212,600 | | |
6.875% senior subordinated notes, due 2015 | | | | 525,000 | | | | | 485,600 | | | | | 525,000 | | | | | 486,900 | | |
4.00% junior subordinated convertible debentures, due 2033 | | | | 345,000 | | | | | 268,200 | | | | | 345,000 | | | | | 246,700 | | |
3.25% convertible senior debentures, due 2035 | | | | 977,500 | | | | | 713,600 | | | | | 977,500 | | | | | 703,800 | | |
Embedded in the Old Trust PIERS, the New Trust PIERS and the 3.25% Convertible Debentures are two derivative instruments, specifically, a contingent interest provision and a contingent conversion parity provision. In addition, the 3.25% Convertible Debentures include an interest reset provision. The embedded derivatives are periodically valued, and at period end, the values of the derivatives embedded in the Old Trust PIERS, the New Trust PIERS and the 3.25% Convertible Debentures were not material. However, the values are subject to change, based on market conditions, which could affect the Company’s future consolidated results of operations, financial position or cash flows.
The Company has operations and revenue that occur outside of the U.S. and transactions that are settled in currencies other than the U.S. dollar, exposing it to market risk related to changes in foreign currency exchange rates. However, the substantial portion of the Company’s operations and revenues and the substantial portion of the Company’s cash settlements are exchanged in U.S. dollars. Therefore, changes in foreign currency exchange rates do not represent a substantial market risk exposure to the Company.
The Company does not have any financial instruments held for trading purposes.
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ITEM 4 - CONTROLS AND PROCEDURES
(a) Under applicable SEC regulations, management of a reporting company, with the participation of the principal executive officer and principal financial officer, must periodically evaluate the Company’s “disclosure controls and procedures,” which are defined generally as controls and other procedures of a reporting company designed to ensure that information required to be disclosed by the reporting company in its periodic reports filed with the SEC (such as this Form 10-Q) is recorded, processed, accumulated and communicated to the Company’s management as appropriate to allow timely decisions regarding disclosure. Omnicare is an acquisitive company that continuously acquires and integrates new businesses. Throughout and following an acquisition, Omnicare focuses on analyzing the acquiree’s procedures and controls to determine their effectiveness and, where appropriate, implements changes to conform them to the Company’s disclosure controls and procedures. The Company’s Chief Executive Officer and Chief Financial Officer evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q and concluded that they are effective.
(b) There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION:
ITEM 1 - LEGAL PROCEEDINGS
On May 18, 2006, an antitrust and fraud action entitledOmnicare, Inc. v. UnitedHealth Group, Inc., et al., 2:06-cv-00103-WOB, was filed by the Company in the United States District Court for the Eastern District of Kentucky against UnitedHealth Group, Inc., PacifiCare Health Systems, Inc., and RxSolutions, Inc. d/b/a Prescription Solutions, asserting claims of violations of federal and state antitrust laws, civil conspiracy and common law fraud arising out of an alleged conspiracy by defendants to illegally and fraudulently coordinate their negotiations with the Company for Medicare Part D contracts as part of an effort to defraud the Company and fix prices. The complaint seeks, among other things, damages, injunctive relief and reformation of certain contracts. On June 5, 2006, the Company filed a first supplemental and amended complaint in which it asserted the identical claims. In an order dated November 9, 2006, a motion by defendants to transfer venue to the United States District Court for the Northern District of Illinois was granted, but a motion to dismiss the antitrust claims was denied without prejudice, with leave to refile in the transferee court. In the United States District Court for the Northern District of Illinois, the defendants renewed their motion to dismiss the Company’s antitrust claims on December 22, 2006, and on September 28, 2007 their motion was denied. On March 7, 2007, the Court entered a Minute Order setting a discovery schedule for the litigation. Fact discovery has been completed, and expert discovery is nearly completed. On June 20, 2008, the defendants filed a motion for summary judgement on all claims and the Company filed a motion for summary judgement on certain affirmative defenses asserted by the defendants. Opposition briefs were filed on July 18, 2008 and reply briefs are due on August 8, 2008. On
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April 18, 2008, the Court entered a Minute Order affirming its previous May 22, 2007 Minute Order that set a trial date of October 14, 2008.
The United States Attorney’s Office, District of Massachusetts, is conducting an investigation relating to the Company’s relationships with certain manufacturers and distributors of pharmaceutical products and certain customers, as well as with respect to contracts with certain companies acquired by the Company. Any action by the U.S. Attorney’s Office, District of Massachusetts, could result in civil or criminal proceedings against the Company. The Company believes that it has complied with all applicable laws and regulations with respect to these matters.
On February 2 and February 13, 2006, respectively, two substantially similar putative class action lawsuits, entitledIndiana State Dist. Council of Laborers & HOD Carriers Pension & Welfare Fund v. Omnicare, Inc., et al., No. 2:06cv26 (“HOD Carriers”), andChi v. Omnicare, Inc., et al., No. 2:06cv31 (“Chi”), were filed against Omnicare and two of its officers in the United States District Court for the Eastern District of Kentucky purporting to assert claims for violation of §§10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeking, among other things, compensatory damages and injunctive relief. The complaints, which purported to be brought on behalf of all open-market purchasers of Omnicare common stock from August 3, 2005 through January 27, 2006, alleged that Omnicare had artificially inflated its earnings by engaging in improper generic drug substitution and that defendants had made false and misleading statements regarding the Company’s business and prospects. On April 3, 2006, plaintiffs in theHOD Carriers case formally moved for consolidation and the appointment of lead plaintiff and lead counsel pursuant to the Private Securities Litigation Reform Act of 1995. On May 22, 2006, that motion was granted, the cases were consolidated, and a lead plaintiff and lead counsel were appointed. On July 20, 2006, plaintiffs filed a consolidated amended complaint, adding a third officer as a defendant and new factual allegations primarily relating to revenue recognition, the valuation of receivables and the valuation of inventories. On October 31, 2006, plaintiffs moved for leave to file a second amended complaint, which was granted on January 26, 2007, on the condition that no further amendments would be permitted absent extraordinary circumstances. Plaintiffs thereafter filed their second amended complaint on January 29, 2007. The second amended complaint (i) expands the putative class to include all purchasers of Omnicare common stock from August 3, 2005 through July 27, 2006, (ii) names two members of the Company’s board of directors as additional defendants, (iii) adds a new plaintiff and a new claim for violation of Section 11 of the Securities Act of 1933 based on alleged false and misleading statements in the registration statement filed in connection with the Company’s December 2005 public offering, (iv) alleges that the Company failed to timely disclose its contractual dispute with UnitedHealth Group (see discussion of theUnitedHealth Group matter above), and (v) alleges that the Company failed to timely record certain special litigation reserves. The defendants filed a motion to dismiss the second amended complaint on March 12, 2007, claiming that plaintiffs had failed adequately to plead loss causation, scienter or any actionable misstatement or omission. That motion was fully briefed as of May 1, 2007. In response to certain arguments relating to the individual claims of the named plaintiffs that were raised in defendants’ pending motion to dismiss, plaintiffs filed a motion to add, or in the alternative, to intervene an additional named plaintiff, Alaska Electrical Pension Fund, on July 27, 2007. On October 12, 2007, the court issued an opinion and order
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dismissing the case and denying plaintiffs’ motion to add an additional named plaintiff. On November 9, 2007, plaintiffs filed a notice of appeal with the United States Court of Appeals for the Sixth Circuit with respect to the dismissal of their case. That appeal is fully briefed and oral argument has been scheduled for September 18, 2008.
On February 13, 2006, two substantially similar shareholder derivative actions, entitledIsak v. Gemunder, et al., Case No. 06-CI-390, andFragnoli v. Hutton, et al., Case No. 06-CI-389, were filed in Kentucky State Circuit Court, Kenton Circuit, against the members of Omnicare’s board of directors, individually, purporting to assert claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment arising out of the Company’s alleged violations of federal and state health care laws based upon the same purportedly improper generic drug substitution that is the subject of the federal purported class action lawsuits. The complaints seek, among other things, damages, restitution and injunctive relief. TheIsak andFragnoli actions were later consolidated by agreement of the parties. On January 12, 2007, the defendants filed a motion to dismiss the consolidated action on the grounds that the dismissal of the substantially identical shareholder derivative action,Irwinv. Gemunder, et al., 2:06cv62, by the United States District Court for the Eastern District of Kentucky on November 20, 2006 should be given preclusive effect and thus bars re-litigation of the issues already decided inIrwin. Instead of opposing that motion, on March 16, 2007, the plaintiffs filed an amended consolidated complaint, which continues to name all of the directors as defendants and asserts the same claims, but attempts to bolster those claims by adding nearly all of the substantive allegations from the most recent complaint in the federal securities class action (seediscussion ofHOD Carriers above) and an amended complaint inIrwin that added the same factual allegations that were added to the consolidated amended complaint in theHOD Carriers action. On April 16, 2007, defendants filed a supplemental memorandum of law in further support of their pending motion to dismiss contending that the amended complaint should be dismissed on the same grounds previously articulated for dismissal, namely, the preclusive effect of the dismissal of the Irwin action. That motion has been fully briefed, oral argument was held on August 21, 2007, and the court reserved decision.
The Company believes the above-described purported class and derivative actions are without merit and will be vigorously defended.
Although the Company cannot predict the ultimate outcome of the matters described in the preceding paragraphs, there can be no assurance that the resolution of these matters will not have a material adverse impact on the Company’s consolidated results of operations, financial position or cash flows.
As part of its ongoing operations, the Company is subject to various inspections, audits, inquiries and similar actions by governmental/regulatory authorities responsible for enforcing laws and regulations to which the Company is subject, including reviews of individual Omnicare pharmacy’s reimbursement documentation and administrative practices.
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ITEM 1A - RISK FACTORS
The Omnicare 2007 Annual Report on Form 10-K includes a detailed discussion of our risk factors. The information presented below updates and should be read in conjunction with the risk factors and information disclosed in that Form 10-K.
Risks Relating to Our Business
Federal and state healthcare legislation has significantly impacted our business, and future legislation and regulations are likely to affect us.
In recent years, federal legislation has resulted in major changes in the healthcare system, which significantly affected healthcare providers. The Balanced Budget Act of 1997 (the “BBA”) mandated a prospective payment system (“PPS”) for Medicare-eligible residents of skilled nursing facilities (“SNFs”). Under PPS, Medicare pays SNFs a fixed fee per patient per day based upon the acuity level of the resident, covering substantially all items and services furnished during a Medicare-covered stay, including pharmacy services. PPS initially resulted in a significant reduction of reimbursement to SNFs. Congress subsequently sought to restore some of the reductions in reimbursement resulting from PPS. One provision gave SNFs a temporary rate increase for certain specific high-acuity patients beginning April 1, 2000, and ending when the Centers for Medicare & Medicaid Services (“CMS”) implemented a refined patient classification system under PPS. For several years, CMS did not implement such refinements, thus continuing the additional rate increase for certain high-acuity patients through federal fiscal year 2005.
On August 4, 2005, CMS issued its final SNF PPS rule for fiscal year 2006. Under the rule, CMS added nine patient classification categories to the PPS patient classification system, thus triggering the expiration of the high-acuity payments add-ons. However, CMS estimated that the rule would have a slightly positive financial impact on SNFs in fiscal year 2006 because the $1.02 billion reduction from the expiration of the add-on payments would be more than offset by a $510 million increase in the nursing case-mix weight for all of the resource utilization group categories and a $530 million increase associated with various updates to the payment rates (including updates to the wage and market basket indexes), resulting in a $20 million overall increase in payments for fiscal year 2006. The new patient classification refinements became effective on January 1, 2006, and the market basket increase became effective October 1, 2005. On July 31, 2006, CMS issued the update to the SNF PPS rates for fiscal year 2007. Effective October 1, 2006, SNFs received the full 3.1 percent market basket increase to rates, increasing payments to SNFs by approximately $560 million for fiscal year 2007. On August 3, 2007, CMS published its final SNF PPS update for fiscal year 2008. Effective October 1, 2007, SNFs received a 3.3 percent market basket increase, which increases Medicare payments to SNFs by approximately $690 million in fiscal year 2008. The final rule also includes several policy and payment provisions, including rebasing the market basket, which currently reflects data from fiscal 1997, to a base year of fiscal year 2004; revisions to the calculation of the SNF market basket (including revising the pharmacy component); changing the threshold for forecast error adjustments from the current 0.25 percentage point to 0.5 percentage point; and continuing a special adjustment made to cover the additional services required by nursing home residents with HIV/AIDS. On May 1, 2008, CMS released its proposed SNF PPS update for fiscal year 2009. Among other things, the proposed rule would
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recalibrate case mix weights, resulting in an overall 3.3 percent reduction in Medicare payments. Most of the decrease would be offset by a 3.1 percent market basket increase, but if the rule were adopted as proposed, SNFs would experience a net reduction in Medicare payments of $60 million, or approximately 0.3 percent. The rule was subject to public comment until June 30, 2008, and a final rule will be issued this summer. While the fiscal year 2007 and 2008 SNF PPS rates do not decrease payments to SNFs, the potential loss of revenues associated with the proposed fiscal year 2009 changes to SNF payments or other potential reimbursement changes could, in the future, have an adverse effect on the financial condition of the Company’s SNF clients which could, in turn, adversely affect the timing or level of their payments to Omnicare.
Moreover, on February 8, 2006, the President signed into law the Deficit Reduction Act (“DRA”), which will reduce net Medicare and Medicaid spending by approximately $11 billion over five years. Among other things, the legislation reduces Medicare SNF bad debt payments by 30 percent for those individuals who are not dually eligible for Medicare and Medicaid. This provision is expected to reduce payments to SNFs by $100 million over five years (fiscal years 2006-2010). On February 4, 2008, the Bush Administration released its fiscal year 2009 budget proposal, which includes legislative and administrative proposals that would reduce Medicare spending by approximately $12.2 billion in fiscal year 2009 and $178 billion over five years. Among other things, the budget would provide no annual update for SNFs in 2009 through 2011 and a -0.65 percent adjustment to the update annually thereafter. In addition, the budget would apply a “sequester” of -0.4 percent to all Medicare provider payments when general fund contributions exceed 45 percent of program spending. The sequester order would increase each year by -0.4 percent until general revenue funding is brought back to 45 percent. The budget also would move toward site-neutral post-hospital payments to limit perceived inappropriate incentives for five conditions commonly treated in both SNFs and inpatient rehabilitation facilities. The Administration also proposes to achieve savings by issuing regulations to adjust for case mix distribution in the SNF payment system. CMS included this provision in its proposed SNF prospective payment system update for fiscal year 2009, released May 1, 2008. CMS estimates that the recalibration would result in an overall 3.3 percent reduction in Medicare payments in fiscal year 2009, although the proposed rule would partially offset the case mix recalibration payment decrease with a 3.1 percent market basket increase. In addition, the budget proposal would eliminate all bad debt reimbursements for unpaid beneficiary cost-sharing over four years. Many provisions of the proposed Bush budget would require Congressional action to implement. Separately, on August 1, 2007, the House of Representatives approved H.R. 3162, the Children’s Health and Medicare Protection Act of 2007, that included a number of Medicare policy changes, including a freeze in fiscal year 2008 SNF PPS rates at fiscal year 2007 levels. Note that while the version of the bill that ultimately passed Congress did not include Medicare provisions impacting SNF reimbursement, Congress may yet consider these and other proposals in the future that would further restrict Medicare funding for SNFs.
In December 2003, Congress enacted the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“MMA”) which included a major expansion of the Medicare prescription drug benefit under a new Medicare Part D.
Under the Medicare Part D prescription drug benefit, Medicare beneficiaries may enroll in prescription drug plans offered by private entities (or in a “fallback” plan offered on behalf of the
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government through a contractor, to the extent private entities fail to offer a plan in a given area), which provide coverage of outpatient prescription drugs (collectively, “Part D Plans”). Part D Plans include both plans providing the drug benefit on a stand alone basis and Medicare Advantage plans providing drug coverage as a supplement to an existing medical benefit under that Medicare Advantage plan, most commonly a health maintenance organization plan. Medicare beneficiaries generally have to pay a premium to enroll in a Part D Plan, with the premium amount varying from plan to plan, although CMS provides various federal subsidies to Part D Plans to reduce the cost to beneficiaries. Effective January 1, 2006, Medicare beneficiaries who are also entitled to benefits under a state Medicaid program (so-called “dual eligibles”) have their prescription drug costs covered by the new Medicare drug benefit. Many nursing home residents Omnicare serves are dual eligibles, whose drug costs were previously covered by state Medicaid programs. In 2007, approximately 42% of Omnicare’s revenue was derived from beneficiaries covered under the federal Medicare Part D program.
CMS provides premium and cost-sharing subsidies to Part D Plans with respect to dual eligible residents of nursing homes. Such dual eligibles are not required to pay a premium for enrollment in a Part D Plan, so long as the premium for the Part D Plan in which they are enrolled is at or below the premium subsidy, nor are they required to meet deductibles or pay copayment amounts. Further, all dual eligibles who do not affirmatively enroll in a Part D Plan are automatically enrolled into a Prescription Drug Plan (“PDP”) by CMS on a random basis from among those PDPs meeting CMS criteria for low-income premiums in the PDP region. As is the case for any nursing home beneficiary, such dual eligible beneficiaries may select a different Part D Plan at any time through the Part D enrollment process. In sum, dual eligible residents of nursing homes are entitled to have their prescription drug costs covered by a Part D Plan, provided that the prescription drugs which they are taking are either on the Part D Plan’s formulary, or an exception to the plan’s formulary is granted. CMS requires the formularies of Part D Plans to include the types of drugs most commonly needed by Medicare beneficiaries and to offer an exceptions process to provide coverage for medically necessary drugs.
Pursuant to the Part D final rule, effective January 1, 2006, we obtain reimbursement for drugs we provide to enrollees of a given Part D Plan in accordance with the terms of agreements negotiated between us and that Part D Plan. We have entered into such agreements with nearly all Part D Plan sponsors under which we provide drugs and associated services to their enrollees. We continue to have ongoing discussions with Part D Plans in the ordinary course. Moreover, we may, as appropriate, renegotiate agreements. Further, the proportion of our Part D business serviced under specific agreements may change over time. Consequently, there can be no assurance that the reimbursement terms which currently apply to our Part D business will not change. In addition, as expected in the transition to a new program of this magnitude, certain administrative and payment issues have arisen, resulting in higher operating expenses, as well as outstanding gross accounts receivable (net of allowances for contractual adjustments, and prior to any allowance for doubtful accounts), particularly for copays. As of June 30, 2008, copays outstanding from Part D Plans were approximately $27 million relating to 2006 and 2007. The Company is pursuing solutions, including legal actions against certain Part D payors, to collect outstanding copays, as well as certain rejected claims. Participants in the long-term care pharmacy industry continue to address these issues with CMS and the Part D Plans and attempt to develop solutions. However, until all administrative and payment issues are fully resolved,
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there can be no assurance that the impact of the Part D Drug benefit on our results of operations, financial position or cash flows will not change based on the outcome of any unforeseen future developments.
The MMA does not change the manner in which Medicare pays for drugs for Medicare beneficiaries covered under a Medicare Part A stay. We continue to receive reimbursement for drugs provided to such residents from the SNFs, in accordance with the terms of the agreements we have negotiated with each SNF. We also continue to receive reimbursement from the state Medicaid programs, albeit to a greatly reduced extent, for those Medicaid beneficiaries not eligible for the Part D program, including those under age 65, and for certain drugs specifically excluded from Medicare Part D.
CMS has issued subregulatory guidance on many aspects of the final Part D rule, including the provision of pharmaceutical services to long-term care residents. CMS has also expressed some concerns about pharmacies’ receipt of discounts, rebates and other price concessions from drug manufacturers. Specifically, in a finalized “Call Letter” for the 2007 calendar year, CMS indicated that beginning in 2007, Part D sponsors must have policies and systems in place, as part of their drug utilization management programs, to protect beneficiaries and reduce costs when long-term care pharmacies are subject to incentives to move market share through access/performance rebates from drug manufacturers. For the purposes of managing and monitoring drug utilization, especially where such rebates exist, CMS instructs Part D Plan sponsors to require pharmacies to disclose to the Part D Plan sponsor any discounts, rebates and other direct or indirect remuneration designed to directly or indirectly influence or impact utilization of Part D drugs. CMS stated that Plan sponsors should provide assurances that such information will remain confidential. CMS has issued subregulatory guidelines specifying the information that CMS is requiring from Plan sponsors with respect to rebates paid to long-term care pharmacies. CMS has also issued reporting requirements for 2008 which, among other things, require disclosure of rebates provided to long-term care pharmacies at a more detailed level. We have agreed with various Plan sponsors and their agents with respect to the format, terms and conditions for providing such information and we intend to continue to work with other sponsors with respect to providing such information.
On July 15, 2008, Congress enacted into law H.R. 6331, the “Medicare Improvements for Patients and Providers Act of 2008” by overriding the President’s veto of the bill. The new law includes further reforms to the Part D program. Among other things, from and after January 1, 2010, the law requires that long-term care pharmacies have between 30 and 90 days to submit claims to a Part D Plan. Commencing January 1, 2009, the law also requires Part D Plan sponsors to update the prescription drug pricing data they use to pay pharmacies no less frequently than every seven days. The law also expands the number of Medicare beneficiaries who will be entitled to premium and cost-sharing subsidies by modifying previous income and asset requirements, eliminates late enrollment penalties for beneficiaries entitled to these subsidies, and limits the sales and marketing activities in which Part D Plan sponsors may engage, among other things.
Moreover, CMS continues to issue guidance on and make revisions to the Part D program. We are continuing to monitor issues relating to implementation of the Part D benefit, and until
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further agency guidance is known and until all administrative and payment issues associated with the transition to this massive program are fully resolved, there can be no assurance that the impact of the final rule or the outcome of other potential developments relating to its implementation on our business, results of operations, financial position or cash flows will not change based on the outcome of any unforeseen future developments.
The MMA also changed the Medicare payment methodology and conditions for coverage of certain items of durable medical equipment prosthetics, orthotics, and supplies (“DMEPOS”) under Medicare Part B. Approximately 1% of our revenue is derived from beneficiaries covered under Medicare Part B. The changes include a temporary freeze in annual increases in payments for durable medical equipment from 2004 through 2008, new clinical conditions for payment, quality standards (applied by CMS-approved accrediting organizations), and competitive bidding requirements. On April 10, 2007, CMS issued a final rule establishing the Medicare competitive bidding program. Only suppliers that are winning bidders will be eligible to provide competitively-bid items to Medicare beneficiaries in the selected areas. Enteral nutrients, equipment and supplies and oxygen equipment and supplies were among the 10 categories of DMEPOS included in the first round of the competitive bidding program.
In mid-2007 CMS conducted a first round of bidding for these 10 DMEPOS product categories in 10 competitive bidding areas, and CMS began announcing winning bidders in March 2008. In light of concerns about implementation of the bidding program, including CMS’ disqualification of many bids based upon bidders’ submission of allegedly incomplete financial documentation and the potential adverse impact on beneficiary access to certain types of DMEPOS, Congress has, through the enactment into law on July 15, 2008 of H.R. 6331, the “Medicare Improvements for Patients and Providers Act of 2008,” terminated the contracts awarded by CMS in the first round of competitive bidding, required that new bidding be conducted for the first round, and required certain reforms to the bidding process. Among other things, the law requires CMS to rebid those areas in 2009, with bidding for round two delayed until 2011. The delay will be financed by reducing Medicare fee schedule payments for all items covered by round one bidding program by 9.5 percent nationwide beginning January 1, 2009, followed by a 2 percent increase in 2014 (with certain exceptions). The legislation also includes a series of procedural improvements to the bidding process, including requiring CMS to notify bidders about paperwork discrepancies and providing suppliers with an opportunity to submit proper documentation, and it requires contracting suppliers to disclose all subcontracting relationships to CMS. We intend to participate in the new bidding process for round one, and are assessing the potential impact of the fee schedule reductions on its business.
CMS requires all existing DMEPOS suppliers to submit proof of accreditation by a deemed accreditation organization by September 30, 2009, although suppliers in the competitive bidding regions and new suppliers have been subject to earlier accreditation deadlines. The Medicare Improvements for Patients and Providers Act of 2008 codifies the requirement that all suppliers be accredited by October 1, 2009 and extends the accreditation requirement to companies that subcontract with contract suppliers under the competitive bidding program. We intend to comply with all accreditation requirements for DMEPOS suppliers by the applicable deadline.
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With respect to Medicaid, the BBA repealed the “Boren Amendment” federal payment standard for Medicaid payments to nursing facilities, giving states greater latitude in setting payment rates for such facilities. The law also granted states greater flexibility to establish Medicaid managed care programs without the need to obtain a federal waiver. Although these waiver programs generally exempt institutional care, including nursing facilities and institutional pharmacy services, some states do use managed care principles in their long-term care programs. Likewise, the DRA includes several changes to the Medicaid program designed to rein in program spending. These include, among others, strengthening the Medicaid asset transfer restrictions for persons seeking to qualify for Medicaid long-term care coverage, which could, due to the timing of the penalty period, increase facilities’ exposure to uncompensated care. This provision is expected to reduce Medicaid spending by an estimated $2.4 billion over five years. The law also gives states greater flexibility to expand access to home and community based services by allowing states to provide these services as an optional benefit without undergoing the waiver approval process, and includes a new demonstration to encourage states to provide long-term care services in a community setting to individuals who currently receive Medicaid services in nursing homes. Together, these provisions could increase state funding for home and community-based services, while prompting states to cut funding for nursing facilities. No assurances can be given that state Medicaid programs ultimately will not change the reimbursement system for long-term care or pharmacy services in a way that adversely impacts the Company.
The DRA also changed the so-called federal upper limit payment rules for multiple source prescription drugs covered under Medicaid. Like the current upper limit, it only applies to drug ingredient costs and does not include dispensing fees, which will continue to be determined by the states. First, the DRA redefined a multiple source drug subject to the upper limit rules to be a covered outpatient drug that has at least one other drug product that is therapeutically equivalent. Thus, the federal upper limit is triggered when there are two or more therapeutic equivalents, instead of three or more as was previously the case. Second, effective January 1, 2007, the DRA changed the federal upper payment limit from 150 percent of the lowest published price for a drug (which is usually the average wholesale price) to 250 percent of the lowest average manufacturer price (“AMP”). Congress expected these DRA provisions to reduce federal and state Medicaid spending by $8.4 billion over five years. On July 17, 2007, CMS issued a final rule with comment period to implement changes to the upper limit rules. Among other things, the final rule: established a new federal upper limit calculation for multiple source drug, based on 250 percent of the lowest AMP in a drug class; required CMS to post AMP amounts on its web site; and established a uniform definition for AMP. Additionally, the final rule provided that sales of drugs to long-term care pharmacies for supply to nursing homes and assisted living facilities (as well as associated discounts, rebates or other price concessions) are not to be taken into account in determining AMP where such sales can be identified with adequate documentation, and that any AMPs which are not at least 40% of the next highest AMP will not be taken into account in determining the upper limit amount (the so-called “outlier” test). However, on December 19, 2007, the United States District Court for the District of Columbia issued a preliminary injunction that enjoins CMS from implementing provisions of the July 17, 2007 rule to the extent that it affects Medicaid reimbursement rates for retail pharmacies under the Medicaid program. The order also enjoins CMS from posting AMP data on a public website or disclosing it to states. As a result of this preliminary injunction, CMS did not post AMPs or new upper limit prices in late December 2007 based upon the July 17, 2007 final rule despite its earlier planned timetable, and
80
the schedule for states to implement the new upper limits will be delayed until further notice. Separately, on March 14, 2008, CMS published an interim final rule with comment period revising the Medicaid rebate definition of multiple source drug set forth in the July 17, 2007 final rule. In short, the effect of the rule will be that federal upper limits apply in all states unless the state finds that a particular generic drug is not available within that state. While the rule’s effective date is April 14, 2008, it is subject to public comment. CMS also notes that the regulation is subject to the injunction by the United States District Court for the District of Columbia to the extent that it may affect Medicaid reimbursement rates for pharmacies. Most recently, on July 15, 2008, Congress enacted into law over the President’s veto H.R. 6331, the “Medicare Improvements for Patients and Providers Act of 2008”. The new law delays the adoption of the DRA’s new federal upper limit payment rules for Medicaid based on AMP for multiple source drugs and prevents CMS from publishing AMP data until October 1, 2009. With the advent of Medicare Part D, our revenues from state Medicaid programs are substantially lower than has been the case previously. However, some of our agreements with Part D Plans and other payors have incorporated the Medicaid upper limit rules into the pricing mechanisms for prescription drugs. Until the litigation regarding the final rule is resolved and new upper limit amounts are published by CMS, we cannot predict the impact of the final rule on our business. There can be no assurance, however, that the changes under the DRA or other efforts by payors to limit reimbursement for certain drugs will not have an adverse impact on our business.
The Medicare Improvements for Patients and Providers Act of 2008 also seeks to promote e-prescribing by providing incentive payments for physicians and other practitioners paid under the Medicare physician fee schedule who are “successful electronic prescribers.” Specifically, successful electronic prescribers are to receive a 2 percent bonus during 2009 and 2010, a 1 percent bonus for 2011 and 2012 and a 0.5 percent bonus for 2013; practitioners who are not successful electronic prescribers are penalized by a 1 percent reduction from the current fee schedule in 2012, a 1.5 percent reduction in 2013, and thereafter a 2 percent reduction. The requirements for a practitioner to qualify as a successful electronic prescriber are to be specified by CMS, and may relate to either the submission of a minimum number of e-prescriptions under Medicare Part D, or to simply having a qualifying e-prescribing system and reporting whether it was used under an existing program for reporting certain physician quality measures for at least 50 percent of applicable encounters. Numerous details relating to this provision, including the timetable for adoption, will need to be specified by CMS. The Company is closely monitoring developments related to this initiative, and will seek to make available to practitioners systems under which they may submit prescriptions to the Company’s pharmacies electronically so as to enable them to qualify for the incentive payments.
President Bush’s fiscal year 2009 budget proposal includes a series of proposals impacting Medicaid, including legislative and administrative changes that would reduce Medicaid payments by more than $18 billion over five years. Among other things, the proposed budget would further reduce the federal upper limit reimbursement for multiple source drugs to 150 percent of the AMP and replace the “best price” component of the Medicaid drug rebate formula with a budget-neutral flat rebate. Many of the proposed policy changes would require Congressional approval to implement. While we have endeavored to adjust to these types of funding pressures in the past, there can be no assurance that these or future changes in Medicaid payments to nursing facilities, pharmacies, or managed care systems, or their potential impact on payments under agreements with Part D Plans, will not have an adverse impact on our business.
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Two recent actions at the federal level could impact Medicaid payments to nursing facilities. The Tax Relief and Health Care Act of 2006 modified several Medicaid policies including, among other things, reducing the limit on Medicaid provider taxes from 6 percent to 5.5 percent from January 1, 2008 through September 30, 2011. The Bush Administration had been expected to issue regulations calling for deeper cuts in this funding. On February 22, 2008, CMS published a final rule that implements this legislation, and makes other clarifications to the standards for determining the permissibility of provider tax arrangements. On June 30, 2008, President Bush signed into law a supplemental appropriations bill (P.L. 110-252) that imposes a moratorium on implementation of certain provisions of this rule until April 1, 2009. Second, on January 18, 2007, CMS published a proposed rule designed to ensure that Medicaid payments to governmentally-operated nursing facilities and certain other health care providers are based on actual costs and that state financing arrangements are consistent with the Medicaid statute. CMS estimates that the rule, if finalized, would save $120 million during the first year and $3.87 billion over five years. On May 29, 2007, CMS published a final rule to implement this provision, but Congress blocked the rule for one year in an emergency fiscal year 2007 spending bill, H.R. 2206. The supplemental appropriations bill, P.L. 110-252, further extends the moratorium on implementation of the rule through April 1, 2009.
Further, in order to rein in healthcare costs, we anticipate that federal and state governments will continue to review and assess alternate healthcare delivery systems, payment methodologies and operational requirements for healthcare providers, including long-term care facilities and pharmacies. Given the continuous debate regarding the cost of healthcare, managed care, universal healthcare coverage, and other healthcare issues, we cannot predict with any degree of certainty what additional healthcare initiatives, if any, will be implemented or the effect any future legislation or regulation will have on our business. Further, we receive discounts, rebates and other price concessions from pharmaceutical manufacturers pursuant to contracts for the purchase of their products. There can be no assurance that any changes in legislation or regulations, or interpretations of current law, that would eliminate or significantly reduce the discounts, rebates and other price concessions that we receive from manufacturers would not have a material adverse impact on our overall consolidated results of operations, financial position or cash flows. Longer term, funding for federal and state healthcare programs must consider the aging of the population; the growth in enrollees as eligibility is potentially expanded; the escalation in drug costs owing to higher drug utilization among seniors; the impact of the Medicare Part D benefit for seniors; the introduction of new, more efficacious but also more expensive medications; and the long-term financing of the entire Medicare program. Given competing national priorities, it remains difficult to predict the outcome and impact on us of any changes in healthcare policy relating to the future funding of the Medicare and Medicaid programs. Further, Medicare, Medicaid and/or private payor rates for pharmaceutical supplies and services may not continue to be based on current methodologies or remain comparable to present levels. Any future healthcare legislation or regulation may adversely affect our business.
Changes in the use of the average wholesale price as a benchmark from which pricing in the pharmaceutical industry is negotiated could adversely affect the Company.
On October 4, 2006, the plaintiffs inNew England Carpenters Health Benefits Fund et al. v. First DataBank, Inc. and McKesson Corporation, CA No. 1:05-CV-11148-PBS (United District
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Court for the District of Massachusetts) and defendant First DataBank, Inc. (“First DataBank”) entered into a settlement agreement relating to First DataBank’s publication of average wholesale price (“AWP”). AWP is a pricing benchmark that is widely used to calculate a portion of the reimbursement payable to pharmacy providers for the drugs and biologicals they provide, including under State Medicaid programs, Medicare Part D Plans and certain of the Company’s contracts with long-term care facilities. The settlement agreement would have required First DataBank to cease publishing AWP two years after the settlement became effective unless a competitor of First DataBank was then publishing AWP, and would have required that First DataBank modify the manner in which it calculates AWP for over 8,000 distinct drugs (“NDCs”) from 125% of the drug’s wholesale acquisition cost (“WAC”) price established by manufacturers to 120% of WAC until First DataBank ceased publishing same. In a related case,District Council 37 Health and Security Plan v. Medi-Span,CA No. 1:07-CV-10988-PBS (United States District Court for the District of Massachusetts), in which Medi-Span is accused of misrepresenting pharmaceutical prices by relying on and publishing First DataBank’s price list, the parties entered into a similar settlement agreement. The Court granted preliminary approval of both agreements, however on January 22, 2008, the court held a hearing on a motion for final approval of the proposed settlements, and after hearing various objections to the proposed settlements indicated that it would not approve the settlements as proposed. The parties filed amendments to the proposed settlements on March 19, 2008, and at a status hearing held that day, the Court asked the parties to further revise the amended settlements. On May 29, 2008, the plaintiffs and First DataBank filed a new settlement that included a reduction in the number of NDCs to which a new mark-up over WAC would apply (20% vs. 25%) from over 8,000 to 1,356, and removed the provision requiring that AWP no longer be published in the future. First DataBank also agreed to contribute $2 million to a settlement fund and for legal fees. First DataBank, independent of the settlement, announced that it would, of its own volition, reduce to 20% the mark-up on all drugs with a mark-up higher than 20% and stop publishing AWP within two years after the changes in mark-up are implemented. On June 3, 2008, the Court granted preliminary approval to the revised settlement, and on July 23, 2008 the Court approved the process for class notification. The matter is still subject to opposition by others, a fairness hearing which has been scheduled for December 17, 2008, and final approval.
The Company is monitoring these cases for further developments and evaluating potential implications and/or actions that may be required, including any adverse effect on the Company’s reimbursement for drugs and biologicals and any actions that may be taken to offset or otherwise mitigate such impact. There can be no assurance, however, that the First DataBank settlement, if approved, or actions, if any, by the government or private health insurance programs relating to AWP would not have an adverse impact on the Company’s reimbursement for drugs and biologicals and have implications for the use of AWP as a benchmark from which pricing in the pharmaceutical industry is negotiated, which could adversely affect the Company.
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ITEM 2 - UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
A summary of the Company’s repurchases of Omnicare, Inc. common stock during the quarter ended June 30, 2008 is as follows (in thousands, except per share data):
| | | | | | | | | | | | | |
Period | | Total Number
of Shares
Purchased(a)(b) | | Average
Price Paid
per Share | | Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs(b) | | Maximum Number (or
Approximate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs(b) | |
| |
| |
| |
| |
| |
April 1 - 30, 2008 | | | — | | $ | — | | | — | | $ | 100,000 | |
May 1 - 31, 2008 | | | 4,144 | | | 24.22 | | | 4,136 | | | — | |
June 1 - 30, 2008 | | | — | | | — | | | — | | | — | |
| |
|
| | | | |
|
| | | | |
Total | | | 4,144 | | $ | 24.22 | | | 4,136 | | $ | — | |
| |
|
| |
|
| |
|
| |
|
| |
| |
(a) | During the second quarter of 2008, the Company purchased 8 shares of Omnicare common stock in connection with its employee benefit plans, including any purchases associated with the vesting of restricted stock awards. These purchases were not made pursuant to a publicly announced repurchase plan or program. |
| |
(b) | On March 27, 2008, the Company announced that its Board of Directors authorized a new program to repurchase, from time to time, shares of Omnicare’s outstanding common stock having an aggregate value of up to $100 million, depending on market conditions and other factors. During the second quarter of 2008, the Company purchased 4,136 shares of Omnicare common stock in connection with this program. Accordingly, as of June 30, 2008, the Company had utilized the full amount of share repurchase authority and successfully completed the program. |
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ITEM 4. – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Omnicare held its Annual Meeting of Stockholders on May 23, 2008.
(b) The names of each director elected at this Annual Meeting, as well as the corresponding number of shares voted for, and withheld from, each nominee follows:
| | | |
| Votes For | | Votes Withheld |
|
| |
|
John T. Crotty | 98,297,310 | | 11,082,907 |
Joel F. Gemunder | 96,549,254 | | 12,830,963 |
Steven J. Heyer | 108,708,847 | | 671,370 |
Sandra E. Laney | 98,246,235 | | 11,133,982 |
Andrea R. Lindell, Ph.D., RN | 98,218,954 | | 11,161,263 |
James D. Shelton | 108,760,016 | | 620,201 |
John H. Timoney | 98,304,309 | | 11,075,908 |
Jeffrey W. Ubben | 106,977,376 | | 2,402,841 |
Amy Wallman | 98,322,364 | | 11,057,853 |
(c) The Stockholders ratified the appointment by the Audit Committee of the Board of Directors of PricewaterhouseCoopers LLP as independent registered public accountants for the Company and its consolidated subsidiaries for the 2008 year. A total of 98,637,902 votes were cast in favor of the proposal; 206,041 votes were cast against it; 10,536,274 votes abstained; and there were no Broker non-votes.
ITEM 6 - EXHIBITS
See Index of Exhibits.
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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.
| |
| Omnicare, Inc. |
|
|
| Registrant |
| | |
Date: July 31, 2008 | By: | /s/ David W. Froesel, Jr. |
| |
|
| | David W. Froesel, Jr. |
| | Senior Vice President and |
| | Chief Financial Officer |
| | (Principal Financial and |
| | Accounting Officer) |
INDEX OF EXHIBITS
| | | | |
Number and Description of Exhibit
(Numbers Coincide with Item 601 of Regulation S-K) | | Document Incorporated by Reference
from a Previous Filing, Filed
Herewith or Furnished Herewith, as
Indicated Below |
| |
|
| | | | |
(3.1) | | Restated Certificate of Incorporation of Omnicare, Inc. (as amended) | | Form 10-K
March 27, 2003 |
| | | | |
(3.3) | | Second Amended and Restated By-Laws of Omnicare, Inc. | | Form 10-Q
November 14, 2003 |
| | | | |
(12) | | Statement of Computation of Ratio of Earnings to Fixed Charges | | Filed Herewith |
| | | | |
(31.1) | | Rule 13a-14(a) Certification of Chief Executive Officer of Omnicare, Inc. in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | | Filed Herewith |
| | | | |
(31.2) | | Rule 13a-14(a) Certification of Chief Financial Officer of Omnicare, Inc. in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | | Filed Herewith |
| | | | |
(32.1) | | Section 1350 Certification of Chief Executive Officer of Omnicare, Inc. in accordance with Section 906 of the Sarbanes-Oxley Act of 2002** | | Furnished Herewith |
| | | | |
(32.2) | | Section 1350 Certification of Chief Financial Officer of Omnicare, Inc. in accordance with Section 906 of the Sarbanes-Oxley Act of 2002** | | Furnished Herewith |
** A signed original of this written statement required by Section 906 has been provided to Omnicare, Inc. and will be retained by Omnicare, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
E-1
EXHIBIT 12
|
Statement of Computation of Ratio of Earnings to Fixed Charges |
Omnicare, Inc. and Subsidiary Companies |
(in thousands, except ratios) |
Unaudited |
| | | | | | | | | | | | | |
| | Three months ended
June 30, | | Six months ended
June 30, | |
| |
| |
| |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| |
| |
| |
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Income before income taxes | | $ | 58,378 | (1) | $ | 81,354 | (1) | $ | 108,177 | (1) | $ | 150,913 | (1) |
Add fixed charges: | | | | | | | | | | | | | |
Interest expense | | | 33,904 | | | 39,682 | | | 68,923 | | | 79,693 | |
Amortization of debt expense | | | 2,036 | | | 2,036 | | | 4,073 | | | 4,073 | |
Interest portion of rent expense | | | 6,703 | | | 6,223 | | | 13,168 | | | 12,254 | |
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Adjusted income | | $ | 101,021 | | $ | 129,295 | | $ | 194,341 | | $ | 246,933 | |
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Fixed charges: | | | | | | | | | | | | | |
Interest expense | | $ | 33,904 | | $ | 39,682 | | $ | 68,923 | | $ | 79,693 | |
Amortization of debt expense | | | 2,036 | | | 2,036 | | | 4,073 | | | 4,073 | |
Interest portion of rent expense | | | 6,703 | | | 6,223 | | | 13,168 | | | 12,254 | |
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Fixed charges | | $ | 42,643 | | $ | 47,941 | | $ | 86,164 | | $ | 96,020 | |
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Ratio of earnings to fixed charges(2) | | | 2.4 | x | | 2.7 | x | | 2.3 | x | | 2.6 | x |
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(1) Income before income taxes includes the following special pretax charges: |
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| | Three months ended
June 30, | | Six months ended
June 30, | |
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| | 2008 | | 2007 | | 2008 | | 2007 | |
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Restructuring and other related charges (a) | | $ | 10,784 | | $ | 6,250 | | $ | 17,232 | | $ | 15,424 | |
Litigation and other related professional fees (b) | | | 16,022 | | | 9,010 | | | 37,664 | | | 15,917 | |
Heartland matters (b) | | | 1,740 | | | 4,911 | | | 3,633 | | | 10,703 | |
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(a) See the “Restructuring and Other Related Charges” note of the Notes to the Consolidated Financial Statements. |
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(b) See the “Commitments and Contingencies” note of the Notes to the Consolidated Financial Statements. |
(2) The ratio of earnings to fixed charges has been computed by adding income before income taxes and fixed charges to derive adjusted income, and dividing adjusted income by fixed charges. Fixed charges consist of interest expense on debt (including the amortization of debt expense) and one-third (the proportion deemed representative of the interest portion) of rent expense.
E-2
