10-Q 1 a10-q.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: JUNE 30, 2000 / / 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) 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 flied 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:

================================================================================ 1 FORM 10-Q TABLE OF CONTENTS PART I - FINANCIAL INFORMATION....................................................................................3 Financial Statements.....................................................................................3 Condensed Consolidated Balance Sheets....................................................................3 Condensed Consolidated Statements of Operations (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.............................................17 PART II. OTHER INFORMATION......................................................................................18 Exhibits and Reports On Form 8-K........................................................................18 SIGNATURES.......................................................................................................19

2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements. HORIZON Pharmacies, Inc. Condensed Consolidated Balance Sheets ASSETS

See accompanying notes. 4

See accompanying notes. 5

See accompanying notes. 6 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. ("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, 1999. The results of operations for the six months ended June 30, 2000, are not necessarily indicative of the results to be expected for the full year ending December 31, 2000. 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 and six months ended June 30, 1999 and 2000. NOTE 2 Weighted average common shares outstanding used in the calculation of basic earnings (loss) per share for the three month and six month periods ended June 30, 2000 totaled 5,948,774 and 5,917,421, respectively. Weighted average common shares outstanding for the three and six month periods in 1999 were 5,729,803 and 5,693,914, respectively. Common shares used in the calculation of diluted earnings per share for the three month and six month periods ended June 30, 2000 totaled 5,948,774 and 5,917,421, respectively. Common shares used for the calculation of fully diluted earnings per share for the three and six month periods in 1999 were 5,882,358 and 5,891,411, 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, and 81,763 shares and 80,985 shares for the three months and six months ended June 30, 2000, respectively. NOTE 3 No income taxes are provided due to the existence of net operating loss carry forwards. NOTE 4 At June 30, 2000, we operated 48 free-standing retail pharmacies, 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. The number of pharmacies acquired during the six months ended June 30, 1999 and 2000 were five and one, respectively. Proforma results of operations data giving effect to the acquisitions completed during the six month periods ended June 30, 1999 and 2000, as if the transactions had been consummated as of January 1, 1999, were not materially different from historical operating results. 7 NOTE 5 In March 2000, we signed an agreement with Informed.com, Inc. ("Informed.com") to sell to Informed.com a newly organized subsidiary d/b/a InformedScripts.com, Inc. ("InformedScripts.com") for $5,500 ($1,500 in cash and $4,000 in Informed.com's common stock). At the same time, we entered into a fulfillment and guaranty agreement with InformedScripts.com to be its exclusive fulfillment house for prescription drugs and OTC drug needs, and in exchange for the exclusive designation, we agreed to guarantee certain levels of gross sales and pretax profits of InformedScripts.com during the three-year term of the agreement. As additional consideration we issued warrants for the purchase of 700,000 shares of our common stock to Informed.com which have an estimated fair value of approximately $1,500 and which will be amortized over the term of the fulfillment and guaranty agreement. In lieu of receiving cash at closing, we accepted a short-term note subject to the completion of a private placement by Informed.com. Because InformedScripts.com failed to remit to us the required payments under the $1,500 note by August 15, 2000, we exercised our option to terminate the fulfillment and guaranty agreement. We have not reflected the above transaction in the accompanying financial statements because it is contingent on the collection of the $1,500 note. NOTE 6 The Company has a credit arrangement with its primary supplier which provides for borrowings up to $8,000 under a revolver and $3,000 under a term loan. Availability of the revolver is subject to a borrowing base determined by the supplier and amounted to $7,678 as of June 30, 2000. Borrowings outstanding at June 30, 2000 consist of $7,678 under the revolver and $3,000 under the term loan. The agreement requires the Company to maintain at least a specified amount of net worth and satisfy certain financial ratios. At June 30, 2000, the Company had not complied with several covenants of the credit agreement. These covenant violations have not been cured or waived, and the supplier has the right to demand payment of outstanding borrowings. Accordingly, amounts payable under the credit agreement are classified as current in the accompanying financial statements. If the violations are not waived or the compliance covenants are not revised, the Company may be required to liquidate additional stores or inventories in order to pay the debt. NOTE 7 The Company is dependent on existing credit agreements with lenders, including the largest supplier, and proceeds from potential debt and equity offerings in order to fund its operations and pay its obligations. As of June 30, 2000, the Company has working capital lines of credit with two lenders. These lines of credit are the primary sources of liquidity for the Company. As of June 30, 2000, the credit agreements provided for borrowings up to $17,678 including the Company's $7,000 bank credit facility which expires on September 1, 2000. As of June 30, 2000, the Company had no availability for additional borrowings under the lines and was in default on certain compliance covenants of the lines. Management's plan for the remainder of 2000 provides for the Company to improve its financial condition and operating results through the sale or closure of several underperforming pharmacies, increased selling prices, the reduction of receivables and inventories levels, reduction in store operating hours and labor costs and various debt and equity alternatives. As discussed above, the Company is in default on its working capital lines of credit. The Company believes that in the event that the lenders do not waive the defaults and renew or otherwise extend the credit facilities, it will be able to secure replacement financing at similar terms or otherwise retire the debt with sales 8 proceeds from the stores identified as held for disposal. In the event such sales proceeds are not sufficient or that alternative financing is not arranged, the Company may have to sell the assets of certain performing stores (which have previously received unsolicited purchase inquiries) to provide the additional funds to retire the debt. Such additional store sales would reduce future revenues and could have a material adverse effect on the financial position and results of operations of the Company. NOTE 8 During the fourth quarter of 1999, the Company identified several underperforming pharmacies with long-lived assets (primarily intangibles) carrying amounts of $1,001 and committed to a plan to sell them. Accordingly, the Company began marketing these pharmacies to potential buyers and sold several of these pharmacies during the six months ended June 30, 2000. The Company estimates the fair value (based primarily on bids received from potential buyers or previous sales proceeds) less costs to sell the pharmacies. During the six months ended June 30, 2000, the Company revised its estimates of fair values and recorded additional impairment of $64. As of June 30, 2000, the Company had identified one underperforming pharmacy whose operating results indicated that long-lived assets of this pharmacy might be impaired. The long-lived assets of this pharmacy had combined carrying amounts of $186. As a result of analyses performed, the Company determined that the pharmacy was impaired and recorded a $186 impairment loss. Management's estimate of undiscounted future cash flows indicates that the remaining carrying amounts as of December 31, 1999 are expected to be recovered. However, it is reasonably possible that the estimate of undiscounted cash flows may change in the near future resulting in the need to write-down one or more of the identified assets to fair value. NOTE 9 Under the 2000 stock option plan approved by stockholders in June 2000, options for up to 250,000 shares of common stock may be granted to employees and directors at prices as specified in the plan on the dates the options are granted. No options under the 2000 plan have been granted to date. NOTE 10 The Company and certain present and former officers or directors were named as defendants in an action that was filed seeking 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. The Company has contingent liabilities for other lawsuits and various other matters 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 and six months ended June 30, 2000 and compares those results to the comparable periods of 1999. 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 9 events and results may differ materially 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, with it being generally desired that one-third of the purchase price be seller-financed and the balance split between cash and other consideration, such as our Common Stock. In 1999, we made a strategic decision to enter the mail order and e-commerce business. In June 1999, we purchased a combination retail, mail order and Internet pharmacy operation, and in the fourth quarter of 1999 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 existing 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 six months ended June 30, 1999, we acquired five retail pharmacies. During the six months ended June 30, 2000, we acquired the prescription files and inventory of one pharmacy and consolidated them into an existing store, and we acquired an infusion pharmacy operation in Corpus Christi, Texas. 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 expect that continuing acquisitions and expansion of our e-commerce activities will be the most significant factors in our growth strategy. Currently, our primary source of revenue is the sale of prescription drugs. During the three months ended June 30, 1999 and 2000, sales of prescription drugs generated 75.5% and 76.2%, respectively, of net revenues; during the six month period ended June 30, 1999 and 2000, sales of prescription drugs generated 75.8% and 76.5%, 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. Our net revenues and operating results should be improved 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. Accordingly, revenues and profits should be highest in the fourth quarter and the first quarter of each year. However, we have been making investments in the future of our e-commerce operations over the past three quarters. Consequently, we experienced losses in the fourth quarter of 1999 and the first and second quarters of 2000, which were attributable, in part, to such investments and, in part, 10 to certain underperforming stores. We expect to incur additional losses in the near future while we continue to invest in our e-commerce operations and the building of an infrastructure necessary for our growth. We anticipate entering into strategic alliances with various e-commerce companies, as well as pursuing e-commerce strategies through existing retail centers, such as grocery stores. During the first quarter of 2000, we entered into a relationship with Informed.com, an e-commerce start-up that provides telemedicine services (e.g., counseling and virtual nursing). Informed.com will provide us their e-commerce expertise as we design and develop electronic kiosks to conduct e-commerce in retail centers. We agreed to guaranty certain levels of gross sales and pretax profits for Informed.com's subsidiary, InformedScripts.com, Inc., and to serve, in essence, as its exclusive wholesale supplier for its prescription drug and OTC drug orders; however, because of InformedScripts.com, Inc.'s failure to remit certain payments to us under the terms of a promissory note, we exercised our option to terminate the fulfillment and guaranty agreement. During the second quarter, we entered into a Cooperative Marketing Agreement with eGrocery.com, Inc. ("eGrocery.com") pursuant to which eGrocery.com will, among other things, link our web site to, and display promotional advertisements on, certain web sites operated and maintained by eGrocery.com. eGrocery.com will also endeavor to generate cooperative advertising dollars for us from general merchandise, trade funds and display allowances at the retail stores we own and manage. We will attempt to enter into additional alliances in 2000 in order to provide us increased visibility in cyberspace and access to high traffic retail centers for electronic kiosks. RESULTS OF OPERATIONS The following table sets forth the percentage relationship of certain income statement data for the periods indicated:

----------- (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. 11 NET REVENUES Our net revenues increased $4,070, or 12.9%, to $35,610 for the three months ended June 20, 2000, compared to $31,540 for the three months ended June 30, 1999. The increase was attributable to an increase in same store sales and an increase in store operating months from 148 in the second quarter of 1999 to 152 in the second quarter of 2000. Our net revenues increased $8,187, or 13.1%, to $70,712 for the six months ended June 30, 2000, compared to $62,525 for the six months ended June 30, 1999. The increase was primarily attributable to the increase in store operating months from 292 in the six months ended June 30, 1999 to 308 for the six months ended June 30, 2000. Sales of prescription drugs increased from 75.5% of total net revenues for the three months ended June 30, 1999 to 76.2% of total net revenues for the three months ended June 30, 2000. Sales of prescription drugs increased from 75.8% of total net revenues for the six months ended June 30, 1999 to 76.5% of total net revenues for the six months ended June 30, 2000. 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. Same store sales increased from $26,760 in the second quarter of 1999 to $28,031 in the second quarter of 2000, an increase of 4.7%. Same store sales for the six month period increased from $56,825 in 1999 to $58,941 in 2000, an increased of 3.7%. The following tables show our prescription drug gross margins and total revenues margins for the three months and six months ended June 30, 1999 and 2000:

The decrease in the gross margin on prescription drug sales from 1999 to 2000 was primarily due to a decrease in margin on third party insurance plans and an increase in the percentage of third party prescription drug sales, which have lower margins. COSTS AND EXPENSES Cost of sales increased $4,969, or 22.1%, from $22,444 in the three months ended June 30, 1999 to $27,413 in the three months ended June 30, 2000. For the six month period cost of sales increased $8,847, or 19.9%, from $44,359 in 1999 to $53,206 in 2000. This increase is primarily the result of increased sales volume resulting from the increased number of store operating months. Our cost of sales as a percentage of total net revenues increased 5.8% from 71.2% in the three months ended June 30, 1999 to 77.0% in the three months ended June 30, 2000. For the six month period cost of sales as a percentage of revenues increased 4.2% from 70.9% in 1999 to 75.2% in 2000. This increase in total cost of sales is primarily due to an increase in third party prescriptions. Selling, general and administrative expenses increased from $8,120 in the three months ended June 30, 1999 to $9,872 in the three months ended June 30, 2000. Such expenses, expressed as a percentage of net 12 revenues, were 25.7% and 27.7% for the three months ended June 30, 1999 and 2000, respectively. For the six month period selling, general and administrative expenses increased from $16,137 in 1999 to $19,634 in 2000. Such expenses, expressed as a percentage of total net revenue were 25.8% and 27.8% for the six months ended June 30, 1999 and 2000, respectively. This increase is primarily due to costs associated with the loading of inventory levels and reorder points in the new pharmacy systems (which were installed in the third and fourth quarters of 1999), the additional personnel added to monitor and manage the new pharmacy systems, the start-up costs of HorizonScripts.com and the costs associated with the sale of the four stores. Additionally, a portion of the increase is due to an increased store count and the resulting increased store operating months. Depreciation and amortization increased from $378, or 1.2% of total net revenues, for the three months ended June 30, 1999 to $566, or 1.6% of net revenues, for the three months ended June 30, 2000. For the six month period, depreciation increased from $717, or 1.1% of total net revenues, in 1999 to $1,064 or 1.5% of total net revenues of 1999. These increases were due primarily to our purchase of new stores. Interest expense was $410 in the second quarter of 1999 compared to $651 during the second quarter of 2000. For the six month period interest expense was $807 in 1999 compared to $1,307 in 2000. 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 $51 in the second quarter of 1999 compared to $2 in the second quarter of 2000. For the six month period interest and other income was $121 in 1999 compared to $19 in 2000. EARNINGS We had a net loss of $3,126 for the three months ended June 30, 2000 as compared to net income of $239 in the same period of 1999. We had a net loss of $4,730 for the six month period ended June 30, 2000 as compared to net income of $626 in the same period of 1999. We incurred no income tax expense in either period as a result of loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities increased $1,575 to $1,733 during the six months ended June 30, 2000 as compared to $158 for the six months ended June 30, 1999. The net loss was the primary reason for the increased usage of cash. Net cash used in investing activities was $1,694 for the six months ended June 30, 2000 as compared to $3,227 for the comparable period in 1999. Net cash provided by financing activities was $2,586 for the six months ended June 30, 2000 as compared to $43 in the six months ended June 30, 1999. Cash and cash equivalents decreased $841 to $422 during the six months ended June 30, 2000 as compared to $1,263 as of December 31, 1999. McKesson HBOC, Inc. ("McKesson") currently provides us with a $10,678 credit facility and provides a guaranty for a $7,000 revolving credit facility from Bank One, Texas, NA ("Bank One") due on September 1, 2000. Both the McKesson credit facility and the Bank One revolving credit facility are subject to certain restrictive covenants, including financial ratio requirements, which we must meet to maintain the credit facility and revolving line of credit. At June 30, 2000 we were in default of several of these covenants. These covenant violations have not been cured or waived, and the lenders have the right to demand payment of outstanding borrowings. At August 15, 2000, we had borrowed $10,678 under the credit facility and $7,000 under the revolving credit facility. 13 During February 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 stock) the prescription files and inventory of an infusion therapy operation in Corpus Christi, Texas. As a result of the loss we incurred in 1999, we readjusted the formula we use when analyzing possible acquisitions. Until we are able to raise additional capital or secure additional credit lines for acquisitions, we will seek acquisition opportunities that require less cash and rely more on 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 until January 1998 and the uncertainty of the current regulations, we do not plan to expand our home healthcare operations in 2000. We do expect, however, to offer home medical equipment through stores which have not heretofore offered such equipment. Our plan for 2000 is to improve our financial condition and operating results through the sale or closure of several underperforming pharmacies (four of which were sold in the second quarter of 2000), increase retail prices when possible, reduce our receivables, inventories levels, store operating hours and labor costs and analyze various debt and equity alternatives. In March 2000, the Company issued $2,500 in convertible debentures which netted the Company $2,175, which was used for working capital needs. As discussed above, the Company is in default on its working capital lines of credit. We believe that in the event the lenders do not waive the defaults and renew or otherwise extend the credit facilities, we will be able to secure 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 and results of operations of the Company. 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. We attempt to minimize the effect of higher operating costs by achieving operating efficiencies through the use of technology. FACTORS AFFECTING OPERATIONS DEPENDENCE ON ACQUISITIONS FOR GROWTH. Our growth strategy is two-fold. First, we will continue to seek to acquire, consolidate and operate existing free-standing pharmacies and related businesses on a profitable basis subject to the availability of capital. We continually review acquisition proposals and are currently engaged in discussions with third parties with respect to possible acquisitions. However, we compete for acquisition candidates with buyers who have greater financial and other resources than us and, consequently, may be able to pay higher acquisition prices. To the extent we are unable to acquire suitable retail pharmacies or to integrate such stores successfully into our operations, our ability to expand our business may be reduced significantly. Second, we are expanding our operations into, and attempting to redirect revenues through, e-commerce by entering into strategic alliances with e-commerce partners. We believe this e-commerce strategy will allow us to increase our customer and prescription bases as well as our revenues. 14 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 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 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, we sustained a substantial loss (as a result of the decline in gross margins in the fourth quarter 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 new pharmacy web site, HorizonScripts.com). We also incurred a loss in 1998 (as a result of the malfunction of our computerized pricing system which failed to receive and integrate average wholesale price updates that were electronically transmitted from our primary supplier). We cannot assure you that we will not experience similar problems to those encountered in 1998 and 1999 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. 15 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 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, 16 and 7 of our 48 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 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. NEED FOR ADDITIONAL CAPITAL We believe that a planned reduction in our inventory and accounts receivable levels, the sale of certain underperforming stores and 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 We currently purchase approximately 80% 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 16 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 McKesson 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 lines of credit was $17,678 at June 30, 2000. 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. 17 PART II. OTHER INFORMATION. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits

----------------------------------------------------- * Management contract or compensatory plan or arrangement (b) Reports on Form 8-K During the six months ended June 30, 2000, the Company filed the following Current Reports on Form 8-K: (1) Current Report on Form 8-K filed with the Commission on March 9, 2000. 18 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 18, 2000 /s/ Ricky D. Mccord ------------------------------------------ Ricky D. McCord President, Chief Executive Officer Date: August 18, 2000 /s/ John N. Stogner ------------------------------------------ John N. Stogner Chief Financial Officer 19 EXHIBIT LIST

HORIZON PHARMACIES INC 10-Q