10-Q 1 d10q.txt FORM 10-Q ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ___________ FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: March 31, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission File Number 0-22403 ___________ HORIZON Pharmacies, Inc. (Exact name of registrant as specified in its charter) DELAWARE 75-2441557 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 531 West Main Street Denison, Texas 75020 (Address of principal executive offices) (903) 465-2397 (Registrant's telephone number) ___________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Title of Each Class Outstanding at May 15 , 2001 ------------------- ---------------------------- Common stock, par value $.01 per share 6,215,851 shares ================================================================================ FORM 10-Q HORIZON Pharmacies, Inc. TABLE OF CONTENTS Page ---- PART I-FINANCIAL INFORMATION 1 Item 1. Financial Statements (Unaudited) 1 Condensed Consolidated Balance Sheets 1 Condensed Consolidated Statements of Operations (Unaudited) 3 Condensed Consolidated Statements of Cash Flows (Unaudited) 4 Notes to Condensed Consolidated Financial Statements (Unaudited) 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 3. Quantitative and Qualitative Disclosures about Market Risks 16 PART II. OTHER INFORMATION 17 Exhibits and Reports On Form 8-K 17 SIGNATURES 18
i PART I-FINANCIAL INFORMATION Item 1. Financial Statements. HORIZON Pharmacies, Inc. Condensed Consolidated Balance Sheets
December 31, March 31, 2000 2001 ----------- ----------- (Audited) (Unaudited) (In Thousands) ASSETS Current assets: Cash and cash equivalents..................................................... $ 2,347 $ 2,377 Certificate of deposit........................................................ 375 -- Accounts receivable, net...................................................... 10,127 9,799 Inventories................................................................... 18,212 17,970 Prepaid expenses and other.................................................... 463 509 -------- -------- Total current assets........................................................... 31,524 30,655 Debt issue costs, net of accumulated amortization, and other assets............ 898 781 Property, equipment and capital lease assets: Property and equipment: Land, buildings and improvements........................................... 1,430 1,430 Software and equipment..................................................... 8,307 8,422 -------- -------- 9,737 9,852 Less accumulated depreciation and amortization............................... 2,230 2,603 -------- -------- Property and equipment, net.................................................. 7,507 7,249 Equipment under capital leases, net of accumulated amortization.............. 518 451 -------- -------- Property, equipment and capital lease assets, net.............................. 8,025 7,700 Intangibles, at cost: Noncompete covenants and customer lists...................................... 2,272 2,277 Goodwill..................................................................... 13,069 13,069 -------- -------- 15,341 15,346 Less accumulated amortization................................................ 1,880 2,064 -------- -------- Intangibles, net............................................................... 13,461 13,282 -------- -------- $ 53,908 $ 52,418 ======== ========
-1- December 31, March 31, 2000 2001 ----------- ----------- (Audited) (Unaudited) (In Thousands) Liabilities and stockholders' equity (deficit) Current liabilities: Note payable................................................................. $ 7,000 $ 7,000 Long-term debt subject to acceleration....................................... 10,562 12,724 Accounts payable............................................................. 18,132 18,866 Accrued liabilities.......................................................... 3,237 5,424 Lease termination settlements and other exit costs........................... 719 688 Current portion of long-term debt and obligations under capital leases....... 2,577 2,564 -------- -------- Total current liabilities..................................................... 42,227 47,266 Noncurrent liabilities: Lease termination settlements................................................ 846 782 Long-term debt and obligations under capital leases.......................... 9,003 6,034 -------- -------- Total noncurrent liabilities................................................... 9,849 9,849 Stockholders' equity (deficit): Preferred stock, $.01 par value, authorized 1,000,000 shares, none issued.... - - Common stock, $.01 par value, authorized 14,000,000 shares; issued 6,221,932 shares in 2000 and in 2001....................................... 62 62 Additional paid-in capital................................................... 26,225 26,225 Accumulated deficit.......................................................... (24,385) (27,881) -------- -------- 1,902 (1,594) Treasury stock (6,081 shares), at cost....................................... (70) (70) -------- -------- Total stockholders' equity (deficit).......................................... 1,832 (1,664) -------- -------- $ 53,908 $ 52,418 ======== ========
See accompanying notes. -2- HORIZON Pharmacies, Inc. Condensed Consolidated Statements of Operations (Unaudited)
Three Months Ended ------------------ March 31 -------- 2000 2001 ---- ---- (In Thousands, Except Per Share Data) Net revenues: Prescription drugs sales............................................................. $26,954 $27,403 Other sales and services............................................................. 8,148 5,898 ------- ------- Total net revenues..................................................................... 35,102 33,301 Costs and expenses: Cost of sales and services: Prescription drugs................................................................. 20,677 21,483 Other.............................................................................. 5,116 3,088 Depreciation and amortization........................................................ 499 758 Selling, general and administrative expenses......................................... 9,762 9,266 Contract termination penalty......................................................... - 600 ------- ------- Total costs and expenses............................................................... 36,054 35,195 ------- ------- Loss from operations................................................................... (952) (1,894) Other income (expense): Interest and other income............................................................ 4 158 Interest expense..................................................................... (656) (1,760) ------- ------- Total other income (expense)........................................................... (652) (1,602) ------- ------- Net loss............................................................................... $(1,604) $(3,496) ======= ======= Basic and diluted loss per share (Note 2).............................................. $ (0.27) $ (0.56) ======= =======
See accompanying notes. -3- HORIZON Pharmacies, Inc. Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended ------------------ March 31, --------- 2000 2001 ---- ---- (In Thousands) Operating Activities Net loss.................................................................................... $(1,604) $(3,496) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization........................................................... 499 758 Default interest and contract termination penalty expenses.............................. - 2,100 Other................................................................................... 41 21 Changes in operating assets and liabilities, net of acquisitions of businesses: Accounts receivable................................................................... (78) 320 Inventories........................................................................... 1,218 242 Prepaid expenses and other............................................................ (244) (46) Accounts payable and accrued liabilities.............................................. (2,155) 726 ------- ------- Total adjustments........................................................................... (719) 4,121 ------- ------- Net cash provided by (used in) operating activities........................................ (2,323) 625 Investing Activities Maturity of certificate of deposit.......................................................... -- 375 Proceeds from sales of assets............................................................... 92 -- Purchases of property and equipment......................................................... (952) (115) Assets acquired for cash in acquisitions of businesses...................................... (101) -- Other....................................................................................... -- (5) ------- ------- Net cash provided by (used in) investing activities......................................... (961) 255 Financing Activities Borrowings.................................................................................. 3,100 -- Principal payments on debt and obligations under capital leases............................. (677) (850) ------- ------- Net cash provided by (used in ) financing activities........................................ 2,423 (850) ------- ------- Net increase (decrease) in cash and cash equivalents........................................ (861) 30 Cash and cash equivalents at beginning of period............................................ 1,263 2,347 ------- ------- Cash and cash equivalents at end of period.................................................. $ 402 $ 2,377 ======= ======= Noncash Investing and Financing Activities Issuance of warrants to lenders and vendors (350,000 shares)................................ $ 895 $ -- Acquisitions of businesses financed by 54,036 shares of common stock: Inventories........................................................................... $ 39 $ -- Property and equipment................................................................ 169 -- Intangibles........................................................................... 177 -- ------- ------- 385 -- Less cash paid........................................................................ (101) -- ------- ------- Assets acquired....................................................................... $ 284 $ -- ======= =======
See accompanying notes. -4- HORIZON Pharmacies, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) (In Thousands, Except Share and Store Data) Note 1 The accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal, recurring accruals, which HORIZON Pharmacies, Inc. ("Horizon" or the "Company") considers necessary for a fair presentation of the financial position and the results of operations for the indicated periods. The notes to the financial statements should be read in conjunction with the notes to the financial statements contained in our Form 10-K for the year ended December 31, 2000. The results of operations for the three months ended March 31, 2001 are not necessarily indicative of the results to be expected for the full year ending December 31, 2001. Horizon's net revenues, costs and expenses are higher during peak holiday periods and from Christmas through Easter (the first and fourth quarters of the calendar year). Estimated gross profit rates were used to determine costs of sales for the three months ended March 31, 2000 and 2001. Note 2 The Company has incurred operating and net losses in each of the three years ended December 31, 2000 and continues to experience operating losses through March 2001. Additionally, violations by the Company of covenants in its existing credit agreement which have not been cured or waived by McKesson HBOC, Inc. ("McKesson") and in a note agreement previously with a bank but assumed by McKesson under a guarantee agreement in February 2001 have resulted in such credit arrangements totaling $17,562, being included in current liabilities in the accompanying consolidated financial statements at December 31, 2000 and March 31, 2001. Such classification contributes to a working capital deficiency of $16,611 at March 31, 2001. Management's plans for 2001 related to operating matters include reducing receivables and inventory levels, increased emphasis on higher margin products, including home medical equipment, acceleration of cost reduction programs begun in 2000, which included selling or closing certain unprofitable pharmacies, consolidation of administrative functions to its corporate location in Denison, Texas, and installation of a new point of sale system in its pharmacies. The Company is negotiating with McKesson to restructure the $17,562 in debt set out above as well as its trade payables and other charges due to McKesson totaling approximately $18,200 at March 31, 2001. The Company believes that if such restructuring is successful, additional debt and equity financing will be available to the Company to satisfy its working capital needs and to finance expansion. There are no assurances, however, that such restructuring will be completed on terms satisfactory to the Company. If such restructuring is not completed and replacement financing cannot be accomplished, the Company may be forced to sell pharmacies or inventories in order to pay the indebtedness to McKesson which could have a material adverse impact on the financial condition and operations of the Company. -5- Note 3 Weighted average common shares outstanding used in the calculation of basic and diluted loss per share for the three months ended March 31, 2000 and 2001 totaled 5,886,069 and 6,215,851, respectively. Anti-dilutive employee stock options and warrants excluded amounted to 104,621 shares for the three months ended March 31, 2000 and 2,267,393 shares for the three months ended March 31, 2001. The computation of diluted loss per share did not assume the conversion of the convertible debentures because their inclusion would have been antidilutive. Note 4 No income taxes are provided due to the existence of net operating loss carryforwards. Note 5 At March 31, 2001, we owned 45 pharmacies and related businesses, all of which were acquired from third parties in purchase transactions. Such acquisitions have generally been structured as asset purchases and generally have included inventories, store fixtures and the assumption of store operating lease arrangements. The acquisitions generally have been financed by debt to the sellers and/or an inventory supplier. One pharmacy was acquired during the three months ended March 31, 2000 and none were acquired in the three months ended March 31, 2001. Pro forma results of operations data giving effect to the acquisitions completed during the three month periods ended March 31, 2000 as if the transactions had been consummated as of January 1, 1999 were not materially different from historical operating results. On May 11, 2001, the Company closed one underperforming pharmacy. Total net revenues related to this pharmacy for the three months ended March 31, 2000 and 2001 were $605 and $665, respectively. Note 6 As of March 31, 2001, we were in default of several covenants of our existing credit agreement with McKesson. These covenant violations have not been cured or waived. On April 18, 2001, McKesson accelerated all indebtedness owed by the Company and demanded immediate payment of all such indebtedness, including all amounts owed under the terms of the credit agreement, the related notes and the previously terminated supply agreement. Accordingly, $10,562 due under the credit agreement as of March 31, 2001 is classified as current in the accompanying financial statements. Also payable to McKesson is a $7,000 demand note previously payable to Bank One, N.A. that was acquired in February 2001 by McKesson, accounts payable of $14,425 and accrued interest, penalties and other charges of $3,800. Because of the defaults under the credit agreement, the Company is also in default with respect to its convertible debentures. Accordingly, these debentures ($2,162 net of unamortized -6- discount of $243) are classified as current in the accompanying March 31, 2001 financial statements. On April 20, 2001, McKesson notified the Company that McKesson intended to contact certain third party insurance payors of the Company and instruct them to make payments directly to McKesson of all amounts owed or which in the future may be owed to Horizon. In response to this action the Company is exploring a variety of alternatives, including the possibility of filing for protection under Chapter 11 of the U.S. Bankruptcy Code. The Company's continued losses and lack of liquidity indicate that the Company may not be able to continue as a going concern for a reasonable period of time. The Company's ability to continue as a going concern is dependent upon several factors including, but not limited to, the Company's ability to restructure its debt with McKesson, generate sufficient cash flows to meet its obligations on a timely basis, obtain additional financing, and continue to obtain supplies and services from its vendors. As a result of such defaults and the losses incurred in 1998, 1999, and 2000, our independent auditors included an uncertainty paragraph in their audit report with respect to consolidated financial statements of the Company for the year ended December 31, 2000 related to the Company's ability to continue as a going concern. Note 7 The Company and certain present and former officers or directors are named as defendants in an action that was filed on May 28, 1999. Plaintiffs seek to certify a class of persons who purchased shares of the Company's common stock during the period between August 14, 1998 and March 3, 1999, inclusive, alleging that defendants failed to timely disclose complications with the Company's prescription pricing communications technology. Plaintiffs seek unspecified compensatory and/or rescissory damages. The Company is vigorously defending against the action. The Company has contingent liabilities for other lawsuits and various other matters with certain vendors occurring in the ordinary course of business. Management of the Company believes that the ultimate resolution of these contingencies will not have a material adverse effect on the Company's financial position or results of operations. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. (Dollars in Thousands) Overview The following discussion and analysis reviews the operating results of Horizon for the three months ended March 31, 2001 and compares those results to the comparable period of 2000. Certain statements contained in this discussion are not based on historical facts; rather, they are forward-looking statements that are based upon numerous assumptions about future conditions which may ultimately prove to be inaccurate, and actual events and results may differ materially from anticipated results described in such statements. Our ability to achieve such -7- results is subject to certain risks and uncertainties, such as those inherent generally in the retail pharmacy industry and the impact of competition, pricing and changing market conditions. We disclaim, however, any intent or obligation to update these forward-looking statements. As a result, you should not rely on these forward-looking statements. Horizon's principal business strategy since commencing operations in 1994 has been to establish a chain of retail pharmacies through the acquisition of free standing, full-line retail pharmacies and related businesses. In 1999, we made a strategic decision to enter the mail order and e-commerce pharmacy business. In June 1999, we purchased a combination retail, mail order and Internet pharmacy operation, and in the fourth quarter we started a new Internet pharmacy operation, HorizonScripts.com, which provides customers online access to thousands of prescription and non-prescription items at competitive prices. We believe this Internet pharmacy will enhance our traditional "brick and mortar" operations, and that the "brick and click" strategy will offer our customers and potential customers convenient sources for their health care needs. By expanding our presence through e-commerce, we believe we will expand our name recognition and revenue base, while also cementing our relationship with our existing customers. During the three months ended March 31, 2000, we acquired the prescription files and inventory of one pharmacy and consolidated them into an existing store, we sold the prescription files and pharmaceutical inventory of our Cleburne, Texas store and we acquired an infusion pharmacy operation in Corpus Christi, Texas. During the remainder of 2000, we acquired the prescription files and inventory of one pharmacy and consolidated them into an existing store. During the three months ended March 31, 2001, we did not make any acquisitions or divestitures. The primary measurement of the effect of acquisitions on our operating performance is the number of store operating months, which is the number of months we owned all of the stores counted during the relevant measuring period. We expect that continuing acquisitions and expansion of our e-commerce activities will be the most significant factors in our growth strategy. However, at March 31, 2001, we were in default of several covenants of our existing credit agreement with McKesson. These covenant violations have not been cured or waived, and McKesson has demanded immediate payment of all indebtedness owed by the Company under the terms of such credit agreement, the related notes and the previously terminated supply agreement. As a result, we currently are unable to obtain funds to finance additional acquisitions. Currently, our primary source of revenue is the sale of prescription drugs. During the three months ended March 31, 2000 and 2001, sales of prescription drugs generated 76.8% and 82.3% respectively of our total net revenues. We expect our prescription drug business to continue to increase on an annual basis as a result of the demographic trends toward an aging population and the continued development of new pharmaceutical products. Our revenues, gross profits and expenses customarily are higher during holiday periods and from Christmas through Easter. Sales of health-related products peak during seasonal outbreaks of cough and cold/flu viruses, which typically occur during the winter and spring. -8- Accordingly, revenues, gross profit and expenses should be highest in the fourth quarter and the first quarter of each year. We experienced losses in 2000 and in the first quarter of 2001, which were attributable, in part, to interest, penalties and other charges by McKesson and, in part, to certain underperforming stores. We expect to incur additional losses in the near future while we attempt to negotiate a debt restructuring plan with McKesson, continue to implement a turn-around or dispose of certain underperforming stores and build an infrastructure necessary for our growth. Results of Operations The following table sets forth the percentage relationship of certain income statement data for the periods indicated: Three Months Ended March 31, --------------- 2000 2001 ---- ---- INCOME STATEMENT DATA Revenues: Prescription drugs sales............................. 76.8% 82.3% Other sales and services............................. 23.2% 17.7% Total net revenues................................. 100.0% 100.0% Costs and Expenses: Cost of sales-prescription drugs(1).................. 76.7% 78.4% Cost of sales-other(2)............................... 62.8% 52.4% Selling, general and administrative expenses(3)...... 27.8% 27.8% Contract termination penalty......................... -% 1.8% Depreciation and amortization(3)..................... 1.4% 2.3% Interest expense (3)................................. 1.9% 5.3% Net loss(3).......................................... (4.6)% (10.5)% __________ (1) As a percentage of prescription drugs sales. (2) As a percentage of other sales and services. (3) As a percentage of total net revenues. Net Revenues Our total net revenues decreased $1,801, or 5.1%, to $33,301 for the three months ended March 31, 2001, compared to $35,102 for the three months ended March 31, 2000. The decrease was attributable primarily to the decrease in store operating months from 156 in the first quarter of 2000 to 135 in the first quarter of 2001 resulting from the sale of seven underperforming stores in 2000. Sales of prescription drugs increased to 82.3% of total net revenues for the three months ended March 31, 2001 from 76.8% of total net revenues for the three months ended March 31, 2000. We expect our prescription drug business to continue to increase on an annual basis as a -9- result of the demographic trends toward an aging population and the continued development of new pharmaceutical products. Same-store sales increased $1,076, or 3.5%, to $32,102 in the first three months of 2001 from $31,026 in the first three months of 2000. This increase is primarily the result of increased prescription drug sales (12.6%) due to increases in the number of prescriptions and the price of these prescriptions. The following tables show our prescription drug gross margins and total revenues margins for the three months ended March 31, 2001 and 2000: Gross Margins Gross Margins On On Prescription ---------------- Drug Sales Total Revenues ---------- -------------- Amount Percentage Amount Percentage ------ ---------- ------ ---------- Three Months Ended March 31, 2001........................... $5,920 21.6% $8,730 26.2% 2000........................... $6,277 23.3% $9,309 26.5% The decrease in the gross margin on prescription drug sales from 2000 to 2001 was primarily due to a decrease in the margin on third-party insurance plans and an increase in the percentage of third-party prescription sales. Costs and Expenses Cost of sales decreased $1,222, or 4.7%, to $24,571 in the three months ended March 31, 2001 from $25,793 in the three months ended March 31, 2000. This decrease is primarily the result of decreased sales volume resulting from the decreased number of store operating months resulting from the sale of seven underperforming stores in 2000. Our cost of sales as a percentage of total net revenues increased 0.4% to 73.8% in the three months ended March 31, 2001 from 73.5% in the three months ended March 31, 2000. This increase is primarily due to an increase in the cost of prescription drug sales. Depreciation and amortization increased $259, or 51.9%, to $758, or 2.3% of total net revenues, for the three months ended March 31, 2001 from $499, or 1.4% of total net revenues, for the three months ended March 31, 2000. This increase was due to an increase in depreciation and the amortization of debt issue costs. Selling, general and administrative expenses decreased $496, or 5.1%, to $9,266 in the three months ended March 31, 2001 from $9,762 in the three months ended March 31, 2000. Such expenses, expressed as a percentage of net revenues, were 27.8% and 27.8% for the three months ended March 31, 2000 and 2001, respectively. This decrease is primarily due to a -10- reduction in the number of store operating months resulting from the sale of seven underperforming stores in 2000 and reductions in corporate general and administrative expenses. The contract termination penalty of $600 in the first quarter of 2001 resulted from the cancellation of a supply agreement with McKesson. Reimbursement of such penalty was received in May 2001 from a new supplier. Interest expense increased $1,104, or 168%, to $1,760 in the first quarter of 2001 compared to $656 during the first quarter of 2000. The increase in interest expense resulted primarily from default interest charges by McKesson. Interest and other income increased $154 to $158 in the first quarter of 2001 compared to $4 in the first quarter of 2000. Earnings We had a net loss of $3,496 for the three months ended March 31, 2001 as compared to net loss of $1,604 in the same period of 2000. We incurred no income tax expense in either period. The loss in the three months ended March 31, 2001, resulted primarily from default interest, penalties and other charges by McKesson and a termination penalty due to the cancellation of the supply agreement with McKesson, as well as a decline in the gross margin of prescription drug sales due to lower reimbursements from third party payors. Liquidity and Capital Resources Net cash provided by operating activities increased $2,948 to $625 during the three months ended March 31, 2001 as compared to net cash used in operating activities of $2,323 for the three months ended March 31, 2000. The default interest and contract termination penalty assessed by McKesson and an increase in accounts payable and accrued liabilities, in part related to McKesson, were the primary reasons for the increase in net cash provided by operations. Net cash provided by investing activities was $255 for the three months ended March 31, 2001 as compared to $961 used for the comparable period in 2000. Net cash used in financing activities was $850 for the three months ended March 31, 2001 as compared to net cash provided by financing activities of $2,423 in the three months ended March 31, 2000. Cash and cash equivalents increased $30 to $2,377 during the three months ended March 31, 2001 as compared to $2,347 as of December 31, 2000. McKesson currently provides us with a $11,000 credit facility and a $7,000 line of credit. The McKesson credit facility is subject to certain restrictive covenants, including financial ratio requirements, which we must meet to maintain the credit facility and revolving line of credit. At March 31, 2001, we were in default of several of these covenants. These covenant violations -11- have not been cured or waived. On April 18, 2001, McKesson demanded immediate payment of all indebtedness owed by the Company under the terms of our existing credit agreement, the related notes and the previously terminated supply agreement. At May 15, 2001, pursuant to such credit agreement, we had borrowed $10,562 under the credit facility and $7,000 under the revolving credit facility. The $7,000 line of credit is evidenced by a promissory note which is payable on demand by McKesson. We also have $14,425 in accounts payable and $3,800 in accrued interest and penalties payable to McKesson as of March 31, 2001. The Company is dependent upon continued forbearance by McKesson. On April 20, 2001, McKesson notified the Company that it intended to contact certain third party payors of the Company and instruct them to make payments directly to McKesson of all amounts currently owed or which in the future may be owed to Horizon. In response to this action, the Company is exploring a variety of alternatives, including the possibility of filing for protection under Chapter 11 of the U.S. Bankruptcy Code. During the first quarter of 2001, we made no acquisitions. In February of 2000, we acquired the prescription files and inventory of one store in Gering, Nebraska and consolidated it with our existing store. On March 31, 2000, we acquired (primarily for common stock) the prescription files and inventory of an infusion pharmacy operation in Corpus Christi, Texas. During the remainder of 2000, we acquired the prescription files and inventory of one pharmacy and consolidated them into an existing store. As a result of the net losses we incurred in 1999, 2000 and the first quarter of 2001, and the defaults under the existing credit agreement with McKesson we are unable to make additional acquisitions until we are able to raise additional capital or secure additional credit lines for acquisitions. Because of the federal moratorium on home healthcare licenses from September 1997 until January 1998 and the uncertainty of the current regulations, we do not plan to expand our home healthcare operations in 2001. We do expect, however, to offer home medical equipment through stores which have not heretofore offered such equipment. The Company's plan for 2001 provides for the Company to improve its financial condition and operating results through increased retail prices when possible, by reducing our selling, general and administrative expenses, reducing receivables, inventory levels, store operating hours and labor costs, and analysis of various debt and equity alternatives. If necessary, we will sell or close underperforming and performing pharmacies. As discussed above, the Company is in default of its credit facility and McKesson has demanded immediate payment of all indebtedness owed by the Company under the terms of our existing credit agreement, the related notes and the previously terminated supply agreement. Additionally, McKesson has contacted certain third party insurance payors of the Company and has instructed them to make payments directly to McKesson of all amounts currently owed or which in the future may be owed to Horizon. In response to this action, the Company is exploring a variety of alternatives, including the possibility of filing for protection under Chapter -12- 11 of the U.S. Bankruptcy Code. In the event McKesson does not cease the action with the third party insurance payors, renew, restructure or otherwise extend the credit facility, we will seek replacement financing through a financial institution or supplier at similar terms or otherwise retire the debt with sales proceeds from underperforming stores. In the event such proceeds are not sufficient or that alternative financing is not arranged, we will sell the assets of certain performing stores (for which we have previously received unsolicited purchase inquiries) to provide the additional funds to retire the debt. The sale of such additional stores would reduce future revenues, and could have a material adverse effect on the financial position or results of operations of the Company. Factors Affecting Operations Substantial Indebtedness We have incurred substantial debt and may incur additional indebtedness in the future in connection with our plan of acquisitions. Our ability to make cash payments to satisfy our debt will depend upon our future operating performance, which is subject to a number of factors, including prevailing economic conditions and financial, business and other factors beyond our control. As discussed above, if we are unable to generate sufficient earnings and cash flow to service our debt, we may have to refinance certain of these obligations or dispose of certain assets. In the event we are required to refinance all or any part of our debt, there can be no assurance that we will be able to effect such refinancing on satisfactory terms. As discussed above, we are in default under our existing credit agreement and McKesson has demanded immediate payment of all indebtedness owed by the Company under the terms of such credit agreement, the related notes and the previously terminated supply agreement. We are currently actively pursuing financing from other potential sources to refinance our existing lines of credit as well as engaging in discussions with McKesson to restructure our existing debt and/or extend our lines of credit and to cease interfering with our third party insurance payors. There can be no assurance that we will be successful in either refinancing our existing debt or obtaining satisfactory waivers or extensions from McKesson. Sales to Third-Party Payors We sell a growing percentage of our prescription drugs to customers who are covered by third-party payment programs. Although contracts with third-party payors may increase the volume of prescription sales and gross profits, third- party payors typically negotiate lower prescription prices than non third-party payors. Accordingly, gross profit margins on sales of prescription drugs have been decreasing and are expected to continue to decrease in future periods. Reliance on Medicare and Medicaid Reimbursements Substantially all of our home healthcare revenues, which is approximately 1.5% of total net revenues, are attributable to third-party payors, including Medicare and Medicaid, private -13- insurers, managed care plans and HMOs. The amounts we receive from government programs and private third-party payors are dependent upon the specific benefits included under the program or the patient's insurance policies. Any substantial delays in reimbursement or significant reductions in the coverage or payment rates of third-party payors, or from patients enrolled in the Medicare or Medicaid programs, would have a material adverse effect on our revenues and profitability. Expansion Our ongoing expansion will require us to implement and integrate enhanced operational and financial systems, and additional management, operational and financial resources. Our inability to implement and integrate these systems and/or add these resources could have a material adverse effect on our results of operations and financial condition. There can be no assurance that we will be able to manage our expanding operations effectively or maintain or accelerate our growth. Although we experienced growth in net revenues in 1999 and 2000, we sustained substantial losses as a result of the decline in gross margins related to price conversion difficulties encountered during the pharmacy computer system conversions, the expenses associated with such conversions, the installation of the home office computer system, the installation of the frame relay telecommunication network, and the start-up expenses associated with our new pharmacy Web site, HorizonScripts.com. We cannot assure you that we will not experience similar problems to those encountered in 1999 and 2000 related to expansion or that we will be able to maintain or increase net revenues. Government Regulation and Healthcare Reform Pharmacists and pharmacies are subject to a variety of state and Federal regulations and may be adversely affected by certain changes in such regulations. In addition, prescription drug sales represent a significant portion of our revenues and profits, and are a significant segment of our business. These revenues are affected by regulatory changes, including changes in programs providing for reimbursement of the cost of prescription drugs by third-party payment plans, such as government and private plans, and regulatory changes relating to the approval process for prescription drugs. Regulation of Home Healthcare Services Our home healthcare business is subject to extensive Federal and state regulation. Changes in the law or new interpretations of existing laws could have a material adverse effect on permissible activities, the relative costs associated with doing business and the amount of reimbursement for our products and services paid by government and other third-party payors. Malpractice Liability The provision of retail pharmacy and home healthcare services entails an inherent risk of claims of medical and professional malpractice liability. We may be named as a defendant in such malpractice lawsuits and subject to the attendant risk of substantial damage awards. While -14- we believe we have adequate professional and medical malpractice liability insurance coverage, there can be no assurance that we will not be sued, that any such lawsuit will not exceed our insurance coverage or that we will be able to maintain such coverage at acceptable costs and on favorable terms. Competition The retail pharmacy and home healthcare businesses are highly competitive. We compete with national, regional and local retail pharmacy chains, independent retail pharmacies, deep discount retail pharmacies, supermarkets, discount department stores, mass merchandisers and other retail stores and mail order operations. Similarly, our home healthcare operations compete with larger providers of home healthcare services, including chain operations and independent single unit stores, which may have a more established presence in our markets and which may offer more extensive home healthcare services than us. Most of our competitors have financial resources that are substantially greater than ours, and we cannot assure you that we will be able to compete successfully with our competitors. Geographic Concentration Currently, 15 and 7 of our 45 retail pharmacies are located in Texas and New Mexico, respectively, and we plan to acquire other retail pharmacies located in such states. Consequently, our results of operations and financial condition are dependent upon general trends in the Texas and New Mexico economies and any significant healthcare legislative proposals enacted in those states. Need for Additional Capital We believe that a planned reduction in our inventory and accounts receivable levels, the continued reduction in selling, general and administrative expenses, the sale of certain underperforming stores and the restructuring, refinancing or extension of our existing credit facilities will be adequate to satisfy our working capital requirements for the next twelve months, although circumstances, including the acquisition of additional stores and certain alliances and/or joint ventures in e-commerce, will require that we obtain additional equity and/or long or short-term financing to realize certain business opportunities. No assurance can be made that we will be able to obtain such financing. Reliance on Single Supplier Throughout 2000 and in January 2001, we purchased approximately 90% of our inventory from McKesson, which also provided us with order entry machines, shelf labels and other supplies and who is also our primary lender. However, in February 2001, our supply agreement with McKesson was terminated and we ceased purchasing any inventory or other supplies from McKesson. Thereafter, we began to purchase the majority of our inventory from AmeriSource Corporation. In April 2001, we entered into a long term supply agreement with AmeriSource pursuant to which AmeriSource will be our primary supplier with respect to all -15- pharmaceuticals, including generics, home healthcare, over-the-counter and private label products. We believe that the wholesale pharmaceutical and non- pharmaceutical distribution industry is highly competitive because of the consolidation of the retail pharmacy industry and the practice of certain large retail pharmacy chains to purchase directly from product manufacturers. Although we believe we could obtain our inventory through another distributor at competitive prices and upon competitive payment terms if our relationship with AmeriSource were terminated, there can be no assurance that the termination of such relationship would not adversely affect our business. Potential Fluctuations in Quarterly Results; Seasonality Our results of operations depend significantly upon the net sales generated during the first and fourth quarters, and any decrease in net sales for such periods could have a material adverse effect upon our profitability. As a result, we believe that period-to-period comparisons of our results of operations are not and will not necessarily be meaningful and should not be relied upon as an indication of future performance. Item 3. Quantitative and Qualitative Disclosures about Market Risks. We are exposed to market risk from changes in interest rates on debt. Our exposure to interest rate risk currently consists of our outstanding lines of credit. The aggregate balance outstanding under the McKesson credit facility and line of credit was $17,562 at March 31, 2001. The impact on our results of operations of a one-point interest rate change on balances outstanding to McKesson and others would be $178 on an annual basis. This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in financial markets. -16- PART II. OTHER INFORMATION. Item 6. Exhibits and Reports On Form 8-K. (a) Exhibits. Exhibit No. Name of Exhibit ----------- --------------- 10.38 Primary Vendor Agreement dated May 8, 2001, between AmeriSource Corporation and HORIZON Pharmacies, Inc. (filed electronically herewith in redacted form pursuant to Rule 24b-2 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Filed separately in unredacted form subject to a request for confidential treatment pursuant to Rule 24b-2 under the Exchange Act.) (b) Reports on Form 8-K. During the three months ended March 31, 2001, the Company did not file any Current Reports on Form 8-K. -17- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused the report to be signed on its behalf by the undersigned, thereunto duly authorized. HORIZON Pharmacies, Inc., a Delaware corporation Date: May 21, 2001 /s/ Ricky D. McCord President, Chief Executive Officer Date: May 21, 2001 /s/ Michael F. Loy Chief Financial Officer -18-