<PAGE>
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: June 30, 1999
[ ] 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 Identification Number)
incorporation or organization)
501 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 August 12, 1999
Common stock, par value $.01 per share 5,878,307
1
<PAGE>
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I - FINANCIAL INFORMATION.............................................3
Financial Statements..............................................3
Condensed Consolidated Balance Sheets.............................3
Condensed Consolidated Statements of Income
(Unaudited)..............................................5
Condensed Consolidated Statements of Cash Flows
(Unaudited)..............................................6
Notes to Condensed Consolidated Financial Statements
(Unaudited)..............................................7
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................9
Quantitative and Qualitative Disclosures about Market Risks......18
PART II. OTHER INFORMATION................................................19
Exhibits and Reports On Form 8-K.................................19
SIGNATURES................................................................20
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
HORIZON PHARMACIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30
1998 1999
------------ -----------
(Audited) (Unaudited)
(In thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................ $ 6,617 $ 3,275
Accounts receivable, net:
Third-party providers................................................. 5,040 5,954
Others................................................................ 2,590 3,003
Refundable income taxes.................................................. 503 246
Inventories, at the lower of specific identification cost or market...... 18,084 21,925
Other.................................................................... 311 476
------------------------
Total current assets........................................................ 33,145 34,879
Debt issue costs, net of accumulated amortization........................... 69 131
Property, equipment and capital lease assets:
Property and equipment:
Land and buildings.................................................... 867 1,090
Equipment............................................................. 3,177 3,753
------------------------
Total............................................................... 4,044 4,843
Less accumulated depreciation............................................ 531 774
------------------------
Property and equipment, net.............................................. 3,513 4,069
Equipment under capital leases, net of accumulated amortization of
$184,975 in 1998 and $303,211 in 1999.................................... 530 896
------------------------
Total property, equipment and capital lease assets, net..................... 4,043 4,965
Intangibles, at cost:
Noncompete covenants and customer lists.................................. 1,981 2,638
Goodwill................................................................. 8,145 12,514
------------------------
10,126 15,152
Less accumulated amortization......................................... 736 1,084
------------------------
Intangibles, net............................................................ 9,390 14,068
------------------------
Total Assets.......................................................... $46,647 $54,043
------------------------
------------------------
</TABLE>
3
<PAGE>
HORIZON PHARMACIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30
1998 1999
------------ -----------
(Audited) (Unaudited)
(In thousands)
<S> <C> <C>
Current liabilities:
Accounts payable....................................................... $ 7,889 $ 8,990
Accrued liabilities ................................................... 1,438 1,455
Notes payable.......................................................... 109 -
Current portion of long-term debt...................................... 3,104 2,306
Current obligations under capital leases............................... 167 253
-------------------------
Total current liabilities................................................. 12,707 13,004
Long-term debt............................................................ 13,159 17,557
Obligations under capital leases.......................................... 353 597
Shareholders' equity:
Preferred stock, $.01 par value, authorized 1,000,000 shares,
none issued.......................................................... -- --
Common stock, $.01 par value, authorized 14,000,000 shares;
issued 5,623,743 shares in 1998 and 5,884,388 in 1999................ 56 59
Additional paid-in capital............................................. 22,343 24,171
Accumulated deficit.................................................... (1,901) (1,275)
-------------------------
20,498 22,955
Treasury Stock, at cost; 6,081 shares in 1998 and 1999................. 70 70
-------------------------
Total shareholders' equity................................................ 20,428 22,885
-------------------------
$46,647 $54,043
-------------------------
-------------------------
</TABLE>
See accompanying notes.
4
<PAGE>
HORIZON PHARMACIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------- -------------------------------------
1998 1999 1998 1999
---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA) (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues:
Prescription drugs sales............ $12,206 $23,798 $22,005 $47,413
Other sales and services............ 3,661 7,742 6,684 15,112
------------------------- ------------------------
Total net revenues..................... 15,867 31,540 28,689 62,525
Costs and expenses:
Cost of sales and services:
Prescription drugs............... 8,809 17,545 15,990 34,862
Other............................ 1,989 4,899 3,658 9,497
Depreciation and amortization....... 179 378 330 717
Selling, general and
administrative expenses............ 4,434 8,120 7,744 16,137
------------------------- ------------------------
Total costs and expenses............... 15,411 30,942 27,722 61,213
------------------------- ------------------------
Income from operations................. 456 598 967 1,312
Other income (expense):
Interest and other income........... 33 51 84 121
Interest expense.................... (133) (410) (237) (807)
------------------------- ------------------------
Total other income (expense)........... (100) (359) (153) (686)
------------------------- ------------------------
Income before provision
for income taxes...................... 356 239 814 626
Provision for income taxes
(Note 3).............................. 139 -- 322 --
------------------------- ------------------------
Net income ............................ $ 217 $ 239 $ 492 $ 626
------------------------- ------------------------
------------------------- ------------------------
Basic earnings per share (Note 2)...... $ .05 $ .04 $ .11 $ .11
------------------------- ------------------------
------------------------- ------------------------
Diluted earnings per share (Note 2).... $ .04 $ .04 $ .10 $ .11
------------------------- ------------------------
------------------------- ------------------------
</TABLE>
See accompanying notes.
5
<PAGE>
HORIZON PHARMACIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30,
SIX MONTHS ENDED
1998 1999
---- ----
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.......................................................................... $ 492 $ 626
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization of property, equipment
and capital lease assets...................................................... 177 362
Amortization of intangibles and other............................................ 153 355
Provision for uncollectible accounts receivable.................................. 35 41
Provision (credit) for deferred income taxes..................................... (25) --
Changes in operating assets and liabilities, net of acquisitions of
businesses:
Accounts receivable........................................................... (1,532) (988)
Refundable income taxes....................................................... -- 257
Inventories................................................................... (1,470) (1,727)
Other current assets.......................................................... (139) (202)
Accounts payable.............................................................. 336 1,101
Accrued liabilities........................................................... 65 17
Income taxes payable.......................................................... 109 --
------------------------
Total adjustments................................................................... (2,291) (784)
------------------------
Net cash used in operating activities............................................... (1,799) (158)
INVESTING
Purchase of land.................................................................... (80) --
Purchases of property and equipment................................................. (267) (684)
Assets acquired for cash in acquisitions of businesses.............................. (1,966) (2,543)
------------------------
Net cash used in investing activities............................................... (2,313) (3,227)
FINANCING ACTIVITIES
Borrowings.......................................................................... 650 1,178
Principal payments on debt.......................................................... (1,260) (1,298)
Principal payments on obligations under capital leases.............................. (48) (114)
Issuance of common stock, net of offering costs (852,939 shares in
1998 and 64,247 shares in 1999)................................................... 7,273 277
Purchase of treasury stock.......................................................... (70)
------------------------
Net cash provided by financing activities........................................... 6,545 43
------------------------
Net increase (decrease) in cash and cash equivalents................................ 2,433 (3,342)
Cash and cash equivalents at beginning of period.................................... 4,084 6,617
------------------------
Cash and cash equivalents at end of period.......................................... $ 6,517 $ 3,275
------------------------
------------------------
Supplemental disclosure of interest paid............................................ $ 237 $ 799
NONCASH INVESTING AND FINANCING ACTIVITIES
Equipment leased under capital leases............................................... $ 31 $ 445
Issuance of common stock to reduce long-term debt................................... 45 --
Issuance of common stock to purchase land........................................... 50 --
Reduction of income taxes payable from exercise of stock options.................... 50 --
Acquisitions of businesses financed by debt and common stock:
Accounts receivable and other.................................................... $ 67 $ 380
Inventories...................................................................... 2,133 2,114
Property and equipment........................................................... 743 225
Intangibles...................................................................... 2,661 4,989
------------------------
5,604 7,708
Less cash paid................................................................... (1,966) (2,543)
------------------------
Assets acquired.................................................................. $ 3,638 $ 5,165
------------------------
------------------------
Financed by:
Debt............................................................................. $ 2,956 $ 3,611
Common stock..................................................................... 682 1,554
------------------------
$ 3,638 $ 5,165
------------------------
------------------------
</TABLE>
See accompanying notes.
6
<PAGE>
HORIZON PHARMACIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 1
The unaudited condensed consolidated financial statements include
all adjustments, consisting of normal, recurring accruals, which HORIZON
Pharmacies, Inc. 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, 1998. The results of operations for the six months ended June
30, 1999, are not necessarily indicative of the results to be expected for
the full year ending December 31, 1999. HORIZON's revenues and earnings 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 and six months
ended June 30, 1998 and 1999.
NOTE 2
Weighted average common shares outstanding used in the calculation
of basic earnings per share for the three month and six month periods ended
June 30, 1999 totaled 5,729,803 and 5,693,914, respectively. Weighted average
common shares outstanding for the three and six month periods in 1998 were
4,681,154 and 4,586,865, respectively. Common shares used in the calculation
of diluted earnings per share for the three month and six month periods ended
June 30, 1999 totaled 5,882,358 and 5,891,411, respectively. Common shares
used for the calculation of fully diluted earnings per share for the three
and six month periods in 1998 were 4,968,993 and 4,859,802, respectively. The
differences between weighted average shares outstanding and fully diluted
shares outstanding is attributable to dilutive stock options and warrants.
Anti-dilutive employee stock options and warrants excluded amounted to
101,200 shares and 432,350 shares for the three months and six months ended
June 30, 1999, respectively.
NOTE 3
The provisions for income taxes included in the accompanying
statements of income for the three month and six month periods ended June 30,
1998 are based on an estimated effective tax rate of 40%. No income taxes are
provided for in three month and six month periods ended June 30, 1999 due to
the existence of a net operating loss carry forward resulting from losses in
the fourth quarter of 1998.
NOTE 4
At June 30, 1999, we operated 50 free-standing retail pharmacies,
all of which were acquired from third parties in purchase transactions. Such
acquisitions have each been structured as asset purchases and generally have
included inventories, store fixtures and the assumption of store operating
lease arrangements.
7
<PAGE>
The acquisitions generally have been financed by debt to the sellers and/or an
inventory supplier. A summary of acquisitions for the six months ended June 30,
1998 and 1999 follows:
<TABLE>
<CAPTION>
ASSETS ACQUIRED
ACCOUNTS
SIX MONTHS RECEIVABLE
ENDED STORES PURCHASE AND DEBT COMMON
JUNE 30 ACQUIRED PRICE INVENTORIES INTANGIBLES EQUIPMENT INCURRED STOCK ISSUED
- ------------ -------- -------- ----------- ----------- ---------- -------- ------------------
AMOUNT SHARES
------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998.......... 9 $5,604 $2,133 $2,661 $810 $2,956 $ 682 63,077
1999.......... 5 $7,708 $2,114 $4,989 $605 $3,611 $1,554 196,398
</TABLE>
The following unaudited pro forma results of operations data give
effect to the acquisitions completed during the six month periods ended June 30,
1998 and 1999 as if the transactions had been consummated as of January 1, 1998.
The unaudited pro forma results of operations data is presented for illustrative
purposes and is not necessarily indicative of the actual results that would have
occurred had the acquisitions been consummated as of January 1, 1998, or of
future results of operations. The data reflects adjustments for amortization of
intangibles resulting from the purchases, incremental interest expense resulting
from borrowings to fund the acquisitions, reductions in employee benefits and
rent expense and income taxes.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-----------------------------
1998 1999
---------- ----------
<S> <C> <C>
Unaudited pro forma information:
Net revenues................................ $64,842 $66,443
Net income.................................. 1,283 805
Basic earnings per share.................... .26 .14
Diluted earnings per share.................. .24 .13
</TABLE>
NOTE 5
Pursuant to an agreement with a lender and primary supplier in April
1999, the Company issued warrants to purchase, until April 2009, 201,500 shares
of common stock at $5.71 per share. The value of these warrants at the date of
issuance was not material.
In June 1999, options for 527,950 shares of common stock were granted
to directors and employees at an option price of $5.63 per share which
represented the market value of the Company's common stock at the date of grant.
These options are exercisable in three equal annual installments commencing in
June 2000 and expire in June 2009.
8
<PAGE>
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 and six months ended June 30, 1999 and compares those
results to the comparable periods of 1998. Certain statements contained in this
discussion are not based on historical facts, but 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 materially
differ from anticipated results described in such statements. Our ability to
achieve such 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
evaluating a retail pharmacy for potential acquisition, we (i) evaluate the
target store's profits and losses for preceding years; (ii) review the store's
income tax returns for preceding years; (iii) review computer-generated
prescription reports showing historical information including prescriptions
sold, average price of each prescription, gross margins and trends in
prescription sales; (iv) analyze the store's location and competition in the
immediate area; (v) review the store's lease agreement, if any; and (vi) assess
targeted areas for growth patterns and trends. Based on our analysis of the
foregoing items, we may prepare an offer to purchase the particular store. To
assess the reasonableness of the seller's asking price, we consider the
anticipated rate of return, payback period and the availability and terms of
seller financing, it being generally desired that one-third of the purchase
price be seller-financed with the balance split between cash and other
consideration such as our Common Stock.
During the six months ended June 30, 1998 and 1999, we acquired nine
and five retail pharmacies, respectively. 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 during the
relevant measuring period. We plan to continue making acquisitions as the most
significant factor in our growth strategy.
Currently, our primary source of revenue is the sale of prescription
drugs. During the three months ended June 30, 1998 and 1999, sales of
prescription drugs generated 76.9% and 75.5% respectively of net revenues;
during the six month period ended June 30, 1998 and 1999, sales of prescription
drugs generated 76.7% and 75.8% respectively. We expect our prescription drug
business 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. However, we anticipate that such sales will decrease as a percentage
of our overall net revenues and gross margins as we expand our home healthcare
and other non-pharmaceutical sales and services which have historically
generated higher margins.
9
<PAGE>
Our net revenues and profits are higher during peak 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. Accordingly, revenues and profits are typically highest
in the fourth quarter and the first quarter of the ensuing year.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain
income statement data for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA
NET REVENUES:
Prescription drugs sales............................ 76.9% 75.5% 76.7% 75.8%
Other sales and services............................ 23.1% 24.5% 23.3% 24.2%
------ ------ ------ ------
Total net revenues................................ 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ------
COSTS AND EXPENSES:
Cost of sales-prescription drugs(1)................. 72.2% 73.7% 72.7% 73.5%
Cost of sales-other(2).............................. 54.3% 63.3% 54.7% 62.8%
Selling, general and administrative expenses(3)..... 27.9% 25.7% 27.0% 25.8%
Depreciation and amortization(3).................... 1.1% 1.2% 1.1% 1.1%
Interest expense net(3)............................. .6% 1.1% .5% 1.1%
Income before provision for income taxes(3)......... 2.2% .8% 2.8% 1.0%
Net income (3)...................................... 1.4% .8% 1.7% 1.0%
</TABLE>
- -----------
(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.
Intangible assets, including but not limited to goodwill, pharmacy
files and non-compete covenants, have historically represented a substantial
portion of our acquisition costs. Such assets are amortized over a period of not
more than 40 years. Accordingly, the amortization of intangible assets is not
expected to have a significant effect on our future results of operations.
NET REVENUES
Our net revenues increased $15,673 or 99% to $31,540 for the three
months ended June 30, 1999 compared to $15,867 for the three months ended June
30, 1998. The increase was attributable primarily to the increase in store
operating months from 92 in the second quarter of 1998 to 148 in the second
quarter of 1999. Our net revenues increased $33,836 or 118% to $62,525 for the
six months ended June 30, 1999 compared to $28,689 for the six months ended June
30, 1998. The increase was primarily attributable to the
10
<PAGE>
increase in store operating months from 173 in the six months ended June 30,
1998 to 292 for the six months ended June 30, 1999.
Sales of prescription drugs decreased from 76.9% of total net revenues
for the three months ended June 30, 1998 to 75.5% of total net revenues for
three months ended June 30, 1999. Sales of prescription drugs decreased from
76.7% of total net revenues for the six months ended June 30, 1998 to 75.8% of
total net revenues for the six months ended June 30, 1999. We expect that
prescription drug sales will continue to decrease as a percentage of total
revenues as the Company expands its home healthcare and other non-pharmaceutical
sales and services whose gross margins exceed those of pharmaceutical sales.
Same store sales for our first 32 stores increased from $15,713 in the
second quarter of 1998 to $16,933 in the second quarter of 1999 an increase of
7.8%. Same store sales for the six month period increased from $28.271 in 1998
to $30.920 in 1999, an increase of 9.4%. Management believes that this increase
of 9.4% is primarily the result of increased advertising and promotions as well
as an enhanced product mix.
The following tables show our prescription drug gross margins and total
revenues margins for the three and six months ended June 30, 1998 and 1999;
<TABLE>
<CAPTION>
GROSS MARGINS ON GROSS MARGINS ON
PRESCRIPTION DRUG SALES TOTAL REVENUES
--------------------------- --------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Three Months Ended June 30,
1999................................. $ 6,253 26.3% $ 9,096 28.8%
1998................................. $ 3,697 27.8% $ 5,070 32.0%
Six Months Ended June 30,
1999................................. $12,551 26.6% $18,166 29.1%
1998................................. $ 6,015 27.3% $ 9,042 31.5%
</TABLE>
The decrease in the gross margin on prescription drug sales from 1998
to 1999 was primarily due to an increase in third party sales, which have lower
margins and the acquisition of new stores which historically have had margins
lower than our existing stores. The decrease in the gross margin on other sales
and services from 1998 to 1999 was primarily the result of a change in sales mix
and the acquisition of new stores which historically have had lower margins than
those of our existing stores.
COSTS AND EXPENSES
Cost of sales increased $11,646 or 108% from $10,798 in the three
months ended June 30, 1998 to $22,444 in the three months ended June 30, 1999.
For the six month period cost of sales increased $24,711 or 126% from $19,648 in
1998 to $44,359 in 1999. These increases are primarily the result of increased
sales volume resulting from the increased number of store operating months.
11
<PAGE>
Our cost of sales as a percentage of total net revenues increased 3.2%
from 68.0% in the three months ended June 30, 1998 to 71.2% in the three months
ended June 30, 1999. For the six month period cost of sales as a percentage of
revenues increased 2.4% from 68.5% in 1998 to 70.9% in 1999. This increase in
total cost of sales is primarily due to an increase in third party prescriptions
and from our acquisition of stores with lower gross margins than we have
historically reported.
Selling, general and administrative expenses increased from $4,434 in
the three months ended June 30, 1998 to $8,120 in the three months ended June
30, 1999. Such expenses, expressed as a percentage of net revenues, were 27.9%
and 25.7% for the three months ended June 30, 1998 and 1999, respectively. For
the six month period selling, general and administrative expenses increased from
$7,744 in 1998 to $16,137 in 1999. Such expenses, expressed as a percentage of
total net revenues were 27.0% and 25.8% for the six months ended June 30, 1998
and 1999, respectively. The amounts increased principally due to increased store
count and resulting increased store operating months. The decrease in selling,
general and administrative expenses as a percentage of total net revenues both
for the quarter and six months periods is a result of certain operating
efficiencies.
Depreciation and amortization increased to $378 or 1.2% of total net
revenues for the three months ended June 30, 1999 from $179 or 1.1% of net
revenues for the three months ended June 30, 1998. For the six month period
depreciation increased to $717 or 1.1% of total net revenues in 1999 from $330
or 1.2% of total net revenues in 1998. These increases were due primarily to our
purchase of new stores.
Interest expense was $133 in the second quarter of 1998 compared to
$410 during the second quarter of 1999. For the six month period interest
expense was $237 in 1998 compared to $807 in 1999. The increases in interest
expense for the three and six month periods resulted primarily from the increase
in debt associated with our acquisitions.
Interest and other income was $33 in the second quarter of 1998
compared to $51 in the second quarter of 1999. For the six month period interest
and other income was $84 in 1998 compared to $121 in 1999.
EARNINGS
Pretax income was $239 for the three months ended June 30, 1999 as
compared to $356 in the same period of 1998. Net income for the second quarter
of 1999 was $239 compared to $217 in 1998. Pretax income for the six months
ended June 30, 1999 was $626 as compared to $814 in the six months ended June
30, 1998. We incurred no income tax expense in 1999 as a result of a loss
carryforward from the fourth quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the six months ended June 30,
1999 was $158 as compared to net cash used of $1,799 for the six months ended
June 30, 1998. Increases in accounts receivable and inventories, which were
partially offset by an increase in accounts payable and net income, were the
primary reasons for the decreased usage of cash.
12
<PAGE>
Net cash used in investing activities was $3,227 and $2,313 for the six
months ended June 30, 1999 and 1998, respectively. The principal cause of this
difference was the lower number and cost of stores acquired by the Company
during the six months ended June 30, 1999 compared to 1998.
Net cash decreased $3,342 during the six months ended June 30, 1999
from $6,617 at December 31, 1998 to $3,275 at June 30, 1999.
Typically, cash provided by operations is adequate to supply working
capital and external sources are used mainly to finance new store acquisitions
and other capital expenditures. We believe that our working capital needs,
including growth in accounts receivable and inventory, will be funded by cash
flow from operations. New store acquisitions and other capital expenditures will
be funded by the McKesson credit facility and capital leases. McKesson currently
provides us with a $18,000 credit facility, subject to certain restrictive
covenants (including financial ratio requirements) which we must meet to
maintain the credit facility. At December 31, 1998 we were in default of several
of these covenants, but McKesson waived such defaults pursuant to an agreement
executed April 15, 1999. At June 30, 1999 we had borrowed $9,678 under this
credit facility. We believe that, based on our prior acquisitions, the average
acquisition cost per store will be approximately $750 to $1,000 plus inventory
based on such variables as store sales, margins and profits. We also believe
that we will be able to obtain seller financing for approximately 30% to 40% of
such acquisition.
During January 1999, we acquired four additional stores; however, as a
result of the loss incurred in 1998, we temporarily suspended acquisitions. We
resumed acquisition activity in the latter part of the second quarter and
completed one acquisition in June, 1999. During 1999 we expect to fund such
acquisitions with the existing credit facility, seller financing, cash flow from
operations, the issuance of a limited number of restricted shares of common
stock, and possibly another acquisition line of credit or equity offering.
Thereafter we expect to fund acquisitions with cash flow from current
operations, seller financing, and the public or private offering of certain
equity or long-term debt securities.
Because of the Federal moratorium on home healthcare licenses from
September 1997 to January 1998, and the uncertainty of the current regulations,
we do not plan to expand our home healthcare operations in 1999. We expect,
however, to offer home medical equipment through stores which have not
heretofore offered such equipment.
YEAR 2000
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of our
computer programs or hardware that have date-sensitive software or embedded
computer chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations which could
disrupt our normal business activities.
We have established a plan to prepare our systems for the Year 2000
issue and to reasonably assure that our critical business partners are prepared.
We have completed our assessment of all internal systems that could be
significantly affected by the Year 2000 issue and have determined that we will
be required to modify or replace portions of our software primarily related to
our accounting and pharmacy systems. We believe that with modifications or
replacements of the identified software programs, the Year 2000 issue can
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be mitigated. However, if all additional phases of the Year 2000 plan are not
completed timely, the Year 2000 issue could have a material impact on our
operations as discussed under "Risks and Contingency Plans." In addition, we are
in the process of gathering information about the Year 2000 compliance status of
our key third-party business partners.
STATUS
Our internal information technology exposures are primarily related to
four areas: (i) our financial accounting system; (ii) our management information
systems comprising primarily stand-alone PCs; (iii) our pharmacy system used in
connection with the dispensation of pharmaceuticals; and (iv) our point of sale
system for our automated cash registers. As of June 30, 1999, we had completed
upgrading our accounting and management information systems, and we expect to
complete software reprogramming and replacement for the pharmacy and point of
sale systems no later than November 30, 1999. Once the software is reprogrammed
or replaced with a Year 2000 compliant version, we will test and implement the
software. As of June 30, 1999, we had completed 75% of our testing and had
implemented 60% of our remediated applications. Completion of the testing phase
for all significant systems is expected by September 1999 with all remediated
systems fully tested and implemented by November 1999.
Our non-Information Technology systems consist primarily of
miscellaneous office equipment which is not material to our business. The
initial assessment of these systems has indicated that modification or
replacement will not be necessary as a result of the Year 2000 issue. As such,
we are not currently remediating this operating equipment. However, the
existence of embedded technology is by nature more difficult to identify. While
we believe that all significant non-Information Technology systems are Year 2000
compliant, we plan to continue testing our operating equipment and expect to
complete the testing by September 30, 1999.
SIGNIFICANT THIRD PARTIES
Our significant third-party business partners consist of our suppliers,
banks and third party insurance carriers. An initial inventory of significant
suppliers and banks has been completed and letters mailed requesting information
regarding each parties' Year 2000 compliance status. We intend to develop
contingency plans by September 30, 1999 for suppliers that appear to have
substantial Year 2000 operational risks which may include the change of
suppliers to minimize such risks. We will continue our efforts to raise
awareness and inform store managers of the risks posed by the Year 2000
throughout fiscal year 1999.
COSTS
Our Year 2000 plan encompasses the use of both internal and external
resources to identify, remediate, test, and implement systems for Year 2000
readiness. External resources include contract resources which will be used to
supplement available internal resources. The total cost of the Year 2000
project, excluding internal personnel costs, is estimated at $1,500 and is being
funded by operating cash flows and capital lease financing. As of June 30, 1999,
we had incurred expenses of $300 related to the Year 2000 project. Of the total
remaining project costs, approximately $1,000 is attributable to the purchase
and implementation of new hardware and software and will be capitalized. The
remaining $200 relates to remediation and testing of software and will be
expensed as incurred.
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RISKS AND CONTINGENCY PLANS
We believe we have an effective plan in place to resolve the Year 2000
issue in a timely manner. However, due to the forward-looking nature and lack of
historical experience with Year 2000 issues, it is difficult to predict with
certainty what will happen after December 31, 1999. Despite the Year 2000
remediation efforts being made, it is likely that there will be disruptions and
unexpected business problems during the early months of 2000. We plan to make
diligent efforts to assess the Year 2000 readiness of our significant business
partners and will develop contingency plans for critical areas where we believe
our exposure to Year 2000 risk is the greatest. However, despite our efforts, we
may encounter unanticipated third party failures, more general public
infrastructure failures or a failure to successfully conclude our remediation
efforts as planned. If the remaining Year 2000 plan is not completed timely, in
addition to the implications noted above, we may be required to utilize manual
processing of certain otherwise automated processes primarily related to partner
compensation and cash management. Any one of these unforeseen events could have
a material adverse impact on our results of operations, financial condition, or
cash flows in 1999 and beyond.
IMPACT OF INFLATION AND CHANGING PRICES
Inflation continues to cause increases in product, occupancy and
operating expenses, as well as the cost of acquiring capital assets. The effect
of higher operating costs is minimized by achieving operating efficiencies.
FACTORS AFFECTING OPERATIONS
DEPENDENCE ON ACQUISITIONS FOR GROWTH. Our growth strategy depends upon
our ability to continue to acquire, consolidate and operate existing
free-standing pharmacies and related businesses on a profitable basis. We
continually review acquisition proposals and are currently engaged in
discussions with third parties with respect to possible acquisitions. We compete
for acquisition candidates with buyers who have greater financial and other
resources and may be able to pay higher acquisition prices than we are able to
pay. To the extent we are unable to acquire suitable retail pharmacies, or to
successfully integrate such stores into our operations, our ability to expand
our business will be reduced significantly.
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.
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RELIANCE ON MEDICARE AND MEDICAID REIMBURSEMENTS
Substantially all of our home healthcare revenues are attributable to
third-party payors, including Medicare and Medicaid, private 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 we
will be able to manage our expanding operations effectively or maintain or
accelerate our growth. Although we experienced growth in net sales in 1998 and
1999, and increased profits in 1998 and 1999, we sustained a substantial loss in
the fourth quarter of 1998 as a result of the malfunction of our computerized
pricing system which failed to receive and/or integrate average wholesale price
updates electronically transmitted from our primary supplier. While such
malfunction has been corrected, there can be no assurance we will not experience
other such problems 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 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 we believe we have adequate
professional and medical malpractice liability insurance coverage, there can be
no assurance that we will not
16
<PAGE>
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 other larger providers of home healthcare services including chain
operations and independent single unit stores which are more established in that
market and which offer more extensive home healthcare services than we offer.
Most of our competitors have financial resources that are substantially greater
than ours, and we cannot assure that we will be able to continue to successfully
compete with such competitors.
GEOGRAPHIC CONCENTRATION
Currently, 19 and 7 of our 50 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.
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. If we are unable to generate sufficient earnings and cash flow to
service such 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 such debt, there can be no assurance that we will be able to effect such
refinancing on satisfactory terms.
POSSIBLE NEED FOR ADDITIONAL CAPITAL
We believe the proceeds from operating revenues and the McKesson credit
facility will be adequate to satisfy our working capital requirements for the
next 12 months, although circumstances, including the acquisition of additional
stores, may require that we obtain additional long or short-term financing or
sell additional equity to realize certain business opportunities. No assurance
can be made that we will be able to obtain such financing.
RELIANCE ON SINGLE SUPPLIER
We currently purchase approximately 70% of our inventory from McKesson,
which also provides us with order entry machines, shelf labels and other
supplies. 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
17
<PAGE>
manufacturers. Although we believe we could obtain our inventory through another
distributor at competitive prices and upon competitive payment terms if our
relationship with McKesson was 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 line of
credit. The balance outstanding under the line of credit was $9,678 at June 30,
1999. The impact on our results of operations of a one-point interest rate
change on balances outstanding under the line of credit would be immaterial.
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.
18
<PAGE>
PART II. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO. NAME OF EXHIBIT
----------- ---------------
<S> <C>
3.1. Articles of Incorporation of HORIZON Pharmacies,
Inc., incorporated by reference to Exhibit 3.1 of
our Quarterly report on Form 10-QSB filed on
August 14, 1998.
3.2. Bylaws of HORIZON Pharmacies, Inc., incorporated
by reference to Exhibit 3.2 of our Quarterly
Report on Form 10-QSB filed on August 14, 1998.
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
During the three months ended June 30, 1999, the Company filed no
Current Reports on Form 8-K.
19
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Company
caused the report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HORIZON Pharmacies, Inc.,
a Delaware corporation
Date: August 16, 1999 /S/ Ricky D. McCord
----------------------------------
Ricky D. McCord
President, Chief Executive Officer
Date: August 16, 1999 /S/ John N. Stogner
----------------------------------
John N. Stogner
Chief Financial Officer
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,275
<SECURITIES> 0
<RECEIVABLES> 9,174
<ALLOWANCES> 217
<INVENTORY> 21,925
<CURRENT-ASSETS> 34,879
<PP&E> 4,843
<DEPRECIATION> 774
<TOTAL-ASSETS> 54,043
<CURRENT-LIABILITIES> 13,004
<BONDS> 18,154
0
0
<COMMON> 59
<OTHER-SE> 22,826
<TOTAL-LIABILITY-AND-EQUITY> 54,043
<SALES> 62,525
<TOTAL-REVENUES> 62,525
<CGS> 44,359
<TOTAL-COSTS> 61,213
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 807
<INCOME-PRETAX> 626
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