UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL QUARTER ENDED MARCH 31, 1994
Commission Registrant, State of Incorporation IRS Employer
File Number Address and Telephone Number Identification No.
- ------------- ---------------------------------- ------------------
0-13813 Alco Health Services Corporation 23-2353106
(a Delaware Corporation)
P.O. Box 959, Valley Forge,
Pennsylvania 19482
(215) 296-4480
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 preceding 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
--- ---
The number of shares of common stock of Alco Health Services Corporation
outstanding as of March 31, 1994 was 1,000.
INDEX
ALCO HEALTH SERVICES CORPORATION
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements (Unaudited)
Consolidated balance sheets -- March 31, 1994 and
September 30, 1993
Consolidated statements of operations -- Three months
ended March 31, 1994 and March 31, 1993
Consolidated statements of operations -- Six months
ended March 31, 1994 and March 31, 1993
Consolidated statements of cash flows -- Six months
ended March 31, 1994 and March 31, 1993
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Alco Health Services Corporation Financial Statements (Unaudited)
-----------------------------------------------------
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------
(dollars in thousands)
March 31 September 30
ASSETS 1994 1993
- ------ -------------- ------------
Current Assets
Cash $ 27,695 $ 27,098
Accounts receivable less
allowance for doubtful
accounts: 3/94 - $8,752
9/93 - $7,681 267,472 251,999
Merchandise inventories 356,775 346,371
Prepaid expenses 2,120 1,977
--------------- --------
Total current assets 654,062 627,445
Property and Equipment, at cost 65,804 57,282
Less accumulated depreciation 24,626 21,176
--------------- --------
41,178 36,106
Other Assets
Excess of cost over net assets
acquired, less accumulated
amortization: 3/94 - $27,714
9/93 - $25,053 181,149 183,810
Deferred financing costs and other,
less accumulated amortization:
3/94 - $5,271; 9/93 - $3,703 12,483 15,453
--------------- --------
193,632 199,263
--------------- --------
$ 888,872 $862,814
=============== ========
See notes to consolidated financial statements.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------
(dollars in thousands)
March 31 September 30
LIABILITIES AND STOCKHOLDER'S EQUITY 1994 1993
- ------------------------------------ ---------- -------------
Current Liabilities
Current portion of other debt $ 126 $ 122
Accounts payable 382,790 379,826
Accrued expenses 20,127 24,507
Accrued income taxes 13,456 7,899
Deferred income taxes 31,650
-------- --------
Total current liabilities 448,149 412,354
Long-Term Debt
Revolving credit facility 266,910 248,000
Senior subordinated notes 166,134 170,562
Other debt 1,304 1,311
Convertible subordinated debentures 238 238
-------- --------
434,586 420,111
Other Liabilities
Deferred compensation 511 701
Other 4,145 740
-------- --------
4,656 1,441
Stockholder's Equity
Common stock, $.01 par value:
1,000 shares authorized and issued 1 1
Capital in excess of par value 78,050 78,050
Retained earnings (deficit) (76,570) (49,143)
-------- --------
1,481 28,908
-------- --------
$888,872 $862,814
======== ========
See notes to consolidated financial statements.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------------------
(dollars in thousands)
Three Months Ended
March 31
----------------------
1994 1993
---------- ----------
Revenues $1,067,112 $920,195
Costs and expenses
Cost of goods sold 1,008,632 866,810
Selling and administrative 36,033 33,722
Depreciation 1,489 1,336
Interest 13,048 12,080
Non-recurring charges 821
---------- --------
1,059,202 914,769
---------- --------
Income before taxes and extraordinary
items 7,910 5,426
Taxes on income 3,472 2,700
---------- --------
Income before extraordinary items 4,438 2,726
Extraordinary charge - write-off
of deferred financing fees, net
of income tax benefit (2,635)
---------- --------
Net income $ 4,438 $ 91
========== ========
See notes to consolidated financial statements.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------------------
(dollars in thousands)
Six Months Ended
March 31
-----------------------
1994 1993
---------- ----------
Revenues $2,112,888 $1,837,876
Costs and expenses
Cost of goods sold 2,000,409 1,733,113
Selling and administrative 70,419 67,450
Depreciation 3,078 2,760
Interest 24,615 24,076
Non-recurring charges 1,982
---------- ----------
2,098,521 1,829,381
Income before taxes, extraordinary items
and cumulative effects of accounting
changes 14,367 8,495
Taxes on income 6,307 4,800
---------- ----------
Income before extraordinary items and
cumulative effects of accounting
changes 8,060 3,695
Extraordinary charge - early retirement
of debt, net of income tax benefit (442)
Extraordinary charge - write-off of
deferred financing fees, net of income
tax benefit (2,635)
Cumulative effect of change in accounting
for postretirement benefits other than
pensions (1,199)
Cumulative effect of change in accounting
for income taxes (33,846)
---------- ----------
Net income (loss) $ (27,427) $ 1,060
========== ==========
See notes to consolidated financial statements.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------
(dollars in thousands)
Six Months Ended
March 31
------------------------
1994 1993
---------- ----------
OPERATING ACTIVITIES
Net income (loss) $ (27,427) $ 1,060
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating
activities:
Depreciation 3,078 2,760
Amortization 4,856 4,823
Provision for losses on accounts receivable 1,617 1,778
Loss on disposal of property and equipment 185 2,010
Loss on early retirement of debt 679
Write-off of deferred financing fees 3,285
Cumulative effects of changes in accounting
principles 35,045
Changes in operating assets and liabilities:
Accounts receivable (17,090) (7,472)
Merchandise inventories (10,404) 38,932
Prepaid expenses (143) (235)
Accounts payable, accrued expenses and
income taxes 1,703 29,253
Miscellaneous (812) (96)
---------- ----------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (8,713) 76,098
INVESTING ACTIVITIES
Capital expenditures (4,597) (2,863)
Proceeds from sales of property and equipment 119 1,003
---------- ----------
NET CASH (USED IN)
INVESTING ACTIVITIES (4,478) (1,860)
FINANCING ACTIVITIES
Long-term debt borrowings 460,195 673,024
Long-term debt repayments (446,315) (733,570)
Deferred financing costs (92) (8,178)
---------- ----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 13,788 (68,724)
---------- ----------
Increase in cash 597 5,514
Cash at beginning of period 27,098 13,768
---------- ----------
CASH AT END OF PERIOD $ 27,695 $ 19,282
========== ==========
See notes to consolidated financial statements.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 - Basis of Presentation
The accompanying financial statements present the consolidated financial
position, results of operations and cash flows of Alco Health Services
Corporation ("Alco" or the "Company"). All material intercompany accounts and
transactions of Alco have been eliminated in consolidation. Alco is a wholly-
owned subsidiary of Alco Health Distribution Corporation ("Distribution").
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary to present
fairly the financial position as of March 31, 1994, the results of operations
for the three and six months ended March 31, 1994 and 1993 and the cash flows
for the six months ended March 31, 1994 and 1993 have been included. Earnings
(loss) per share are not presented, as all of Alco's issued and outstanding
common stock is owned by Distribution. Certain information and footnote
disclosures normally included in financial statements presented in accordance
with generally accepted accounting principles, but which are not required for
interim reporting purposes, have been omitted. The accompanying unaudited
condensed consolidated financial statements should be read in conjunction with
the financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended September 30, 1993.
Note 2 - Excess of Cost Over Net Assets Acquired
The excess of cost over net assets acquired ("goodwill") was recorded at the
time of the Acquisition in 1988. Since the Acquisition, the Company has been
unable to achieve the operating results projected at the time of the
Acquisition. The projections at the time of the Acquisition assumed
significant growth rates in revenues, stable gross profit margins and cash
flow from operations to reduce Acquisition indebtedness. Due to persistent
competitive pressures and a shift in the customer mix to larger volume, lower
margin customers, gross profit margins have declined from 7.10% in fiscal 1989
to 5.63% in fiscal 1993 and 5.32% for the six months ended March 31, 1994,
resulting in higher than expected losses and an increase in the Company's
indebtedness. During this period, the Company has been affected by price
competition for market share withn the industry, health care industry
consolidation and the impact of group purchasing organizations, managed care
and health care reform on drug prices. As a result of the potential negative
impact of these factors on the ability to recover the recorded goodwill value
over its remaining estimated life and the recent increase in interest rates,
the Company
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 2 - Excess of Cost Over Net Assets Acquired (continued)
initiated a detailed evaluation of the carrying value of goodwill. The Company
is currently evaluating whether the carrying value of goodwill can be recovered
through future earnings. Although the Company currently cannot predict the
outcome of this evaluation, a determination could be made that, based on the
trends noted above, future earnings may not be sufficient to support the
recoverability of goodwill. Such a determination would require that all or a
portion of the carrying value of goodwill be written-off.
Note 3 - Long-Term Debt
In October, 1993, the Company redeemed an aggregate principal amount of
$4,428,000 of senior subordinated notes. The extraordinary charge of $442,000
from the early retirement of this debt relates to the write-off of unamortized
financing fees and premiums paid on redemption, net of a tax benefit.
The Company recently completed an exchange of $40,329,000 principal amount of 14
1/2% Senior Subordinated Notes due 1999, Series A (the "New Notes") and $101,000
in cash for $40,329,000 principal amount of its 14 1/2% Senior Subordinated
Notes due 1999 (the "Existing Notes"). The only material difference between the
terms of the New Notes and the terms of the Existing Notes is that the indenture
of the New Notes does not have the minimum consolidated net worth provisions set
forth in the indenture of the Existing Notes. The indenture of the Existing
Notes requires the Company to maintain a consolidated net worth (as defined) of
$80 million. If the Company's consolidated net worth, as defined in the
indenture of the Existing Notes, is less than $80 million at the end of each of
any two consecutive fiscal quarters, the Company is required to offer to
purchase (the "Offer") an amount of Existing Notes equal to 20% of the principal
amount of Existing Notes outstanding at the time the Offer is made. The
purchase price in any Offer is equal to 100% of the principal amount purchased
plus accrued interest to the date of purchase. The Offer required could be
triggered if the Company generated losses from operations, had charges or
expenses relating to a restructuring or recapitalization, or reductions in the
book value of tangible or intangible assets, if in each case the losses or
charges are of a sufficient magnitude. As a result of the elimination of the
minimum consolidated net worth provision in the indenture of the New Notes, the
Company would not be required to make an Offer to holders of the New Notes, even
in the event of a material decrease in the Company's consolidated net worth. In
addition to the exchange noted above, the Company paid the holders of an
aggregate of $125,388,000 in principal amount of Existing Notes cash
consideration of $523,000 in exchange for each holder's agreement not to tender
any of the Existing Notes as a result of any required Company Offer or to
exercise any rights they have or may have with respect to the consolidated net
worth provision of the indenture of the Existing Notes. The total cash
consideration of $624,000 noted above as well as related fees and expenses of
$600,000 were recognized as interest expense during the three months ended March
31, 1994.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 4 - Postretirement Benefits
As a result of special termination benefit packages previously offered, the
Company provides medical, dental and life insurance benefits to certain retirees
and their dependents. These benefit plans are unfunded. Prior to October 1,
1993, the Company recognized the expenses for these plans on the cash basis.
Effective October 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 106 "Employers' Accounting for Postretirement Benefits Other Than
Pensions" (Statement 106), which requires that the cost of postretirement health
care benefits be recognized on the accrual basis as employees render service to
earn the benefit instead of on the cash basis when the benefits are paid. As of
October 1, 1993, the Company adopted Statement 106 by recognizing the
accumulated obligation related to these benefits. The cumulative effect of this
change in accounting principle resulted in a non-cash charge to net income of
$1.2 million. The application of the new rules will not result in an increase
in fiscal 1994 postretirement benefit cost, which will be approximately
$150,000. The weighted average discount rate used in determining the
accumulated postretirement benefit obligation was 7.25%. A health care cost
trend rate of 13% was assumed for fiscal 1994, gradually declining to an
ultimate level of 5.50% over 15 years. A 1% increase in the health care cost
trend rate would increase the accumulated postretirement benefit obligation as
of October 1, 1993 by $77,500.
Note 5 - Taxes on Income
Effective October 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (Statement 109), which requires
a change in the method of accounting for income taxes from the deferred method
to the liability method. In accordance with Statement 109, the Company recorded
an adjustment of $33.8 million for the cumulative effect of adopting Statement
109 as of October 1, 1993. As permitted under Statement 109, prior period
financial statements have not been restated. The cumulative effect adjustment
relates principally to the provision of deferred income taxes to reflect the tax
consequences on future years of the difference between the tax and financial
reporting basis of merchandise inventories. Significant components of the
Company's deferred tax liabilities (assets) as of October 1, 1993 are as follows
(in thousands):
Inventory $ 35,748
Fixed assets 4,996
Other 376
--------
Gross deferred tax liabilities 41,120
--------
Net operating losses and tax credit carryovers (5,646)
Allowance for doubtful accounts (3,072)
Accrued expenses (2,488)
Other postretirement benefits (480)
Other (1,064)
--------
Gross deferred tax assets (12,750)
--------
Valuation allowance for deferred tax assets 5,452
--------
Net deferred tax liabilities $ 33,822
========
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 6 - Legal Matters and Contingencies
In the ordinary course of its business, the Company becomes involved in
lawsuits, administrative proceedings and governmental investigations, including
antitrust, environmental and Drug Enforcement Administration matters. In some
of these proceedings, plaintiffs may seek to recover large and sometimes
unspecified amounts and the matters may remain unresolved for several years.
The Company does not believe that these matters, individually or in the
aggregate, will have a material adverse effect on its business or financial
condition.
In November 1993, the Company was named a defendant, along with six other
wholesale distributors and twenty-four pharmaceutical manufacturers, in fourteen
civil actions filed in the United States District Court for the Southern
District of New York by several independent retail pharmacies. Plaintiffs seek
to establish these lawsuits and over thirty-four others (to which the Company is
not a party) filed by other pharmacies as a class action. In essence, these
lawsuits all claim that the manufacturer and wholesaler defendants have
combined, contracted and conspired to fix the prices charged to plaintiffs and
class members for prescription brand name pharmaceuticals. Specifically,
plaintiffs claim that the defendants used "chargeback agreements" to give some
institutional pharmacies discounts that are not made available to retail drug
stores. Plaintiffs seek injunctive relief, treble damages, attorneys' fees and
costs. These actions were recently transferred to the United States District
Court for the Northern District of Illinois for consolidated and coordinated
proceedings. The Company believes it has meritorious defenses to the claims
asserted in these lawsuits and intends to vigorously defend itself in all of
these cases.
The Company has become aware that its former Charleston, South Carolina
distribution center, was previously owned by a fertilizer manufacturer and that
there is evidence of residual soil contamination remaining from the fertilizer
manufacturing process operated on that site over thirty years ago. The Company
engaged an environmental consulting firm to conduct a soil survey and expects to
initiate a groundwater study during fiscal year 1994. At the present time, it
is not possible to ascertain the cost, if any, of remediation or whether the
Company will be able to obtain reimbursement for such costs from any third party
that caused the contamination or any insurance carrier. Accordingly, the
Company has not recorded any provision for this matter.
Alco has been named as a defendant in several lawsuits based upon alleged
injuries and deaths attributable to the product L-Tryptophan. Alco did not
manufacture L-Tryptophan; however, prior to an FDA recall, Alco did distribute
the L-Tryptophan products of several of its vendors. Alco believes that it is
entitled to full indemnification by its suppliers and the manufacturer of L-
Tryptophan with respect to these lawsuits and any other lawsuits involving L-
Tryptophan in which Alco may be named in the future. To date, the indemnity to
Alco in such suits has not been in dispute and, although the Company believes it
is unlikely it will incur any loss as a result of such lawsuits, the Company
believes that its insurance coverage and supplier endorsements are adequate to
cover any losses should they occur.
ALCO HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 6 - Legal Matters and Contingencies (continued)
At March 31, 1994, there were contingent liabilities with respect to taxes,
guarantees of borrowings by certain customers, lawsuits and environmental and
other matters occurring in the ordinary course of business. On the basis of
information furnished by counsel and others, management believes that none of
these contingencies will materially affect the Company.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Results of Operations
---------------------
3 Months 3 Months 6 Months 6 Months
Ended Ended Ended Ended
March 31, March 31, March 31, March 31,
1994 1993 1994 1993
---------- ---------- ----------- -----------
Revenues $1,067,112 $920,195 $2,112,888 $1,837,876
Cost of goods sold 1,008,632 866,810 2,000,409 1,733,113
---------- -------- ---------- ----------
Gross profit 58,480 53,385 112,479 104,763
Operating expenses:
Selling and administrative 34,668 32,354 67,678 64,715
Depreciation 1,489 1,336 3,078 2,760
Amortization of intangibles 1,365 1,368 2,741 2,735
---------- -------- ---------- ----------
Operating income 20,958 18,327 38,982 34,553
Interest expense - in cash 11,691 11,036 22,500 21,988
Amortization of deferred
financing costs 1,357 1,044 2,115 2,088
Non-recurring charges 821 1,982
---------- -------- ---------- ----------
Income before taxes,
extraordinary items and
cumulative effects of
accounting changes 7,910 5,426 14,367 8,495
Taxes on income 3,472 2,700 6,307 4,800
---------- -------- ---------- ----------
Income before extraordinary
items and cumulative
effects of accounting
changes 4,438 2,726 8,060 3,695
Extraordinary charge - early
retirement of debt, net
of income tax benefit (442)
Extraordinary charge -
write-off of deferred
financing fees, net of
income tax benefit (2,635) (2,635)
Cumulative effect of change
in accounting for
postretirement benefits
other than pensions (1,199)
Cumulative effect of change
in accounting for income
taxes (33,846)
---------- -------- ---------- ----------
Net income (loss) $ 4,438 $ 91 $ (27,427) $ 1,060
========== ======== ========== ==========
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
(Continued)
Revenues in the second quarter of fiscal 1994 increased 16% to $1.1 billion from
$920 million in fiscal 1993. For the six months ended March 31, 1994, revenues
were $2.1 billion, an increase of 15% over the $1.8 billion reported for the six
months ended March 31, 1993, reflecting real volume growth as well as the pass
through to customers of price increases from manufacturers. Price increases
accounted for approximately one-seventh of the 15% revenue growth. The most
significant part of the revenue increase for the six months ended March 31, 1994
was attributable to the hospital customer group, where revenues were 29% ahead
of the comparable period of the prior year. Excluding brokerage business, sales
to the chain drug store customer group increased 10%, while sales to independent
drug store customers declined slightly during the six months ended March 31,
1994 as compared with the prior year. During the six months ended March 31,
1994, sales to hospitals accounted for 45% of total revenues, while sales to
independent drug stores represented 34% and sales to chain drug stores, 21% of
the total.
As a percentage of revenues, the gross profit margin for the second quarter was
5.48% as compared to 5.80% in the prior year. For the six months ended March
31, 1994, the gross profit margin percentage was 5.32% versus 5.70% in 1993.
The declines in the gross profit margin percentages reflect continuing industry
price competition and increased sales to larger volume, lower margin customers,
such as hospitals.
Selling and administrative expenses for the second quarter of fiscal 1994 were
$34.7 million compared to $32.4 million for the second quarter of fiscal 1993,
an increase of 7.2%. For the first six months of fiscal 1994, selling and
administrative expenses were $67.7 million, an increase of 4.6% over the prior
year. The cost increases reflect inflationary increases and increases in
warehouse and delivery expenses which are variable with the level of sales
volume. As a percentage to revenues, selling and administrative expenses
improved to 3.2% in the six months ended March 31, 1994 from 3.5% in the 1993
period. The decrease in the ratio of expenses to revenues reflects the
Company's ongoing efforts to control costs in response to the decline in the
gross profit margin as a percentage of revenues and the economies associated
with increased business with larger volume, lower cost to service customers.
As a result of the above, operating income increased 14.4% to $21.0 million for
the second quarter of fiscal 1994 versus the comparable prior year period. For
the six months ended March 31, 1994, operating income increased 12.8% to $39.0
million in comparison to the prior year. Operating income as a percentage of
revenues was 1.84% for the six months ended March 31, 1994 versus 1.88% in 1993.
The increase in interest expense in the second quarter of fiscal 1994 in
comparison to the second quarter of fiscal 1993 was as a result of higher
interest rates offset in part by lower borrowing levels under the Company's
revolving credit facility. Interest in the second quarter of fiscal 1994
includes $624,000 in consideration payable to the holders of an aggregate of
$165.7 million in principal amount of senior subordinated notes (see Note 2 of
"Notes to Consolidated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
(Continued)
Financial Statements"). Interest expense in the second quarter and for the six
months ended March 31, 1994 reflects reductions as a result of the purchase and
retirement of an aggregate principal amount of $8.9 million on senior
subordinated notes, which occurred during the fourth quarter of fiscal 1993 and
first quarter of fiscal 1994. During the six-month period ended March 31, 1994,
the average outstanding debt level was $458 million at an average interest rate
of 9.5%. During the six-month period ended March 31, 1993, the comparable
average outstanding debt level was $483 million at an average interest rate of
9.1%. Interest expense in 1994 and 1993 includes $2.1 million in amortization
of financing fees.
As noted below, the Company changed its method of accounting for income taxes
effective October 1, 1993. Income taxes for the three and six month periods
ended March 31, 1994, were computed on a regular tax basis and based on an
estimate of the full year effective tax rate. The extraordinary charge of
$679,000, net of a tax benefit of $237,000, relates to the purchase and
retirement of an aggregate principal amount of $4.4 million of senior
subordinated notes.
Effective October 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 106 "Employers' Accounting for Postretirement Benefits Other Than
Pensions" (Statement 106) and Statement of Financial Accounting Standards No.
109 "Accounting for Income Taxes" (Statement 109). The Company recorded, as of
October 1, 1993, a total of $35.0 million in non-cash charges to net income for
the effects of transition to these two new standards. Statement 106 requires
that the expected cost of providing postretirement medical benefits be accrued
during employees' working years rather than on a pay-as-you-go basis as was
previously permitted. The cumulative effect of this change in accounting
principle resulted in a non-cash charge to net income of $1.2 million as of
October 1, 1993. Statement 109 requires a change in the method of accounting
for income taxes from the deferred method to the liability method. Under the
liability method, deferred taxes result from differences between the tax and
financial reporting bases of assets and liabilities and are adjusted for changes
in tax rates and tax laws when changes are enacted. The cumulative effect of
this change in accounting principle resulted in a non-cash charge to net income
of $33.8 million as of October 1, 1993, principally related to the provision of
deferred income taxes to reflect the tax consequences on future years of the
difference between the tax and financial reporting basis of merchandise
inventories.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
(Continued)
Liquidity and Capital Resources
Historically, the Company's operating results have generated sufficient cash
flows which, together with borrowings under the revolving credit facility and
credit terms from suppliers, have provided sufficient capital resources to
finance working capital and cash operating requirements, fund capital
expenditures and interest currently payable on outstanding debt. Future cash
flows are expected to be sufficient to fund capital expenditures and interest
currently payable over the near term.
During the six-month period ended March 31, 1994, the Company's operating
activities used $8.7 million in cash. Accounts receivable and merchandise
inventories increased during the period by $17.1 million and $10.4 million,
respectively, offset by an increase of $3.0 million in accounts payable. The
increases in accounts receivable and merchandise inventories are commensurate
with the Company's revenue growth. A portion of the increase in merchandise
inventories was the result of the opening of the Dallas, Texas distribution
facility, which occurred in the first quarter of fiscal 1994. The decrease of
$4.4 million in accrued expenses was primarily the result of the timing of
interest payments due on LIBOR contracts maturing under the revolving credit
facility. Operating cash uses during the six-month period ended March 31, 1994
included $24.2 million in interest payments and $2.4 million in income tax
payments.
Capital expenditures for the six months ended March 31, 1994 were $4.6 million
and relate principally to improvements in warehouse distribution and management
information systems. Capital expenditures for the fiscal year ended September
30, 1994 are projected to approximate $8.0 million. Cash used in investing
activities during the six months ended March 31, 1994 included $5.0 million in
payments associated with the redemption of an aggregate principal amount of $4.4
million of senior subordinated notes. At March 31, 1994, borrowings under the
Company's $425 million revolving credit facility were $266.9 million (at an
average interest rate of 7.0%) as compared to the $248.0 million (at an average
interest rate of 6.4%) outstanding at September 30, 1993.
The Company has become aware that its former Charleston, South Carolina
distribution center, was previously owned by a fertilizer manufacturer and that
there is evidence of residual soil contamination remaining from the fertilizer
manufacturing process operated on that site over thirty years ago. The Company
engaged an environmental consulting firm to conduct a soil survey and expects to
initiate a groundwater study during fiscal year 1994. At the present time, it
is not possible to ascertain the cost, if any, of remediation or whether the
Company will be able to obtain reimbursement for such costs from any third party
that caused the contamination or any insurance carrier. Accordingly, the
Company has not recorded any provision for this matter.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
(Continued)
The Company's primary ongoing cash requirements will be to fund payment of
principal and interest on indebtedness, finance working capital and fund capital
expenditures. An increase in interest rates would adversely affect the
Company's operating results and the cash flow available after debt service to
fund operations and any expansion and, if permitted to do so under its revolving
credit facility and the indenture for the senior subordinated notes, to pay
dividends on its capital stock.
The excess of cost over net assets acquired ("goodwill") was recorded at the
time of the Acquisition in 1988. Since the Acquisition, the Company and its
parent, Alco Health Distribution Corporation ("Distribution"), have been unable
to achieve the operating results projected at the time of the Acquisition. The
projections at the time of the Acquisition assumed significant growth rates in
revenues, stable gross profit margins and cash flow from operations to reduce
Acquisition indebtedness. Due to persistent competitive pressures and a shift
in the customer mix to larger volume, lower margin customers, gross profit
margins have declined from 7.10% in fiscal 1989 to 5.63% in fiscal 1993 and
5.32% for the six months ended March 31, 1994, resulting in higher than expected
losses and an increase in the Company's indebtedness. While the Company has
recently improved its operating results and Distribution has been able to reduce
its pre-tax losses from $26.3 million in fiscal 1991 to $1.1 million in fiscal
1993, and has a pre-tax profit of $6.9 million for the six months ended March
31, 1994, the Company believes these recent improvements in operating results
may not be indicative of the long-term prospects of Distribution or the Company
due to the following factors:
Gross Profit Margin: The Company expects that gross profit margins will
continue to erode due to price competition for market share within the industry,
health care industry consolidation and the impact of group purchasing
organizations, managed care and health care reform on drug prices.
Selling and Administrative Expenses: Since the Acquisition, as a result of
facility consolidations and other ongoing efforts to control costs, the Company
has dramatically decreased selling and administrative expenses as a percentage
of revenues. This rate of decrease is not expected to continue as the Company
has substantially completed its facility consolidations.
Interest Expense: Since the Acquisition, the Company and Distribution have
operated with a substantial amount of indebtedness, which is expected to remain
at the same level or increase in the future. Given the substantial amount of
indebtedness, the Company's interest expense can be significantly impacted by
interest rate fluctuations. The Company's interest expense since 1991 has been
favorably impacted by a downward movement in interest rates. Given the recent
increase in interest rates combined with projected levels of indebtedness in the
future, the Company expects future interest expense to be higher than recent
results.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
(Continued)
As a result of the potential negative impact of these factors on the ability to
recover the recorded goodwill value over its remaining estimated life, the
Company initiated a detailed evaluation of the carrying value of goodwill. The
Company is currently evaluating whether the carrying value of goodwill can be
recovered through future earnings. Although the Company currently cannot
predict the outcome of this evaluation, a determination could be made that,
based on the trends noted above, future earnings may not be sufficient to
support the recoverability of goodwill. Such a determination would require that
all or a portion of the carrying value of goodwill be written-off.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits: The following exhibits are filed as part of this
-------- report (listed by number corresponding to the
Exhibit Table of Item 601 of Regulation S-K):
Number Description
------ -----------
(4) Instruments defining the rights
of security holders, including
indentures.
(b) Reports on Form 8-K: No reports on Form 8-K were filed
------------------- during the quarter ended March 31, 1994.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALCO HEALTH SERVICES CORPORATION
/s/ John F. McNamara
----------------------------
John F. McNamara
Chairman, President and
Chief Executive Officer
(Principal Financial Officer)
Date: May 13, 1994 /s/ John A. Kurcik
------------ ----------------------------
John A. Kurcik
Vice President, Controller
(Principal Accounting Officer)
INDEX TO EXHIBITS
Exhibit
Number
- -------
4.1 Indenture, dated as of March 31, 1994, between Alco and Bankers
Trust Company, as Trustee relating to the 14 1/2% Senior Subordinated
Notes due 1999, Series A.
4.2 Agreement, dated as of April 28, 1994 by and among Alco, W.R.Huff
Asset Management Co., L.P. and certain holders of Alco's 14 1/2% Senior
Subordinated Notes due 1999.
4.3 Amended and Restated Second Amendment to Credit Agreement, dated as
of March 31, 1993 among Alco, General Electric Capital Corporation,
individually and as agent, BA Business Credit, Inc., as co-agent, and
the banks and other financial institutions named therein.