** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**Quarterly report under Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

 

**For the quarterly period endedMarch 31, 2008**

 

**CommissionFile Number 000-51518**

 

**Chem Rx Corporation******(Exact name of registrant as specified in its charter)

 

| **Delaware**

(State or other Jurisdiction of  Incorporation or Organization) | ** ** | **20-2938469**

(I.R.S. Employer Identification No.) |
|-------------------------------------------------------------------------------|------------|------------------------------------------------------|

 

**750Park PlaceLong Beach, NY 11561**(Address of Principal Executive Office)

 

**(516) 889-8770**(Registrant’s Telephone Number, Including AreaCode)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Exchange Act during thepast 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yes x No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| Large  accelerated filer o                     |   | Accelerated  filer o         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                       |   | Smaller  reporting company x |
| (Do  not check if a smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).    Yes o No x

 

As of May 28,2008, 13,794,103 shares of common stock, par value $.0001 per share, wereissued and outstanding.

 

 

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TABLE OFCONTENTS

 
| PART I:  FINANCIAL INFORMATION:                                                               | 3                                                                                                           |
|----------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                                                                               |                                                                                                        |
| Item 1. Financial  Statements                                                                      | 3                                                                                                           |
|                                                                                               |                                                                                                        |
|                                                                                               | Consolidated Balance Sheets as of  March 31, 2008 (Unaudited) and December 31, 2007               | 3 |
|                                                                                               |                                                                                                        |   |
|                                                                                               | Consolidated  Statements of Operations for the Three Months Ended March 31, 2008 and  2007 (Unaudited) | 4 |
|                                                                                               |                                                                                                        |   |
|                                                                                               | Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2008 and 2007  (Unaudited) | 5 |
|                                                                                               |                                                                                                        |   |
|                                                                                               | Notes to Consolidated  Financial Statements                                                                 | 6 |
|                                                                                               |                                                                                                        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operation | 17                                                                                                          |
|                                                                                               |                                                                                                        |
| Item 3. Quantitative and Qualitative Disclosures about  Market Risk                                | 31                                                                                                          |
|                                                                                               |                                                                                                        |
| Item 4. Controls and Procedures                                                                    | 31                                                                                                          |
|                                                                                               |                                                                                                        |
| PART II  – OTHER INFORMATION                                                             | 34                                                                                                          |
|                                                                                               |                                                                                                        |
| Item  1. Legal Proceedings                                                                         | 34                                                                                                          |
|                                                                                               |                                                                                                        |
| Item  1A. Risk Factors                                                                        | 34                                                                                                          |
|                                                                                               |                                                                                                        |
| Item 2.  Unregistered Sales of Equity Securities  and Use of Proceeds                         | 34                                                                                                          |
|                                                                                               |                                                                                                        |
| Item  6. Exhibits                                                                                  | 35                                                                                                          |

 

2

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** **

**PART I: FINANCIALINFORMATION**

** **

**Item 1. Financial Statements**

** **

**CHEM RX CORPORATION ANDSUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**(In thousands, except share andper share data)**

 
| ** **                                                                                                                                                                                  | ** ** | **March********31, 2008** | ** ** | **December  31, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **(unaudited)**                | ** ** | **(Note 2)**           | ** ** |
| CURRENT ASSETS                                                                                                                                                                              |       |                           |       |                        |       |
| Cash                                                                                                                                                                                        |       | $                              | 2,755      |                        | $          | 3,740 |   |
| Accounts receivable, net                                                                                                                                                                    |       | 69,196                         |       | 65,038                      |       |
| Inventory                                                                                                                                                                                   |       | 19,106                         |       | 22,354                      |       |
| Prepaid expenses and other  current assets                                                                                                                                                  |       | 5,610                          |       | 4,562                       |       |
| Total Current Assets                                                                                                                                                                        |       | 96,667                         |       | 95,694                      |       |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| Property and equipment, net                                                                                                                                                                 |       | 9,766                          |       | 8,806                       |       |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| Intangible assets, net                                                                                                                                                                      |       | 80,267                         |       | 82,033                      |       |
| Goodwill                                                                                                                                                                                    |       | 38,626                         |       | 38,626                      |       |
| Deferred financing costs, net                                                                                                                                                               |       | 4,607                          |       | 4,779                       |       |
| Other assets                                                                                                                                                                                |       | 2,907                          |       | 2,562                       |       |
| Deferred tax asset                                                                                                                                                                          |       | 1,049                          |       | 544                         |       |
| TOTAL ASSETS                                                                                                                                                                                |       | $                              | 233,889    |                        | $          | 233,044 |   |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| CURRENT LIABILITIES                                                                                                                                                                         |       |                           |       |                        |       |
| Accounts payable                                                                                                                                                                            |       | $                              | 24,011     |                        | $          | 24,280 |   |
| Accrued expenses and other  current liabilities                                                                                                                                             |       | 2,406                          |       | 3,284                       |       |
| Current portion of long-term debt                                                                                                                                                           |       | 2,000                          |       | 2,000                       |       |
| Total Current Liabilities                                                                                                                                                                   |       | 28,417                         |       | 29,564                      |       |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| Long-term debt                                                                                                                                                                              |       | 131,500                        |       | 129,000                     |       |
| Subordinated notes payable - related  parties                                                                                                                                               |       | 8,619                          |       | 8,408                       |       |
| Total Liabilities                                                                                                                                                                           |       | 168,536                        |       | 166,972                     |       |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                               |       |                           |       |                        |       |
|                                                                                                                                                                                        |       |                           |       |                        |       |
| STOCKHOLDERS’ EQUITY                                                                                                                                                                   |       |                           |       |                        |       |
| Preferred stock, $.0001 par  value, authorized 1,000,000 shares; none issued                                                                                                                |       | —                         |       | —                      |       |
| Common stock, $.0001 par value,  authorized 150,000,000 shares in 2008 and 2007; 14,400,000 issued; 13,762,915  outstanding at March 31, 2008 and December 31, 2007, respectively |       | 1                              |       | 1                           |       |
| Treasury stock, 637,085 shares  (at cost)                                                                                                                                                   |       | (3,654                         | )          | (3,654                      | )          |
| Additional paid-in-capital                                                                                                                                                                  |       | 67,381                         |       | 67,372                      |       |
| Accumulated other comprehensive  loss                                                                                                                                                       |       | (342                           | )          |                        |       |
| Retained earnings                                                                                                                                                                           |       | 1,967                          |       | 2,353                       |       |
| Total Stockholders’ Equity                                                                                                                                                             |       | 65,353                         |       | 66,072                      |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                            |       | $                              | 233,889    |                        | $          | 233,044 |   |

 

The accompanying notes arean integral part of the consolidated financial statements.

 

3

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**CHEM RX CORPORATION ANDSUBSIDIARY**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except shareand per share data)**

**(UNAUDITED)**

 
| ** **                                                                       | ** ** | **Three months ended   March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
|                                                                             |       |                                                   |       |   |   |
| Net sales                                                                        |       | $                                                      | 87,536     |   | $ | — |   |
|                                                                             |       |                                                   |       |   |   |
| Cost of sales                                                                    |       | 65,586                                                 |       | — |   |
|                                                                             |       |                                                   |       |   |   |
| Gross profit                                                                     |       | 21,950                                                 |       | — |   |
|                                                                             |       |                                                   |       |   |   |
| Selling, general and  administrative expenses                                    |       | 19,114                                                 |       | 167 |   |
|                                                                             |       |                                                   |       |   |   |
| Operating income (loss)                                                          |       | 2,836                                                  |       | (167 | ) |
|                                                                             |       |                                                   |       |   |   |
| Other income (expense):                                                          |       |                                                   |       |   |   |
| Interest income                                                                  |       | 8                                                      |       | 470 |   |
| Interest expense                                                                 |       | (3,795                                                 | )          | — |   |
| Other income, net                                                                |       | 298                                                    |       | — |   |
|                                                                             |       |                                                   |       |   |   |
| Income (loss) before income taxes                                                |       | (653                                                   | )          | 303 |   |
| (Benefit) provision for income  taxes                                            |       | (267                                                   | )          | 1 |   |
| Net income (loss)                                                                |       | (386                                                   | )          | 302 |   |
|                                                                             |       |                                                   |       |   |   |
| Accretion of trust fund relating to  common stock subject to possible redemption |       | —                                                 |       | 94 |   |
|                                                                             |       |                                                   |       |   |   |
| Net income (loss) available to  common stockholders                              |       | $                                                      | (386       | ) | $ | 208 |   |
|                                                                             |       |                                                   |       |   |   |
| Net income (loss) per share –  basic and diluted                            |       | $                                                      | (0.03      | ) | $ | 0.02 |   |
|                                                                             |       |                                                   |       |   |   |
| Weighted average shares  outstanding – basic and diluted                    |       | 13,762,915                                             |       | 9,945,977 |   |

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

4

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**CHEM RX CORPORATION ANDSUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

**(UNAUDITED)**

 
| ** **                                                                                          | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Cash flows provided by (used in)  operating activities:                                             |       |                                             |       |   |   |
| Net income (loss)                                                                                   |       | $                                                | (386       | ) | $ | 302 |   |
| Adjustments to reconcile net  income (loss) to net cash provided by (used in) operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                                       |       | 2,294                                            |       |   |   |
| Amortization of deferred  financing fees                                                            |       | 204                                              |       |   |   |
| Deferred rent                                                                                       |       | 45                                               |       |   |   |
| Deferred income taxes                                                                               |       | (267                                             | )          |   |   |
| Interest accrued on subordinated  notes payable – related parties                              |       | 211                                              |       |   |   |
| Provision for doubtful accounts                                                                     |       | 300                                              |       |   |   |
|                                                                                                |       |                                             |       |   |   |
| Changes in operating assets and  liabilities:                                                       |       |                                             |       |   |   |
| Accounts receivable                                                                                 |       | (4,458                                           | )          |   |   |
| Inventory                                                                                           |       | 3,248                                            |       |   |   |
| Prepaid expenses and other  current assets                                                          |       | (1,048                                           | )          | 39 |   |
| Other assets                                                                                        |       | (345                                             | )          |   |   |
| Accounts payable                                                                                    |       | (269                                             | )          | 47 |   |
| Accrued expenses and other  current liabilities                                                     |       | (1,504                                           | )          |   |   |
| Other                                                                                               |       | —                                           |       | 51 |   |
| Net cash (used in) provided by  operating activities                                                |       | (1,975                                           | )          | 439 |   |
|                                                                                                |       |                                             |       |   |   |
| Cash flows used in investing  activities:                                                           |       |                                             |       |   |   |
| Investment held in trust fund                                                                       |       | —                                           |       | (469 | ) |
|                                                                                                |       |                                             |       |   |   |
| Property and equipment additions                                                                    |       | (1,487                                           | )          |   |   |
| Net cash used in investing  activities                                                              |       | (1,487                                           | )          | (469 | ) |
|                                                                                                |       |                                             |       |   |   |
| Cash flows provided by (used in)  financing activities:                                             |       |                                             |       |   |   |
| Principal borrowings under  revolving credit facility, net                                          |       | 3,000                                            |       |   |   |
| Principal payments under credit  facility                                                           |       | (500                                             | )          |   |   |
| Payment of deferred financing  fees                                                                 |       | (32                                              | )          |   |   |
| Other                                                                                               |       | 9                                                |       |   |   |
| Net cash provided by financing  activities                                                          |       | 2,477                                            |       | — |   |
|                                                                                                |       |                                             |       |   |   |
| Net decrease in cash and cash  equivalents                                                          |       | (985                                             | )          | (30 | ) |
| Cash and cash equivalents at  beginning of period                                                   |       | 3,740                                            |       | 54 |   |
| Cash and cash equivalents at end  of period                                                         |       | $                                                | 2,755      |   | $ | 24 |   |
|                                                                                                |       |                                             |       |   |   |
| Supplemental disclosures:                                                                           |       |                                             |       |   |   |
| Accretion of trust fund relating  to common stock subject to possible redemption                    |       |                                             |       | $ | 94 |   |
| Cash paid for:                                                                                      |       |                                             |       |   |   |   |
| Interest                                                                                            |       | $                                                | 3,295      |   |   |   |
| Income taxes                                                                                        |       | $                                                | 388        |   | $ | 1 |   |

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

5

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* *

***CHEM RX CORPORATION ANDSUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS***

***(In thousands, except share and per share data)***

***(UNAUDITED)***

* *

**1.**             Organizationand Other Matters

** **

Chem Rx Corporation (the “Company”) was formed as a blank check companyin 2005.  On October 26, 2007, theCompany consummated a business combination by acquiring all of the issued andoutstanding capital stock and other equity interests of B.J.K. Inc., a New Yorkcorporation doing business as Chem Rx, and certain related entities(collectively, the “B.J.K. Entities”). The sellers of such capital stock and other equity interests arereferred to hereinafter as the “Sellers.” The B.J.K. Entities provide institutional pharmacy services to skillednursing facilities and other long-term healthcare institutions.  Institutional pharmacy services consist ofthe fulfillment of orders for prescription and non-prescription drugs andrelated goods for residents of various healthcare institutions.

 

As of May 28, 2008, the Company services its customers primarilyfrom its main pharmacy operations center in Long Beach, New York, and to alesser extent from its operating facilities in South Plainfield, New Jersey;Sciota, Pennsylvania; Albany, New York; and Deerfield Beach, Florida.

 

The Company’s business operations are conducted in a single segmentconsisting of the provision of institutional pharmacy services.

 

**Acquisition of Chem Rx**

 

The Company acquired the capital stock and other equity interests ofthe B.J.K. Entities for an aggregate purchase price of $191,444 includingtransaction costs of $11,813 (the “Business Combination”). The acquisition wasaccounted for using the purchase method, in accordance with FinancialAccounting Standards Board (FASB) Statement No. 141, “BusinessCombinations.” Accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their estimated fair values.

 

The purchase price paid by the Company consisted of the following:

 
| Cash paid to or on behalf of Sellers                        |   | $       | 123,752 |   |
|-------------------------------------------------------------|--------|---------|---------|--------|
| Cash paid for transaction costs                             |   | 11,813  |    |
| Total cash paid                                             |   | 135,565 |    |
| Subordinated notes payable issued to  Sellers               |   | 8,259   |    |
| B.J.K. Entities bank debt paid at closing                   |   | 33,745  |    |
| Issuance of 2,500,000 shares of common  stock to Sellers(1) |   | 13,875  |    |
| Total purchase price paid                                   |   | $       | 191,444 |   |

 

6

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(1)           The common stock was valued at $5.55 pershare, which approximates the quoted market price of the common stock at thetime the Business Combination was agreed to and amended.

 

The fair value of the assets acquired and liabilities assumed arisingfrom the Business Combination were as follows:

 
| ** **                                                    | ** ** | **Fair Value  October 26, 2007** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------|------------|
| *Assets Acquired:*                                            |       |                                            |       |
| Cash                                                          |       | $                                               | 113        |   |
| Accounts receivable                                           |       | 61,914                                          |       |
| Inventory                                                     |       | 18,605                                          |       |
| Other current assets                                          |       | 5,580                                           |       |
| Property and equipment                                        |       | 8,273                                           |       |
| Intangible assets                                             |       | 83,210                                          |       |
| Other assets                                                  |       | 2,542                                           |       |
| Total assets acquired                                         |       | 180,237                                         |       |
| *Liabilities Assumed:*                                        |       |                                            |       |
| Accounts payable and accrued liabilities                      |       | (27,419                                         | )          |
| Net assets acquired over liabilities  assumed                 |       | 152,818                                         |       |
| Excess of purchase price over net assets  acquired (Goodwill) |       | 38,626                                          |       |
| Total purchase price paid                                     |       | $                                               | 191,444    |   |

 

The Company and the Sellers agreed to treat the acquisition as an assetpurchase for income tax purposes. Accordingly, deferred taxes were not recorded, since the financial statementand income tax basis of the assets acquired and liabilities assumed wereidentical on the date of acquisition. Goodwill in the amount of $38,626 is tax deductible. Until the Business Combination,the Company had no operations and existed with the sole purpose of identifyingand acquiring an operating business, which was accomplished through theacquisition of the B.J.K. Entities.

 

In the first quarter of 2008, the Company adjusted the assets acquiredin the Business Combination in connection with a correction principally relatedto its accounting for manufacturing rebates as well as certain other immaterialadjustments (see Note 2).  As a result ofthe correction, previously reported assets acquired were adjusted as follows:decreases in goodwill ($2,083); inventory ($483) and other long-term assets($19) and increases in prepaid and other current assets of $2,243 and accountsreceivable of $342.

 

The Company could be required to pay the Sellers anadditional amount of cash up to $12,500 and issue up to an aggregate of9,000,000 newly issued shares of its common stock subject to the achievement ofcertain milestones as defined in the Stock Purchase Agreement.

 

Such milestones include the achievement of specified quoted commonstock prices and adjusted earnings before interest, taxes, depreciation andamortization (“EBITDA”) during the years 2007 through 2011. Such milestones arebased on annual and cumulative thresholds and include both possible limitationsand accelerations.  No such milestoneswere achieved for any measurement period through March 31, 2008. Thiscontingent consideration will be accounted for as additional purchase price ifand when payment becomes probable.

 

7

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TheSellers do not have the right to receive shares of the Company’s common stockas contingent stock consideration to the extent that, after giving effect toany such issuance, the Sellers (together with their affiliates) wouldbeneficially own in excess of 20% (“the Maximum Percentage”) of the number ofshares of the Company’s common stock outstanding immediately after givingeffect to such issuance.  In lieu ofissuing such shares, the Company may pay each Seller an amount in cash equal tothe number of shares to which such Seller was entitled to but limited by theMaximum Percentage, multiplied by the average of the closing prices for theCompany’s common stock for a period of 30 consecutive trading days immediatelypreceding the date such shares become issuable to the Sellers.

 

Unaudited pro-forma results, as corrected, for the Company, as if theBusiness Combination had occurred on January 1, 2007, are as follows:

 
| ** **                                                 | ** ** | **Three months  ended  March 31, 2007** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net Sales                                                  |       | $                                                      | 72,833     |   |
| Net Loss                                                   |       | $                                                      | (293       | ) |
| Loss per share—basic and diluted                      |       | $                                                      | (0.02      | ) |
| Weighted average shares outstanding—basic and diluted |       | 13,762,915                                             |       |

 

**Initial Public Offering**

 

On October 27, October 31 and November 1, 2005, theCompany sold an aggregate of 9,775,000 units in its initial public offering (“IPO”)at $6.00 per unit, for total gross proceeds of $58,650 and net proceeds of$53,473. Each unit consists of one share of the Company’s common stock, and tworedeemable common stock purchase warrants (the “Unit”).  Each warrant entitles the holder to purchasefrom the Company one share of common stock at an exercise price of $5.00 pershare. The warrants became exercisable on the date of the Company’s businesscombination, October 26, 2007.

 

The warrants sold in the IPO (the “IPO Warrants”) are redeemable by theCompany at a price of $.01 per warrant upon 30 days’ notice if the closingsale price of the common stock is at least $8.50 per share for any 20 tradingdays within a 30 trading day period ending on the third day prior to the dateon which notice of redemption is given.

 

In connection with the IPO, the Company issued a unit purchase option(the “UPO”), for $0.10, to the representative of the underwriters in the IPO,to purchase 425,000 units (creating 425,000 potential common shares and 850,000warrants) at an exercise price of $7.50 per unit.  The warrants underlying such units areexercisable at $6.25 per share. The Company has accounted for the fair value ofthis UPO as an expense of the IPO resulting in a charge directly tostockholders’ equity. The Company estimated that the fair value of the UPO atthe date of issuance was approximately $922 ($2.17 per unit) using aBlack-Scholes option-pricing model.  Thefair value of the option granted to the representative was estimated as of thedate of grant using the following assumptions: (1) expected volatility of42.875%, (2) risk-free interest rate of 4.03% and (3) expected lifeof 5 years. The UPO may be exercised for cash or on a “cashless”basis.  The holders of the warrantsunderlying the UPO are not entitled to receive net cash settlement of thewarrants.

 

8

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As of March 31, 2008, all 19,550,000 warrants and all 425,000 units(creating 425,000 potential common shares and 850,000 warrants) remainoutstanding.

 

**2.**             Summary of Significant AccountingPolicies

** **

The accompanying unaudited consolidated financial statements of theCompany have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and with theinstructions to Quarterly Report on Form 10-Q. Accordingly, they do notinclude all of the information and footnotes required by U.S. generallyaccepted accounting principles for complete financial statements.  Interim results are not necessarilyindicative of results for a full year.

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reported period. Actual results could differ from those estimates.Estimates and assumptions are reviewed periodically and the effects ofrevisions are reflected in the consolidated financial statements in the periodthey are determined to be necessary. Significant estimates made in theaccompanying unaudited consolidated financial statements include, but are notlimited to, the allowance for doubtful accounts, sales discounts, inventoryvaluation, valuation and recoverability of long lived assets, indefinite livedintangibles (including the values assigned to acquired intangible assets) and incometaxes.

 

Asummary of the Company’s critical and significant accounting policies ispresented in the Company’s 2007 Annual Report on Form 10-K.  Users of financial information produced forinterim periods are encouraged to refer to the notes contained in the 2007Annual Report on Form 10-K when reviewing interim financial results.  Since December 31, 2007, there have beenno significant changes to the Company’s significant accounting policies or tothe related assumptions and estimates involved in applying these policies,except for a change in the accounting for manufacturer rebates.  The change in accounting for manufacturingrebates, from a cash basis of accounting to the accrual method, has been accounted foras a correction of previously issued financial reports, as discussed below.

 

TheCompany was unable to file its quarterly report on Form 10-Q for the quarterended March 31, 2008 by the required filing date of May 15, 2008because the Company determined that it was necessary to reconsider its use ofthe cash basis of accounting for manufacturer rebates.  The Company subsequently completed thisevaluation and concluded that sufficient information was available in priorperiods for the Company to make a reasonable estimate of manufacturer rebates andaccount for such rebates on an accrual basis. The Company further determined that the adjustments required topreviously reported amounts under the accrual method of accounting would beimmaterial.

 

Asa result, the consolidated balance sheet as of December 31, 2007 has beenrevised to correct the immaterial errors in the Company’s accounting formanufacturer rebates, as well as other income and certain professional fees.  The effect of this correction, shown in thetable below, is principally related to periods prior to the BusinessCombination and accordingly is reflected through a reduction in goodwill. Forthe period subsequent to the Business Combination, net income was overstated by$142 and accordingly retained earnings has been reduced.   The Company believes that the effect of thiscorrection was not material, either quantitatively or qualitatively, to 2007 orany prior year.

 

9

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The following table represents the impact of the correction on the December31, 2007 consolidated balance sheet:

 
| ** **                                 |   | **Reported** | ** ** | **Correction** | ** ** | **Revised** | ** ** |
|--------------------------------------------|--------|--------------|------------|----------------|------------|-------------|------------|
| Accounts receivable                        |   | $            | 64,613     |           | $          | 425         |       | $ | 65,038 |   |
| Inventory                                  |   | $            | 22,858     |           | $          | (504        | )          | $ | 22,354 |   |
| Prepaid expenses and other  current assets |   | $            | 2,419      |           | $          | 2,143       |       | $ | 4,562 |   |
| Goodwill                                   |   | $            | 40,709     |           | $          | (2,083      | )          | $ | 38,626 |   |
| Accrued expenses                           |   | $            | 3,157      |           | $          | 127         |       | $ | 3,284 |   |
| Retained earnings                          |   | $            | 2,495      |           | $          | (142        | )          | $ | 2,353 |   |

 

Inthe opinion of management, the accompanying unaudited consolidated financialstatements contain all material adjustments, consisting only of normalrecurring adjustments, necessary to present fairly the consolidated financialposition, results of operations and cash flows of the Company for the interimperiods presented.

 

**Recent Accounting Pronouncements**

 

InDecember 2007, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 141 (revised2007), “Business Combinations” (“SFAS 141R”). Among other changes, SFAS 141Rrequires the acquiring entity in a business combination to recognize all (andonly) the assets acquired and liabilities assumed in the transaction at fairvalue; establishes the acquisition-date fair value as the measurement objectivefor all assets acquired and liabilities assumed, including earn-out provisions.SFAS 141R is generally effective for business combinations occurring in thefirst annual reporting period beginning after December 15, 2008.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS160”). Among other items, SFAS 160 requires all entities to reportnoncontrolling (minority) interests in subsidiaries in the same way as equityin the consolidated financial statements. SFAS 160 is effective for the firstannual reporting period beginning after December 15, 2008. The Company isevaluating the anticipated effect of this recently issued standard on itsconsolidated results of operations, financial position and cash flows.

 

InDecember 2007, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”(“SFAS 161”). Among other items, SFAS 161 requires qualitative disclosuresabout objectives and strategies for using derivatives, quantitative disclosuresabout fair value amounts of, and gains and losses on, derivative instruments, and disclosuresabout credit-risk-related contingent features in derivative agreements. SFAS161 is effective for the first annual reporting period beginning after November 15,2008. The Company is evaluating the anticipated effect of this recently issuedstandard on its consolidated results of operations, financial position and cashflows.

 

Management does not believe that any other recently issued, but not yeteffective, accounting standards if currently adopted would have a materialeffect on the accompanying financial statements.

 

**3.**             Related PartyTransactions

** **

In January 2007, two of the Company’s initialdirectors (J. Jay Lobell and Lindsay Rosenwald) entered into a personal warrantpurchase plan to collectively purchase up to an additional 1,000,000 warrantsin the public marketplace at prices not to exceed $.64 per warrant. Thepurchase plan was completed during February 2007, resulting in thepurchase of 1,000,000 warrants pursuant to such purchase plan.

 

Prior to the Business Combination, the Companyoccupied office space provided by an affiliate of Lindsay Rosenwald, who wasthe Company’s chairman at the time.  TheCompany paid such affiliate $7.50 per month for such services commencing on October 21,2005 and ending on October 26, 2007. For the three months ended March 31,2007, the Company incurred expense

 

10

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totaling $22.5 to suchaffiliate pursuant to this agreement.

 

The Company leases its 75,000-square-foot LongBeach, New York facility from 750 Park Place Realty Co., LLC (the “Long BeachLandlord”) under a lease agreement that expires December 31, 2020. Theownership interests in the Long Beach Landlord are owned by Jerry Silva, StevenSilva, Rosalie Silva and the heirs of Mark Baldinger. Rosalie Silva is JerrySilva’s wife. Mark Baldinger was a former principal of the B.J.K. Entities.Under the lease, the Company pays rent at the monthly rate of $125, increasingto $150 on January 1, 2010, $175 on January 1, 2013, $200 on January 1,2016 and $225 on January 1, 2019. Jerry Silva, Rosalie Silva and StevenSilva currently earn approximately $385, $385 and $55, respectively, from theirownership interests in the Long Beach Landlord. These amounts are net of annualmortgage payments of approximately $353 and other operating expenses. Under thelease, the Company is obligated to pay the real estate taxes relating to thepremises. The Company expensed $86 in real estate taxes during the three monthsended March 31, 2008 with respect to the Long Beach facility. The Companybelieves that these rental amounts represent market rates for a facility ofthis type located in Long Beach, New York.

 

Jerry Silva, the Company’s chairman and chiefexecutive officer, and Steven Silva, the Company’s president and chiefoperating officer (together, the “Silvas”), entered into separate put optionagreements with certain institutional investors pursuant to which the Silvasgranted to each investor an option to require the Silvas to purchase up to atotal of 5,879,998 shares of the Company’s common stock from them at aspecified time and a specified price in the future to the extent the applicableinvestor purchased outstanding shares of the Company’s common stock and causedthose shares to be voted in favor of the Business Combination at the specialmeeting of the Company’s stockholders.  Eachput option may be exercised at any time, and from time to time, beginning July26, 2008 and ending October 27, 2008. The exercise price for each put option is the average price paid by theInvestor to acquire the shares subject to the put option, but not to exceed$6.00 per share.  If exercised, the putoption may be settled in cash or physically settled, at the option of theSilvas. The option may be settled in cash only if the Company’s shares aretraded on the Nasdaq Capital Market, the Nasdaq Global Market, or anyregistered national stock exchange. If the put options are exercised in full,assuming they are physically settled, the Silva’s and their affiliates wouldown approximately 59% of the Company’s outstanding shares of common stock.

 

On April 8, 2008, the Company arranged for oneof the Company’s major pharmaceutical vendors to extend certain benefits to theCompany.  The vendor, AmerisourceBergen Drug Corporation (“ABDC”), and theCompany are parties to a prime vendor agreement.  The prime vendoragreement was amended in connection with the Company’s Business Combination toprovide, among other things, that the Company would be required to maintain acash deposit of $2,500 as security for its pharmaceutical purchases fromABDC.  On April 8, 2008, Jerry Silva delivered to ABDC a personalletter of credit in the amount of $2,500 as security for pharmaceuticalpurchases by the Company under the prime vendor agreement.  In exchangefor the delivery of the letter of credit, ABDC agreed, among other things, toreturn to the Company the $2,500 cash deposit.  No payment or otherfinancial accommodation was given to Jerry Silva by the Company with respect tothe letter of credit.

 

**4.**             Commitments andContingencies

** **

The initial stockholders of the Company are entitledto registration rights with respect to their founding shares pursuant to anagreement dated October 21, 2005. The holders of the majority of theseshares are entitled to make certain demands that the Company register theseshares at any time commencing three months prior to October 21, 2008. Inaddition, the initial stockholders have certain “piggy-back” registrationrights on registration statements filed subsequent to October 21, 2008.

 

11

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Pursuant to an agreement dated October 26, 2007, the Sellers areentitled to certain piggyback and demand registration rights with respect tothe shares of the Company’s common stock that they were issued as part of thepurchase price under the stock purchase agreement of the Business Combination.

 

On December 20, 2007, JMP Securities LLC and Shattuck HammondPartners LLC filed a complaint in the Superior Court of California for theCity and County of San Francisco against B.J.K. Inc., the Company, andcertain individuals affiliated with the Company.  The plaintiffs allege that they are entitledto compensation as a result of the Company’s acquisition of B.J.K. Inc. on October 26,2007.  The complaint asserts variousclaims including breach of contract, breach of implied covenant of good faithand fair dealing, fraud, negligent misrepresentation and unjust enrichment, andseeks various damages including compensatory damages of not less than $2.23million, punitive damages, the reimbursement of the plaintiffs’ legal fees andcourt costs, and a declaratory judgment as to the validity and enforceabilityof a financial advisory and investment banking services agreement entered intoby B.J.K. Inc.  Following mediation, theparties have tentatively agreed on a settlement and are negotiating itsterms.  No assurance can be given,however, that the parties will be able to reach a definitive settlementagreement.  The Company believes thatJerry Silva, Steven Silva, and certain of their affiliates are obligated toindemnify the Company for these claims and reasonable attorney fees under theterms of the stock purchase agreement dated as of June 1, 2007, pursuantto which these parties sold B.J.K. Inc. to the Company.  The Company therefore believes that paymentof any settlement or judgment resulting from the lawsuit will not have anadverse effect on the Company’s results of operations or financial position.

 

**5.**             Accounts Receivable

** **

Gross accounts receivable at March 31, 2008 andDecember 31, 2007 totaled approximately $77,350 and $72,893 million,respectively.  The allowance for doubtfulaccounts and sales discounts was $6,676 and $1,478 at March 31, 2008 and$6,615 and $1,239 at December 31, 2007, respectively.  Accounts receivable from nursing homes andprescription drug plans and other third parties totaled approximately $67,553and $63,947 or 87% and 88% of the gross accounts receivable, respectively.Approximately $19,619 and $19,528 of the respective balances wereoutstanding for more than 180 days.

 

**6.**             Long-Term Debt

** **

On October 26, 2007, the Company entered into a first lien creditand guaranty agreement in an aggregate amount not to exceed $125,000,consisting of $80,000 aggregate principal amount of initial term loan, $20,000aggregate principal amount of delayed draw term loan commitments, and up to$25,000 aggregate principal amount of revolving commitments. Additionally, on October 26,2007, the Company entered into a second lien and guaranty agreement whichconsists of a second lien term loan facility in an aggregate amount not toexceed $37,000, collectively herein referred to as the “Credit Facilities.” On October 26,2007, the Company utilized an aggregate of $121,000 of the Credit Facilities tofund the purchase of the B.J.K. Entities.

 

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The initial term loan matures on October 26, 2013 and, prior tothe amendment on March 31, 2008, described below, bore interest at thelender’s prime rate plus an applicable margin, as defined, of 3% or LIBOR plus 4%,at the option of the Company. At March 31, 2008, $79,500 was outstandingunder the initial term loan.  Principal paymentsrelated to the initial term loan are $2,000 per annum from 2008 through 2010and $4,000 per annum in 2011 and 2012. The interest rate on the initial termloan approximated 7.1% as of March 31, 2008.

 

The delayed draw term commitments expire on July 31, 2008. Anyborrowings under the delayed loan draw term commitments mature on October 26,2013 and, prior to the amendment on March 31, 2008, bore interest at thelender’s prime rate plus 3% or LIBOR plus 4%, at the option of the Company. At March 31,2008, there were no borrowings due under the delayed draw term loancommitments.  Effective May 14,2008, the delayed draw term commitments were terminated.

 

The revolving commitments expire on October 26, 2012 and, prior tothe amendment on March 31, 2008, bore interest at the lender’s prime rateplus 3% or LIBOR plus 4%, at the option of the Company.  As of March 31, 2008, $17,000 wasoutstanding under the revolving commitments at an effective blended interestrate of approximately 7.3%.

 

The second lien term loan facility matures on October 26, 2014and, prior to the amendment on March 31, 2008, bore interest at an agreedupon base rate plus an applicable margin of 7.0% or the adjusted Eurodollarrate (as defined in the Credit Facilities) plus 8.0%, at the option of theCompany. As of March 31, 2008, $37,000 was outstanding under the secondlien term loan facility. There are no principal repayment requirements underthe second lien term loan facility until the maturity date. The interest rate onthe second lien term loan approximated 13.25% as of March 31, 2008.

 

The Credit Facilities are collateralized by substantially all theassets of the Company. The Company is also required to comply with certainrestrictive and financial covenants. The Credit Facilities provide for certainmandatory prepayments in the event cash proceeds are received from the sale ofcertain assets, the issuance of equity securities, the issuance of debt and inthe event the Company has consolidated excess cash flow (as defined) in anyfiscal year commencing in 2008. The Credit Facilities also provide for areduction in the applicable margin, as defined, based on the total leverageratio of the Company.

 

Effective March 31, 2008, the Company and its Lenders amended theCredit Facilities. The amendments were made in connection with certainviolations of the financial covenants relating to fixed charge coverage ratiosand total leverage ratios. The covenant violations arose because the definitionof “Consolidated Adjusted EBITDA” in the Credit Facilities excluded only $5,350of employee bonuses which were paid at the time of the Business Combination,instead of the entire $11,000 of such employee bonuses which were intended tobe excluded for this purpose. Accordingly, after the amendments, the definitionof “Consolidated Adjusted EBITDA” provides that the entire $11,000 of employeebonuses paid in conjunction with the Business Combination is excluded from suchcalculation, effective as of the original date of the Credit Facilities.

 

The amendment of the first lien credit and guaranty agreement includedan increase to the applicable margin ranges for LIBOR loans from 4.0% to 4.5%(from the original range of 3.5% to 4.0%) and for base rate loans from 3.00% to3.50% (from the original range of 2.5% to 3.0%), respectively, as well as anamendment fee of .25% on the outstanding first lien indebtedness. The amendmentto the second lien credit and guaranty agreement established a LIBOR-based loanfloor interest rate of 13.25%, and a base rate-based loan floor interest rateof 14.25%. As a result, the applicable interest rate beginning March 28,2008 for the second lien debt will be either (i) for Eurodollar rateloans, the greater of 13.25% or a rate equal to LIBOR plus the applicableoriginal margin of 8.00%, or (ii) non-Eurodollar loans, the greater of14.25% or a rate equal to the prime rate plus the applicable original margin of7.0%.

 

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The Credit Facilities require the Company to enter into interest rateprotection agreements to provide interest rate protection for a minimum of 50%of the Company’s consolidated total funded indebtedness under the first lienand second lien credit and guaranty agreements for a term of not less thanthree years.  Effective January 28,2008, the Company entered into a swap agreement (the “Swap”) with CanadianImperial Bank of Commerce (“CIBC”) to provide the required interest rateprotection and to manage its exposure to changes in LIBOR. The Swap is for anotional amount of $58,500 expiring on January 28, 2011 with a fixed rateof LIBOR interest of 3.07%.   The Swaphas been designated as a cash flow hedge of the variability of the cash flowsdue to changes in LIBOR and has been deemed to be highly effective.  Accordingly, the Company records the fairvalue of the Swap as an asset or liability on its consolidated balance sheet,and any unrealized gain or loss is included in accumulated other comprehensiveincome.  As of March 31, 2008, theCompany recorded a liability of $579, included in accrued expenses and othercurrent liabilities, in the accompanying consolidated balance sheet.  The Company also recorded in accumulatedother comprehensive income (loss) $(342) (net of tax of $237) for the three months ended March 31, 2008. Nohedge ineffectiveness was recorded during the three months ended March 31,2008.

 

**Subordinated Notes Payable—related parties**

 

As part of the financing of the Business Combination, the Companyissued subordinated notes totaling $8,259 ($8,619 at March 31, 2008including $360 of unpaid earned interest) to the former stockholders of theB.J.K. Entities. The notes mature on April 15, 2015 and bear interest atan interest rate of 10%.

 

**7.            **Comprehensive Income (Loss)

** **

**The components of comprehensive income (loss) wereas follows:**

** **
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| ** **                        | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net Income (loss)                 |       | $                                                | (386       | ) | $ | 302 |   |
| Other comprehensive loss:         |       |                                             |       |   |   |
| Change  in fair value of the Swap |       | (342                                             | )          | 0 |   |
|                              |       |                                             |       |   |   |
| Total comprehensive income (loss) |       | $                                                | (728)      |   | $ | 302 |   |

** **

**8.**             Income Taxes

** **

The Company recorded a benefit from income taxes of $267 for the threemonths ended March 31, 2008.  The benefitwas based on the Company’s expected effective tax rate of 41% for the yearending December 31, 2008.  TheCompany recorded an income tax provision of $1 for the three months ended March 31,2007 based on the Company’s expected effective tax rate of 0.3% for the yearended December 31, 2007.  Theincrease in the effective income tax rate is primarily related to the Business Combination.

 

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A valuation allowance is recorded when management determines that it ismore likely than not that some portion or all of the deferred tax assets willnot be realized.  The Company considers thescheduled reversal of deferred tax liabilities, projected future taxableincome, and tax planning strategies, among other factors, in making thisassessment.  There was no valuationallowance as of March 31, 2008 and December 31, 2007 as the Companybelieves it is more likely than not that the net deferred tax assets will berealized.

 

**9.             Stockholders’ Equity**

** **

**EarningsPer Share**

** **

Basic earnings (loss) per share (“EPS”) is computed by dividing the netincome (loss) available to the common stockholders by the weighted averagenumber of common shares outstanding during the period. Common shares totaling1,954,999 are subject to possible redemption and have been excluded from thecalculation of basic EPS for the three months ended March 31, 2007 sincesuch shares, if redeemed, only participated in their pro rata share of thetrust fund earnings. Upon completion of the Business Combination, such shareswere no longer redeemable.

 

Diluted EPS adjusts basic EPS for the effects of warrants, the warrantsissuable pursuant to the UPO (see Note 1) and other potentially dilutivefinancial instruments, only in the periods in which such effect is dilutive.

 

On February 15,2008 the Company entered into a business advisory agreement with a third partyto provide certain services and advice regarding the Company’s business andfinancing activities.  In connection withthe business advisory agreement, the Company agreed to issue warrants topurchase up to a maximum of 100,000 shares of the Company’s common stock.  On February 15, 2008, the Companygranted a warrant to purchase 25,000 shares of the Company’s common stock inconnection with this agreement (the “Advisory Warrant”). The Advisory Warrantis exercisable at a price of $7.00 per share. The fair value of the Advisory Warrant was estimated on the date ofgrant using a Black-Scholes option-pricing model with the following assumptionsutilized: risk-free interest rate of 3.00%; expected life of 5 years; andexpected volatility of 48.6%.  Theexpected volatility used was based on an examination of the historical andimplied volatility of the stock prices of selected comparable companies and thenature of those companies, and other relevant factors. The Company recorded anon-cash charge of $47 in the three months ended March 31, 2008 related tothe Advisory Warrant.

 

Common shares subject to possible redemption include the IPO Warrants(see Note 1) and the warrants issuable pursuant to the UPO. For the threemonths ended March 31, 2008, in the money IPO Warrants and restrictedshares, totaling 1,010,901 common stock equivalents, would have beenanti-dilutive and as such were excluded from the computation of diluted EPS.

 

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2007Incentive Compensation Plan

 

On October 22, 2007, the stockholders of the Company approved the2007 Incentive Compensation Plan (the “Plan”), and authorized 1,350,000 sharesfor award under the Plan.  The Plan provides for the grant of a variety ofequity instruments including stock options, restricted stock, stockappreciation rights, share units, performance units, and dividendequivalents.  Eligible recipients include the Company’s directors,officers, employees and certain third-party service providers.  Awardsunder the Plan are determined by the Company’s board of directors or acommittee thereof.  The board has delegated its authority to grant awardsunder the Plan to the compensation committee of the board.

 

On January 24, 2008, board of directors of the Company (the “Board”)granted an aggregate of 28,302 shares of restricted stock (at a fair marketvalue of $5.30 per share) to the non-employee directors and a consultant,leaving 1,321,698 shares eligible for award under the Plan as of that date. The restriction on the shares lapses in equal annual increments over a threeyear period from date of grant, except under a change in control, as defined,whereby all restrictions lapse immediately. The fair value of the restricted shares is being amortized ratably overthe restriction period.  Accordingly, theCompany recorded a pre-tax compensation charge of $9 for the three months endedMarch 31, 2008. The unamortized pre-tax compensation expense related tothe restricted shares at March 31, 2008 was $141.

 

On April 16, 2008 and April 29, 2008, respectively, the Boardgranted an aggregate of 2,886 shares of common stock as awards to thenon-employee directors and the consultant valued at $5.20 per share and stockoptions to employees for the purchase of 459,470 shares of common stock at$5.18 per share, the respective fair values per share as of the dates of grant. The employee stock options are subject to the execution and delivery of stockoption agreements.  The employee stock options will be exercisable inthree equal annual installments beginning with the first anniversary of thedate of grant, and will expire in seven years.

 

**Treasury Stock**

** **

In connection with the Business Combination, during October 2007,637,085 shares of the Company’s common stock were purchased from stockholderswho voted against the acquisition of the B.J.K. Entities and requested a redemptionof their shares into a pro rata share of the trust fund. The cost of the sharespurchased was $3,654.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operation.**

** **

The following management’s discussion and analysis should be read inconjunction with the “Unaudited Pro Forma Consolidated Financial Information”appearing in this section of this quarterly report and the financial statementsappearing in Item 1 of this quarterly report.

 

On October 26, 2007, we acquired 100% of the issued andoutstanding shares of capital stock and other equity interests ofB.J.K. Inc., which conducts its business as “Chem Rx” (the “BusinessCombination”). Through B.J.K. Inc., we conduct an institutional pharmacybusiness, providing services to skilled nursing facilities and other long-termhealthcare institutions, principally through an operations center based in LongBeach, New York, and also through locations in South Plainfield, New Jersey;Sciota, Pennsylvania; Albany, New York; and Deerfield Beach, Florida.

 

**Overview**

 

We provide pharmacy services to residents of skilled nursingfacilities, assisted living facilities, residential living facilities and otherlong-term healthcare institutions. Our principal market is the New Yorkmetropolitan area and Long Island, New York. Since 2006 we have expanded ouroperations into New Jersey, northeastern Pennsylvania, upstate New York andsoutheastern Florida. As of May 28, 2008 we service over 65,800 bedslocated in over 420 long-term care facilities.

 

Our management has pursued a strategy of seeking manageable growthwithin a defensible market niche. Our industry is highly competitive in termsof product pricing and affords limited opportunities to implement proprietaryproducts or processes. Nevertheless, we believe that we have been able toincrease our business through a focus on service, customer satisfaction andexpanded delivery options, and the integration of technology interfaces.

 

Prior to August 2006, we serviced customers only in the State ofNew York, and conducted all of our operations from leased facilities at variouslocations on Long Island, New York, including, since 2001, from our current leasedfacility in Long Beach, New York. In August 2006, certain members of ourmanagement founded our New Jersey institutional pharmacy operation, Chem Rx NewJersey, which services the New Jersey market through a leased facility locatedin South Plainfield, New Jersey. We acquired the New Jersey operation in theBusiness Combination. In January 2007, we acquired substantially all ofthe assets of our Pennsylvania institutional pharmacy operation, Chem Rx PA,which provides institutional pharmacy services to the eastern Pennsylvaniamarket from a leased facility located in Sciota, Pennsylvania. In August 2007,we acquired a long-term care pharmacy serving the upstate New York market froma leased facility in Albany, New York. On April 1, 2008 we began toservice customers in the South Florida market from our newly opened DeerfieldBeach, Florida leased pharmacy operations center.

 

We believe that each of our pharmacy operations centers must service asufficient number of beds to support a financially viable institutionalpharmacy. Our expansion into the New Jersey market focused on gaining marketshare via the service of long-term care facilities owned or operated byprincipals of facilities already serviced by us in Long Beach, New York. Inaddition to developing

 

17

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amarket with affiliates of existing customers, Chem Rx New Jersey purchasedcustomer lists and directed its marketing efforts toward long-term carefacilities that may be dissatisfied with services provided by a competitor. Asa result of this strategy, by May 28, 2008, Chem Rx New Jersey wasservicing approximately 9,300 beds.

 

We believe that the institutional pharmacy business will continue togrow due to general population aging and a resultant increase in chronicillnesses, increased rates of drug utilization and pharmaceutical priceinflation. Our revenues are affected by the growth in beds under contract, changesin the number of drugs prescribed for each resident and changes in the cost ofpharmaceuticals.

 

**Industry, Sources of Revenue and Purchasing**

 

Competition in the institutional pharmacy services industry is intenseand can impact our financial results. We compete against national, regional andlocal institutional pharmacies as well as local retail pharmacies. Thesecompetitors provide services comparable to ours and may have greater financialand other resources than we do. The consolidation of institutional pharmaciesas well as consolidation among long-term care providers may impact theinstitutional pharmacy market.

 

The implementation of Medicare Part D on January 1, 2006significantly altered the provision of pharmaceutical services to residents oflong-term care facilities. Medicare Part D requires eligible individualsto choose a specific prescription drug plan to receive drug coverage. There arenumerous approved prescription drug plans, and each plan has a unique formularyfor its individual members. Institutional pharmacies must negotiate a serviceagreement with each prescription drug plan and follow that plan’s formulary andreimbursement and administrative processes in providing pharmaceutical servicesto long-term care facility residents who are members of the plan. Compliancewith separate requirements of prescription drug plans may result in increasedadministrative costs. We have agreements with substantially all of thebenchmark prescription drug plans via a group purchasing organization.

 

The implementation of Medicare Part D has changed the mix ofpayment sources in the institutional pharmacy business. Prior to implementationof Part D, institutional pharmacies received payments for products andservices from Medicaid, long-term care facilities and third party payors suchas insurance companies and health maintenance organizations. Sinceimplementation of Part D, we receive a substantial portion of ourreimbursements from prescription drug plans (who in turn receive theirreimbursements from the Centers for Medicare and Medicaid Services (“CMS”)),with the result that direct reimbursements from long-term care facilities havebeen substantially reduced and payments are more timely received.

 

We receive rebates from certain manufacturers of pharmaceuticalproducts via agreements negotiated through a group purchasing organization ordirectly by us. Rebates for brand name products are generally based uponachieving a defined market share tier within a therapeutic class. Rebates forgeneric products are more likely to be based upon achieving stated volumerequirements. We believe that since Part D implementation, manufacturersmay be focusing rebates to a greater extent on prescription drug plans. Inaddition, CMS continues to question whether institutional pharmacies should bepermitted to receive access / performance rebates from manufacturers withrespect to prescriptions covered under Medicare Part D.

 

18

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From time to time we receive discounts for bulk purchases of certainproducts. These discounts vary from period to period depending on howextensively we take advantage of discount offers made by wholesalers.

 

**Results of Operations**

 

The Company was unable to file its quarterly report on Form 10-Q forthe quarter ended March 31, 2008 by the required filing date ofMay 15, 2008 because the Company determined that it was necessary toreconsider its use of the cash basis of accounting for manufacturerrebates.  The Company subsequentlycompleted this evaluation and concluded that sufficient information wasavailable in prior periods for the Company to make a reasonable estimate ofmanufacturer rebates and account for such rebates on an accrual basis.  The Company further determined that theadjustments required to previously reported amounts under the accrual method ofaccounting would be immaterial.

 

As a result, the consolidated balance sheet as of December 31,2007 has been revised to correct immaterial errors in the Company’s accountingfor manufacturer rebates, as well as other income and certain professional fees.  The effect of this correction was to decreasegoodwill, inventory and retained earnings by $2,083, $504 and $142respectively, and increase other assets, accounts receivable and accrued expensesby $2,143, $425 and $127, respectively.  The Company believes that the effect of this correction was notmaterial, either quantitatively or qualitatively, to 2007 or any prior year.

 

The following table sets forth certain unaudited summary financial informationfor our operating subsidiary B.J.K. Inc. for the three months ended March 31,2007, prior to our acquisition of B.J.K. Inc. on October 26, 2007, ona pro forma basis, certain unaudited summary financial information forChem Rx Corporation for the three months ended March 31, 2007 asdescribed below in the section titled “Unaudited Pro Forma ConsolidatedFinancial Information,” and unaudited summary financial information for Chem RxCorporation the three months ended March 31, 2008.

 
| ** **                                   | ** ** | ** **                              | ** ** | **Chem Rx Corporation**            | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | ** **                              | ** ** | **Unaudited**                                | ** ** |
| ** **                                   | ** ** | **B.J.K. Inc.**                    | ** ** | **Consolidated**                             | ** ** |
| ** **                                   | ** ** | **Unaudited  Three months  ended** | ** ** | **Pro Forma  Three months  ended** | ** ** | **Three months  ended** | ** ** |
| ** **                                   | ** ** | **March 31, 2007**            | ** ** | **March 31, 2007**                 | ** ** | **March 31, 2008** | ** ** |
| ** **                                   | ** ** | **Corrected (1)**                  | ** ** | **Corrected (1)**                       | ** ** | ** ** | ** ** |
|                                         |       |                                    |       |                                         |       |   |   |
| Net Sales                                    |       | $                                       | 72,833     |                                         | $          | 72,833 |   | $ | 87,536 |   |
| ** **                                   |       |                                    |       |                                         |       |   |   |
| Cost of Sales                                |       | 54,777                                  |       | 54,777                                       |       | 65,586 |   |
|                                         |       |                                    |       |                                         |       |   |   |
| Gross Profit                                 |       | 18,056                                  |       | 18,056                                       |       | 21,950 |   |
|                                         |       |                                    |       |                                         |       |   |   |
| Selling, General and Administrative Expenses |       | 13,063                                  |       | 14,990                                       |       | 19,114 |   |
| ** **                                   |       |                                    |       |                                         |       |   |   |
| Operating Income                             |       | 4,993                                   |       | 3,066                                        |       | 2,836 |   |
|                                         |       |                                    |       |                                         |       |   |   |
| Other Income (expense)                       |       |                                    |       |                                         |       |   |   |
| Interest income                              |       | 3                                       |       | 3                                            |       | 8 |   |
| Interest expense                             |       | (573                                    | )          | (3,739                                       | )          | (3,795 | ) |
| Other income, net                            |       | 207                                     |       | 207                                          |       | 298 |   |
|                                         |       |                                    |       |                                         |       |   |   |
| Total Other Expense                          |       | (363                                    | )          | (3,529                                       | )          | (3,489 | ) |
|                                              |            |                                         |            |                                              |            |  |  |  |  |  |

 

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| Income (Loss) before Minority Interest and  Income Taxes |   | 4,630  |   | (463   | )      | (653   | )      |
|----------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
|                                                     |   |   |   |   |   |   |   |
| Minority Interest                                        |   | (276   | )      | — |   | — |   |
|                                                     |   |   |   |   |   |   |   |
| Income (Loss) before Income Taxes                        |   | 4,354  |   | (463   | )      | (653   | )      |
|                                                     |   |   |   |   |   |   |   |
| Provision (Benefit) for Income Taxes                     |   | 88     |   | (170   | )      | (267   | )      |
|                                                     |   |   |   |   |   |   |   |
| Net Income (Loss)                                        |   | $      | 4,266  |   | $      | (293   | )      | $ | (386 | ) |
|                                                          |        |        |        |        |        |        |        |  |  |  |

 

20

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(1)The following table represents the impact of the correction on the unauditedoperating results of B.J.K. Inc. for the three months ended March 31, 2007

 
| ** **                                               | ** ** | **Reported** | ** ** | **Adjustment** | ** ** | **Corrected** | ** ** |
|----------------------------------------------------------|------------|--------------|------------|----------------|------------|---------------|------------|
| Net  Sales                                               |       | $            | 72,803     |           | $          | 30            |       | $ | 72,833 |   |
| Cost  of Sales(a)                                        |       | $            | 54,718     |           | $          | 59            |       | $ | 54,777 |   |
| Gross  Profit                                            |       | $            | 18,085     |           | $          | (29           | )          | $ | 18,056 |   |
| Selling,  General and Administrative Expenses(a)         |       | $            | 13,063     |           | $          | 0             |       | $ | 13,063 |   |
| Operating  Income                                        |       | $            | 5,022      |           | $          | (29           | )          | $ | 4,993 |   |
| Other  Income, net                                       |       | $            | 218        |           | $          | (11           | )          | $ | 207 |   |
| Total  Other Expense                                     |       | $            | (352       | )              | $          | (11           | )          | $ | (363 | ) |
| Income  (Loss) before Minority Interest and Income Taxes |       | $            | 4,670      |           | $          | (40           | )          | $ | 4,630 |   |
| Income  (Loss) before Income Taxes                       |       | $            | 4,394      |           | $          | (40           | )          | $ | 4,354 |   |
| Provision  (Benefit) for Income Taxes                    |       | $            | 89         |           | $          | (1            | )          | $ | 88 |   |
| Net  Income (Loss)                                       |       | $            | 4,305      |           | $          | (39           | )          | $ | 4,266 |   |

 

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(a) Represents a reclassbetween Cost of Sales and Selling, General and Administrative Expenses toconform to current year presentation.

 

 

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**UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION**

 

The following table sets forth unaudited summary financial informationfor our pro forma consolidated statement of operations for the quarter ended March 31,2007. The unaudited pro forma financial information includes the consolidatedstatement of operations of Chem Rx Corporation and the combined statement ofincome for B.J.K. Inc. for the three months ended March 31, 2007, adjustedto illustrate the estimated pro forma effects of the Business Combination, thefinancing transactions, and related non-recurring items.

 

The unaudited pro forma consolidated statement of operations giveseffect to the Business Combination and the financing transactions as of January 1,2007.  The unaudited pro formaadjustments are based upon available information and certain assumptions thatwe believe are directly attributable to these transactions and are factuallysupportable. The unaudited pro forma financial information should be read inconjunction with the consolidated financial statements of Chem Rx Corporationand its subsidiary, and other financial information appearing elsewhere in thisForm 10-Q, as well as the financial information and footnotes contained inthe Company’s 2007 Annual report on Form 10-K.

 

The unaudited pro forma financial information is for informationalpurposes only and is not intended to represent or be indicative of theconsolidated results of operations that we would have reported had the BusinessCombination and the financing transactions been completed as of the datepresented, and should not be taken as representative of our future consolidatedresults of operations.

 

**Unaudited Pro Forma Consolidated Statement ofOperations**

**For the Three Months Ended March 31, 2007**

**(in thousands)**

** **
| ** **                                   | ** ** | **Chem Rx  Corporation  Three months  ended********March 31,  2007** | ** ** | **B.J.K. Inc.********Three months  ended  March 31,  2007 (a)** | ** ** | **Adjustments** | ** ** | **Chem Rx  Corporation  Pro Forma********consolidated  Three months  ended********March 31,  2007** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
|                                         |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Net Sales                                    |       | $                                                                                   | —     |                                                                           | $          | 72,833          |       | $                                                                                                                       | —     | ** ** | $ | 72,833 |   |
| ** **                                   | ** ** | ** **                                                                          | ** ** | ** **                                                                     | ** ** | ** **      | ** ** |                                                                                                                    |       |
| Cost of Sales                                |       | —                                                                              | ** ** | 54,777                                                                         |       | —          | ** ** | 54,777                                                                                                                  |       |
|                                         |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Gross Profit                                 |       | —                                                                              | ** ** | 18,056                                                                         |       | —          | ** ** | 18,056                                                                                                                  |       |
| ** **                                   | ** ** | ** **                                                                          | ** ** |                                                                           |       | ** **      | ** ** |                                                                                                                    |       |
| Selling, General and Administrative Expenses |       | 167                                                                                 | ** ** | 13,063                                                                         |       | 1,760           | (b)        | 14,990                                                                                                                  |       |
| ** **                                   | ** ** | ** **                                                                          | ** ** | ** **                                                                     | ** ** | ** **      |       |                                                                                                                    |       |
| Operating Income (Loss)                      |       | (167                                                                                | )          | 4,993                                                                          |       | (1,760          | )          | 3,066                                                                                                                   |       |
|                                         |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Other Income (Expense)                       |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Interest income                              |       | 470                                                                                 |       | 3                                                                              |       | (470            | )(c)       | 3                                                                                                                       |       |
|                                              |            |                                                                                     |            |                                                                                |            |                 |            |                                                                                                                         |            |  |  |  |  |

 

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| ** **                                               | ** ** | **Chem Rx  Corporation  Three months  ended********March 31,  2007** | ** ** | **B.J.K. Inc.********Three months  ended  March 31,  2007 (a)** | ** ** | **Adjustments** | ** ** | **Chem Rx  Corporation  Pro Forma********consolidated  Three months  ended********March 31,  2007** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| Interest expense                                         |       | —                                                                              |       | (573                                                                           | )          | (3,166          | )(d)       | (3,739                                                                                                                  | )          |
| Other income, net                                        |       | —                                                                              |       | 207                                                                            |       | —          |       | 207                                                                                                                     |       |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Total Other Income (Expense)                             |       | 470                                                                                 |       | (363                                                                           | )          | (3,636          | )          | (3,529                                                                                                                  | )          |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Income (Loss) before Minority Interest and  Income Taxes |       | 303                                                                                 |       | 4,630                                                                          | ** ** | (5,396          | )          | (463                                                                                                                    | )          |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Minority Interest                                        |       | —                                                                              |       | (276                                                                           | )          | 276             | (e)        | —                                                                                                                  |       |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Income (Loss) before Income Taxes                        |       | 303                                                                                 |       | 4,354                                                                          |       | (5,120          | )          | (463                                                                                                                    | )          |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Provision (Benefit) for Income Taxes                     |       | 1                                                                                   |       | 88                                                                             |       | (259            | )(f)       | (170                                                                                                                    | )          |
|                                                     |       |                                                                                |       |                                                                           |       |            |       |                                                                                                                    |       |
| Net Income (Loss)                                        |       | $                                                                                   | 302        |                                                                           | $          | 4,266           |       | $                                                                                                                       | (4,861     | ) | $ | (293 | ) |
|                                                          |            |                                                                                     |            |                                                                                |            |                 |            |                                                                                                                         |            |  |  |  |  |

 

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Notesto Unaudited Pro Forma Consolidated Statement of Operations

 

(a)                      See note (1)on the unaudited summary financial information table above.

 

(b)                     Reflects deconsolidation of 750 Park Place and increased rent expense paidto 750 Park Place, which is an affiliate that was not acquired in the BusinessCombination. In addition, the adjustment reflectsexcess salaries paid over senior management’s pro forma contractual levels andan estimated increase of $1.8 million of additional amortization expense for 3months related to intangible assets created by Chem Rx Corporation’sacquisition of the B.J.K. Entities.

 

(c)                      Reflects exclusion of interest income unrelated to the B.J.K. Entitiesprior to the acquisition.

 

(d)                     Reflects estimated pro forma interest expense resulting from our newcapital structure after the close of the acquisition, using an assumed 3-monthLIBOR rate of 5.00% and inclusive of deferred financing cost amortizationexpense.

 

(e)                      Reflects exclusion of the minority interest related to 750 Park Place, anaffiliate that was not acquired in the transaction.

 

(f)                        Reflects an adjustment for the assumedcorporate tax rate of 37%.

 

*Quarter ended March 31, 2008 compared withQuarter ended March 31, 2007*

 

Net sales were $87.5 million for the three months ended March 31,2008, as compared to pro forma net sales of $72.8 million for the three monthsended March 31, 2007, an increase of $14.7 million or 20.2%. This growthin net sales was principally due to increased beds serviced by our New Jersey,Pennsylvania (in operation now for over 22 and 15 months, respectively) and NewYork

 

23

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facilities,primarily as a result of our continued focus on relationship management andhigh quality of service.

 

Gross profit was $22.0 million for the three months ended March, 2008as compared to pro forma gross profit of $18.1 million for the three monthsended March 31, 2007, an increase of $3.9 million or 21.5%. Gross profitas a percentage of net sales was 25.1% and 24.8% for the three months ended March 31,2008 and 2007, respectively. The increase in the gross profit dollars andpercent was attributable to the growth in net sales, coupled with efficienciesresulting from greater utilization of our facilities and other fixed-costresources.

 

Selling, general and administrative expenses were $19.1 million for thethree months ended March 31, 2008 as compared to pro forma SG&A of$15.0 million for the three months ended March 31, 2007. This $ 4.1million increase in selling, general and administrative expenses wasattributable to higher expenditures to support the revenue growth in our SouthPlainfield, New Jersey; Albany, NY; and Sciota, PA facilities and start upcosts of our recently opened Deerfield Beach, Florida location.  In addition, we incurred $.2 million ofexpenses associated with the Business Combination, $.9 million of increasedprofessional and consulting fees related primarily to the cost of being apublic company and an increase in delivery expenses of $.8 million due toincreased sales and higher fuel costs. Selling, general and administrative expenses as a percentage of netsales was 21.8% and 20.6% for the three months ended March 31, 2008 and2007, respectively.  Excluding expensesassociated with the Business Combination and increased professional andconsulting fees, selling, general and administrative expenses as a percentage ofnet sales would have been 20.6% for the three months ended March 31, 2008.

 

Interest expense and other income were $3.5 million for the threemonths ended March 31, 2008 and pro forma for the three months ended March 31,2007.   The Company recorded a benefitfrom income taxes of $267 for the three months ended March 31, 2008, basedon the Company’s expected effective tax rate of 41% for the year ending December 31, 2008.  The Company recorded an income tax provisionof $1 for the three months ended March 31, 2007 based on the Company’s expectedeffective tax rate of .3% for the year ended December 31, 2007.  The increase in the effective income tax rateis primarily related to the Business Combination.

 

**LIQUIDITYAND CAPITAL RESOURCES**

** **

The Company’s liquidity needs arise primarily from debt service on itssubstantial indebtedness and from funding of capital expenditures, ongoingoperating costs and working capital.

 

Principal and interest payments under the Credit Facilities representsignificant liquidity requirements for the Company.  The Company expects that cash flow fromoperating activities and expected available borrowings under the revolvingcommitments of the Credit Facilities will provide sufficient working capital tooperate the Company’s business, to fund expected capital expenditures and tomeet foreseeable liquidity requirements, including debt service on the Company’soutstanding debt.  No assurance can begiven, however, that the Company’s business will, in fact, generate sufficientcash flows or that future borrowings will, in fact, be available in an amountsufficient to enable the Company to service its debt or to fund its otherliquidity needs.

 

The Credit Facilities

 

In connection with the Business Combination on October 26, 2007,the Company entered into a first lien credit and guaranty agreement in anaggregate amount not to exceed $125,000, consisting of $80,000 aggregateprincipal amount of initial term loan, 

 

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$20,000aggregate principal amount of delayed draw term loan commitments, and up to$25,000 aggregate principal amount of revolving commitments. Additionally, on October 26,2007, the Company entered into a second lien and guaranty agreement whichconsists of a second lien term loan facility in an aggregate amount not toexceed $37,000, collectively herein referred to as the “Credit Facilities.” On October 26,2007, the Company utilized an aggregate of $121,000 of the Credit Facility tofund the purchase of the B.J.K. Entities.

 

The initial term loan matures on October 26, 2013 and bearsinterest at the lender’s prime rate plus an applicable margin, as defined, of3% or LIBOR plus 4%, at the option of the Company. At March 31, 2008,$79,500 was outstanding under the initial term loan.  Principal payments related to the initialterm loan are $2,000 per annum from 2008 through 2010 and $4,000 per annum in2011 and 2012.  The interest rate on theinitial term loan approximated 7.1% as of March 31, 2008.

 

The delayed draw term commitments expire on July 31, 2008. Anyborrowings under the delayed loan draw term commitments mature on October 26,2013 and, prior to the amendment on March 31, 2008, bore interest at thelender’s prime rate plus 3% or LIBOR plus 4%, at the option of the Company. At March 31,2008, there were no borrowings due under the delayed draw term loancommitments. Effective May 14, 2008, the delayed draw term commitmentswere terminated.

 

The revolving commitments expire on October 26, 2012 and, prior tothe amendment on March 31, 2008, bore interest at the lender’s prime rateplus 3% or LIBOR plus 4%, at the option of the Company (at rates of 5.25% forprime and 2.7% for LIBOR at March 31, 2008). As of March 31, 2008,$17,000 was outstanding under the revolving commitments at an effective blendedinterest rate of 7.3%.  As of May 28,2008 $11,500 was outstanding under the Revolving Loans, with $13,500 availableto borrow.

 

The second lien term loan facility matures on October 26, 2014and, prior to the amendment on March 31, 2008, interest at an agreed uponbase rate plus an applicable margin, as defined, of 7% or the adjusted Eurodollarrate (as defined in the Credit Facilities) plus 8%, at the option of theCompany. As of March 31, 2008, $37,000 was outstanding under the secondlien term loan facility. There are no principal repayment requirements underthe second lien term loan facility until the maturity date.  The interest rate on the second lien term loanapproximated 13.25% as of March 31, 2008.

 

The Credit Facilities are collateralized by substantially all theassets of the Company. The Credit Facilities provide for certain mandatoryprepayments in the event cash proceeds are received from the sale of certainassets, the issuance of equity securities, the issuance of debt and in theevent the Company has consolidated excess cash flow (as defined) in any fiscalyear commencing in 2008.  The Credit Facilities also provide for areduction in the applicable margin, as defined, based on the total leverageratio of the Company.

 

The Company is also required to comply with certain restrictive andfinancial covenants, including, among other things, limits or restrictions onthe Company’s and its subsidiaries abilities to dispose of assets, incuradditional indebtedness, incur guarantee obligations, prepay otherindebtedness, make dividends, create liens, make investments, make acquisitions,modify the terms of the documents governing the indebtedness, engage in mergersor make capital expenditures or engage in certain transactions withaffiliates.  The Credit Facilities alsorequire the Company to comply with minimum coverage ratios of ConsolidatedAdjusted EBITDA, as defined, to Consolidated Fixed Charges and ConsolidatedAdjusted EBITDA to Total Debt.

 

25

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Effective March 31,2008, the Company amended the Credit Facilities. The amendments were made inconnection with certain violations of the financial covenants relating to fixedcharge coverage ratios and total leverage ratios. The covenant violations arosebecause the definition of “Consolidated Adjusted EBITDA” in the CreditFacilities excluded only $5,350 of employee bonuses which were paid at the timeof the Business Combination, instead of the entire $11,000 of such employeebonuses which were intended to be excluded for this purpose. Accordingly, afterthe amendments, the definition of “Consolidated Adjusted EBITDA” provides thatthe entire $11,000 of employee bonuses paid in conjunction with the BusinessCombination is excluded from such calculation, effective as of the originaldate of the Credit Facilities.

 

The amendment of the first lien credit and guaranty agreement includedan increase to the applicable margin ranges for LIBOR loans from 4.0% to 4.5%(from the original range of 3.5% to 4.0%) and for base rate loans from 3.00% to3.50% (from the original range of 2.5% to 3.0%), respectively, as well as anamendment fee of .25% on the outstanding first lien indebtedness. The amendmentto the second lien credit and guaranty agreement established a LIBOR-based loanfloor interest rate of 13.25%, and a Base Rate-based loan floor interest rateof 14.25%. As a result, the applicable interest rate beginning March 28,2008 for the second lien debt will be either (i) for Eurodollar rateloans, the greater of 13.25% or a rate equal to LIBOR plus the applicableoriginal margin of 8.00%, or (ii) non-Eurodollar loans, the greater of14.25% or a rate equal to the prime rate plus the applicable original margin of7.00%.

 

As of March 31, 2008, the Company was in compliance with thecovenants contained in the Credit Facilities.

 

The Credit Facilities require the Company to enter into interest rateprotection agreements to provide interest rate protection for a minimum of 50%of the Company’s consolidated total funded indebtedness under the first lienand second lien credit and guaranty agreements for a term of not less thanthree years.  Effective January 28,2008, the Company entered into a swap agreement (the “Swap”) with CIBC toprovide the required interest rate protection and to manage its exposure tochanges in LIBOR. The Swap is for a notional amount of $58,500 expiring on January 28,2011 with a fixed rate of LIBOR interest of 3.07%.   The Swap has been designated as a cash flowhedge of the variability of the cash flows due to changes in LIBOR and has beendeemed to be highly effective. Accordingly, the Company records the fair value of the Swap as an assetor liability on its consolidated balance sheet, and any unrealized gain or lossis included in accumulated other comprehensive income.  As of March 31, 2008, the Companyrecorded a liability of $579 in the accompanying consolidated balancesheet.  The Company also recorded inaccumulated other comprehensive income (loss) after-tax net losses of $(342)for the three months ended March 31, 2008. No hedge ineffectiveness wasrecorded during the three months ended March 31, 2008.

 

26

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Borrowings under the revolving commitments of the Credit Facilities area key source of the Company’s liquidity, and the Company’s ability to borrowthereunder is material to the Company’s liquidity and operations.  Failure to comply with the minimumConsolidated Fixed Charge Coverage Ratio test or the Total Leverage test (eachas defined) would result in a violation of the Credit Facilities which, absenta waiver or an amendment, would permit the lenders to accelerate repayment ofborrowings thereunder.  If the debt underthe Credit Facilities is accelerated, there can be no assurance that theCompany would have sufficient assets to pay amounts due under the CreditFacilities, or have access to other sources of funding.

 

Subordinated Notes Payable—Related Parties

 

As part of the financing of the Business Combination, the Company issuedsubordinated notes totaling $8,259 ($8,619 at 3/31/2008 including $360 ofunpaid earned interest) to the former stockholders of the B.J.K. Entities. Thenotes mature on April 15, 2015 and bear interest at an interest rate of10%.

 

Operating Activities

 

Net cash used in operating activities for the three months ended March 31,2008 of $1,975 was principally the result of $2,401 in cash generated (net lossof $386 plus depreciation and amortization of $2,498 and other non cash itemsof $289) and a decrease in inventory of $3,248 offset by an increase inaccounts receivable of $4,458 and payments of accounts payable and accruedexpenses of $1,773.

 

Net cash provided by operating activities for the three months ended March 31,2007 of $439 was principally the result of interest income.

 

Investing Activities

 

Net cash used in investing activities of $1,487 for the three monthsended March 31, 2008 is due to expenditures for property andequipment.  The Company currently expectsthat total expenditures for property and equipment for 2008 will beapproximately $2,500.

 

Net cash used in investing activities of $469 for the three monthsended March 31, 2007 was related to trust fund investments.

 

Financing Activities

 

Net cash provided by financing activities for the three months ended March 31,2008 of $2,477 was primarily due to borrowings under the revolving commitmentsof the Company’s Credit Facilities of $3,000 offset by a required repayment ofthe initial term loan of $500.  TheCompany anticipates that its debt service requirements for the balance of 2008will be approximately $10,500, representing $1,500 of required initial term loanrepayments and interest of approximately $9,000.

 

There was no net cash used in financing activities for the three monthsended March 31, 2007.

 

27

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Off-Balance Sheet Arrangements

 

As of March 31, 2008, the Company has not entered into anyoff-balance sheet financing arrangements, established any special purposeentities, guaranteed any debt or commitments of other entities, or entered intoany options on non-financial assets.

 

Under the Credit Facilities, which are dated as of October 26,2007, the Company has pledged all of its assets (including the assets of itssubsidiaries), to guaranty the obligations of the Company. On April 8,2008, the Company arranged for one of the Company’s major pharmaceuticalvendors to extend certain benefits to the Company.  The vendor,AmerisourceBergen Drug Corporation (“ABDC”), and the Company are parties to aprime vendor agreement.  The prime vendor agreement was amended inconnection with the Company’s Business Combination to provide, among otherthings, that the Company would be required to maintain a cash deposit of $2,500as security for its pharmaceutical purchases from ABDC.  On April 8,2008, Jerry Silva delivered to ABDC a personal letter of credit in the amountof $2,500 as security for pharmaceutical purchases by the Company under theprime vendor agreement.  In exchange for the delivery of this letter ofcredit, ABDC agreed, among other things, to return to the Company the $2,500cash deposit.  No payment or other financial accommodation was given bythe Company to Jerry Silva with respect to the letter of credit.

 

DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our financial statements are prepared in accordance with accountingprinciples generally accepted in the United States. In connection with thepreparation of our financial statements, management is required to makeassumptions, estimates and judgments that affect the reported amounts ofassets, liabilities, stockholders’ equity, revenues and expenses and therelated disclosure of commitments and contingencies. On a regular basis, weevaluate the estimates used, including those related to the allowance fordoubtful accounts, sales discounts, inventory valuation, and valuation andrecoverability of long lived assets, indefinite lived intangibles, (includingthe values assigned to acquired intangible assets) and income taxes. Ourmanagement bases its estimates on a combination of factors, includinghistorical experience, current conditions, feedback from outside advisors wherefeasible and on various other assumptions that are believed to be reasonable atthe time and under the current circumstances. Further information regardingthese policies appears within “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included in the Company’s 2007Annual Report on Form 10-K.

 

**Since December 31, 2007, there have been nosignificant changes to the Company’s critical accounting policies or to therelated assumptions and estimates involved in applying these policies, exceptfor a change in the accounting for manufacturer rebates.  The change in accounting for manufacturingrebates, from a cash basis of accounting to the accrual method, has beenaccounted for as a correction of previously issued financial reports, asdiscussed above in Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operation;Results of Operations.**

 

**Recent Accounting Pronouncements**

 

InDecember 2007, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 141 (revised2007), “Business Combinations” (“SFAS 141R”). Among other changes, SFAS 141R 

 

28

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requiresthe acquiring entity in a business combination to recognize all (and only) theassets acquired and liabilities assumed in the transaction at fair value;establishes the acquisition-date fair value as the measurement objective forall assets acquired and liabilities assumed, including earn-out provisions.SFAS 141R is generally effective for business combinations occurring in thefirst annual reporting period beginning after December 15, 2008.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS 160”). Among other items, SFAS 160 requires all entities to reportnoncontrolling (minority) interests in subsidiaries in the same way as equityin the consolidated financial statements. SFAS 160 is effective for the firstannual reporting period beginning after December 15, 2008. The Company isevaluating the anticipated effect of this recently issued standard on itsconsolidated results of operations, financial position and cash flows.

 

InDecember 2007, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”(“SFAS 161”). Among other items, SFAS 161 requires qualitative disclosuresabout objectives and strategies for using derivatives, quantitative disclosuresabout fair value amounts of, and gains and losses on, derivative instruments,and disclosures about credit-risk-related contingent features in derivativeagreements. SFAS 161 is effective for the first annual reporting periodbeginning after November 15, 2008. The Company is evaluating theanticipated effect of this recently issued standard on its consolidated resultsof operations, financial position and cash flows.

 

Management does not believe that any other recently issued, but not yeteffective, accounting standards if currently adopted would have a materialeffect on the accompanying financial statements.

 

**Forward Looking Statements**

** **

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations and other sections of this Quarterly Report on Form 10-Qinclude “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, (the “Exchange Act”).  All statements other than statements ofhistorical facts included in this Quarterly Report on Form 10-Q, including,without limitation, statements regarding the Company’s liquidity, futurefinancial results, economic conditions, trends, certain risks anduncertainties, business strategy and plans and objectives of management forfuture operations are forward-looking statements. These forward-lookingstatements are based on the beliefs of management, as well as assumptions madeby and information currently available to management. Forward-lookingstatements generally can be identified by the use of forward-looking terminologysuch as “may,” “expect,” “intend,” “estimate,” “anticipate,” “seek,” “should,” “lookforward to,” “indications,” “plan,” “momentum,” “believe” or “continue” or thenegative thereof or variations thereon or similar terminology. These statementsreflect our current view with respect to future events and are subject torisks, uncertainties and assumptions. Many factors could affect our actual financial results and could causeactual results to differ materially from those expressed in the forward-lookingstatements. Important factors that could cause actual results to differmaterially from the Company’s expectations, or “cautionary statements,”include, without limitation:

 

·                  our substantial amount of debt;

 

29

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·                  outcomes of government reviews, inquiries,investigations and related litigation;

 

·                  continued compliance with governmentregulations;

 

·                  legislation or regulatory environments,requirements or changes adversely affecting the businesses in which we areengaged;

 

·                  fluctuations in customer demand;

 

·                  management of rapid growth;

 

·                  intensity of competition from other providersof institutional pharmacy services;

 

·                  timing, approval and market acceptance of newproduct introductions and institutional pharmacy locations;

 

·                  general economic conditions;

 

·                  availability of financial and other resourcesto us;

 

·                  interest rate changes affecting the Company;

 

·                  theeffects of the loss or bankruptcy of or default by a significant customer,supplier or other entity relevant to our operations;

 

·                  theCompany’s estimates of required reserves for doubtful accounts, if futureeconomic conditions, or competitive conditions differ from expectations;

 

·                  our ability to control costs, particularlylabor and employee benefit costs, rising pharmaceutical costs and regulatorycompliance costs;

 

·                  the effects of healthcare reform andgovernment regulations, interpretation of regulations and changes in the natureand enforcement of regulations governing the healthcare and institutionalpharmacy services industries;

 

·                  changes in the reimbursement rates or methodsof payment from Medicare and Medicaid and other third party payors, or theimplementation of other measures to reduce the reimbursement for our servicesor the services of our customers and the impact of Medicare Part D;

 

·                  our ability, and the ability of ourcustomers, to comply with Medicare or Medicaid reimbursement regulations orother applicable laws;

 

·                  further consolidation of managed careorganizations and other third party payors;

 

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·                  our ability to implement our businessstrategy;

 

·                  our estimates of costs and benefits, cashflow from operations and capital expenditures;

 

·                  our ability to list our common stock on stockexchanges;

 

·                  natural disasters, war, civil unrest,terrorism, fire, floods, earthquakes, hurricanes or other matters beyond ourcontrol;

 

·                  elimination of, changes in or our failure tosatisfy pharmaceutical manufacturers’ rebate programs;

 

·                  our ability to attract and retain keyexecutives, pharmacists and other healthcare personnel;

 

·                  changes in the laws, regulations andpolicies, including changes in accounting standards, that affect, or willaffect, the Company;

 

·                  our ability to ensure and maintain aneffective system of internal controls over financial reporting; and

 

·                  geopolitical events and regulatory changes.

 

Readers are cautioned not to place undue reliance on theseforward-looking statements, which reflect management’s analysis, judgment,belief or expectation only as of the date hereof.  The Company undertakes no obligation toupdate or publicly revise these forward-looking statements to reflect events orcircumstances that arise after the date hereof. In addition to the disclosure contained herein, readers should carefullyreview any disclosure of risks and uncertainties contained in other documentsthe Company files or has filed from time to time with the Securities andExchange Commission pursuant to the Exchange Act.

 

**Item 3. Quantitative andQualitative Disclosures about Market Risk.**

** **

The market risk inherent in the Company’s market risk sensitiveinstruments is the potential loss arising from material adverse changes ininterest rates.

 

InterestRate Risk

 

The Company’s borrowings at March 31, 2008 under the CreditFacilities expose earnings to changes in short-term interest rates.  Interest rates on the underlying obligationsare either variable or fixed for such a short period of time as to effectivelybecome variable.  Effective January 28,2008, the Company entered into the Swap with CIBC for a notional amount of$58,500 to hedge its exposure to changes in interest rates on approximately 50%of the first lien credit and second lien credit and guaranty agreements of theCredit Facilities.

 

**Item 4. Controls andProcedures.**

** **

We maintain disclosurecontrols and procedures designed to ensure that information required to bedisclosed in reports we file or submit under the Securities Exchange Act of1934

 

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(the“Exchange Act”) is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to management,including our chief executive officer (“CEO”) and interim chief financialofficer (“interim CFO”), as appropriate to allow timely decisions regardingrequired disclosure.

 

We carried out theevaluation required by paragraph (b) of Exchange Act Rules 13a-15and 15d-15, under the supervision and with the participation of our management,including the CEO and interim CFO, of the effectiveness of our disclosurecontrols and procedures (as defined in the Exchange Act Rules 13a-15(e) and15d-15(e)).  Based upon this evaluation,the CEO and interim CFO concluded that as of March 31, 2008 our disclosurecontrols and procedures were not effective to provide reasonable assurance thatfinancial information we are required to disclose in our reports under theExchange Act was recorded, processed, summarized and reported accurately, dueto following material weaknesses:

 

(1)  We do not maintain sufficient personnel with an appropriatelevel of technical accounting knowledge, experience and training in theapplication of generally accepted accounting principles commensurate with theCompany’s financial accounting and reporting requirements.

 

(2)   We do not maintain anintegrated system for revenue, accounts receivable, inventory and fixedassets.  We do not maintain a detailedfixed asset subsidiary ledger which can be reconciled to our general ledger ona timely basis.  As a result, ourcontrols involve significant manual processing and reliance on detailedmanagement reviews.

 

(3) We do not maintain adequate review controls over theaccounting for and reporting of non-routine transactions and complex accountingmatters.

 

(4)  We do not maintain adequate documentation or assessment ofour internal controls over financial reporting.

 

These weaknesses have thepotential to cause a material misstatement and/or inadequate disclosures in ourconsolidated financial statements.

 

The correction of theCompany’s prior consolidated financial statements for the year ended December31, 2007 as described in Note 2 of the Consolidated Financial Statementspresented elsewhere in this quarterly report and the delay in the filing of theCompany’s Form 10-Q for the quarter ended March 31, 2008 were caused primarilyby the material weaknesses identified above.

 

Because of the weaknessesdescribed above, we performed additional analyses and other post-closingprocedures in order to prepare the consolidated financial statements containedin this quarterly report in accordance with applicable generally acceptedaccounting principles.  Accordingly,management believes that the consolidated financial statements included in thisquarterly report on Form 10-Q for the period ended March 31, 2008fairly present, in all material respects, our financial condition, results ofoperations and cash flows for the periods presented.

 

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Members of our management,including our CEO and interim CFO, are working with our audit committee todevelop a remediation plan to address the weaknesses described above.  At present, this remediation plan consists ofthe following:

 

(a) In order to address the weaknessdescribed in items (1) above, we are in the process of identifyingcandidates with appropriate education and experience in accounting andfinancial reporting.  During the secondand third quarters of 2008 we intend to supplement our financial accountingstaff, as appropriate.

 

(b) In order to address the weakness described in Item (2) above,the Company is in the process of completing the installation of a generalledger software package and is continuing to implement both an integrated perpetualinventory system as well as an integrated revenue recognition / accountsreceivable process.  In addition, theCompany is beginning the implementation of a fixed asset subsidiary ledgerwhich it expects to complete prior to the end of the Company’s third quarter.

 

(c)  In order to address the weakness described in item (3) above,we have implemented a process that ensures the timely review and approval ofcomplex accounting transactions by qualified accounting personnel.  In addition, we now require that allsignificant non-routine transactions be reviewed by senior financialmanagement.  We have also developedimproved monitoring controls in the accounting department.

 

(d) To address the weakness in item (4) above, during thesecond quarter we will retain a nationally recognized accounting firm to assistmanagement in documenting, reviewing and assessing our internal control overfinancial reporting, identifying any material weaknesses in such internalcontrol over financial reporting, assisting in the review and assessment ofappropriate disclosure controls and procedures, and assisting in thedevelopment of any remedial actions.

 

We intend to take furthersteps to strengthen our disclosure controls and procedures in order toremediate these and potentially other weaknesses through ongoing processimprovements, the implementation of additional enhanced policies and controlsand the ongoing re-assessment of the technical accounting capabilities of ourfinancial accounting staff during our fiscal year ending December 31,2008.  We intend for these to be ongoingefforts to which we will devote significant resources and which we will review,maintain and update over time.  Inaddition, we have initiated the systems and process evaluation testing of ourinternal control over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act, in order to allow management to report on the internalcontrol over financial reporting which will be required for the fiscal yearending December 31, 2008.

 

Except to the extentdescribed above, there has been no change in our internal control overfinancial reporting during the quarter ended March 31, 2008, that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II – OTHERINFORMATION.**

** **

**Item 1.  Legal Proceedings.**

** **

On December 20, 2007, JMP Securities LLC and Shattuck HammondPartners LLC filed a complaint in the Superior Court of California for theCity and County of San Francisco against B.J.K. Inc., the Company, andcertain individuals affiliated with the Company.  The plaintiffs allege that they are entitledto compensation as a result of the Company’s B.J.K. Inc. acquisition on October 26,2007.  The complaint asserts variousclaims including breach of contract, breach of implied covenant of good faithand fair dealing, fraud, negligent misrepresentation and unjust enrichment, andseeks various damages including compensatory damages of not less than $2.23million, punitive damages, the reimbursement of the plaintiffs’ legal fees andcourt costs, and a declaratory judgment as to the validity and enforceabilityof a financial advisory and investment banking services agreement entered into by B.J.K. Inc. Followingmediation, the parties have tentatively agreed on a settlement and arenegotiating its terms. No assurance can be given, however, that the partieswill be able to reach a definitive settlement agreement.  The Company believes that Jerry Silva, StevenSilva, and certain other parties are obligated to indemnify the Company forthese claims and reasonable legal costs under the terms of the Stock PurchaseAgreement dated as of June 1, 2007, pursuant to which these parties soldB.J.K. Inc. to the Company.  The Companytherefore believes that payment of any settlement or judgment resulting fromthe lawsuit will not have an adverse effect on the Company’s results ofoperations or financial position.

 

**Item1A.    Risks Factors.**

** **

**There have been no material changes from the riskfactors previously disclosed in our Annual Report on Form 10-K for theyear ended December 31, 2007.**

** **

**Item 2.  UnregisteredSales of Equity Securities and Use of Proceeds.**

** **

On January 24, 2008,the compensation committee of our board of directors made stock awards to eachof the board’s five non-employee directors and to a financial advisor to theboard. The awards were made pursuant to a compensation package approved by theboard of directors. The number of shares of our common stock awarded was 4,717shares for each of the six individuals, or an aggregate of 28,302 shares. Noseparate consideration was required to be paid for these shares. The shareswere awarded in a private placement in reliance upon the exemption providedunder section 4(2) of the Securities Act of 1933 as a transaction by anissuer not involving any public offering.

 

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As of February 15,2008, the Company issued a common stock purchase warrant to a financial advisorto the Company pursuant to which the financial advisor may purchase 25,000shares.  This warrant is exercisable at aprice of $7.00 per share.  No separateconsideration was required to be paid for this warrant. The warrant was issuedin a private placement in reliance upon the exemption provided under section 4(2) ofthe Securities Act of 1933 as a transaction by an issuer not involving anypublic offering.

 

On April 16, 2008, thecompensation committee of our board of directors made stock awards to each ofthe board’s five non-employee directors and to a financial advisor to theboard. The awards were made pursuant to a compensation package approved by theboard of directors. The number of shares of our common stock awarded was 481shares for each of the six individuals, or an aggregate of 2,886 shares. Noseparate consideration was required to be paid for these shares. The shareswere awarded in a private placement in reliance upon the exemption providedunder section 4(2) of the Securities Act of 1933 as a transaction by anissuer not involving any public offering.

 

**Item6.  Exhibits.**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                           |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                |
| 31.1                |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                      |
| 31.2                |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                      |
| 32.1                |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                      |
| 32.2                |       | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   |               | (Registrant)                     |
|--------|--------------------|----------------------------------|
|   |               |                             |
|   | May 30,  2008 | /s/  Jerry Silva                 |
|   |               | Jerry  Silva                     |
|   |               | Chief Executive Officer          |
|   |               |                             |
|   |               |                             |
|   | May 30,  2008 | /s/ Joseph Sinicropi             |
|   |               | Joseph  Sinicropi                |
|   |               | Interim  Chief Financial Officer |

 

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