10-Q 1 l93929ae10-q.txt NCS HEALTHCARE, INC. FORM 10-Q 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 Quarter Ended March 31, 2002 Commission File Number- 0-27602 ------- NCS HealthCare, Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware No. 34-1816187 ------------------------------------ ----------------------------------- (State or other jurisdiction (IRS employer identification umber) of incorporation or organization) 3201 Enterprise Parkway, Suite 220, Beachwood, Ohio 44122 ---------------------------------------------------------- (Address of principal executive offices and zip code) (216) 378-6800 ----------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check 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 requirement for the past 90 days. Yes X No __ -- Common Stock Outstanding Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practical date. Class A Common Stock, $ .01 par value - 18,461,599 shares as of May 10, 2002 Class B Common Stock, $ .01 par value - 5,255,210 shares as of May 10, 2002 1 NCS HEALTHCARE, INC. AND SUBSIDIARIES INDEX
Page ---- Part I. Financial Information: Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets- March 31, 2002 and June 30, 2001 3 Condensed Consolidated Statements of Operations Three and nine months ended- March 31, 2002 and 2001 4 Condensed Consolidated Statements of Cash Flows- Nine months ended- March 31, 2002 and 2001 5 Notes to Condensed Consolidated Financial Statements - March 31, 2002 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk 13 Part II. Other Information: Item 6. Exhibits and Reports on Form 8-K 13 Signatures 14
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NCS HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE INFORMATION)
(UNAUDITED) (NOTE A) MARCH 31, JUNE 30, 2002 2001 --------- --------- ASSETS Current Assets: Cash and cash equivalents $ 42,238 $ 39,464 Accounts receivable, less allowances 88,913 94,447 Inventories 31,248 32,770 Other 2,636 3,301 --------- --------- Total current assets 165,035 169,982 Property and equipment, at cost net of accumulated depreciation and amortization 29,617 34,019 Goodwill, less accumulated amortization 301,589 301,907 Other assets 7,831 8,063 --------- --------- Total assets $ 504,072 $ 513,971 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Line of credit in default $ 206,130 $ 206,130 Convertible subordinated debentures in default 102,361 102,107 Accounts payable 49,260 56,349 Accrued expenses and other liabilities 30,988 21,925 --------- --------- Total current liabilities 388,739 386,511 Long-term debt, excluding current portion 490 825 Other 89 140 Stockholders' Equity: Preferred stock, par value $ .01 per share, 1,000,000 shares authorized; none issued -- -- Common stock, par value $ .01 per share: Class A - 50,000,000 shares authorized; 18,461,599 and 18,421,845 shares issued and outstanding at March 31, 2002 and June 30, 2001, respectively 184 184 Class B - 20,000,000 shares authorized; 5,255,210 and 5,294,964 shares issued and outstanding at March 31, 2002 and June 30, 2001, respectively 53 53 Paid-in capital 271,943 271,943 Accumulated deficit (157,426) (145,685) --------- --------- Total stockholders' equity 114,754 126,495 --------- --------- Total liabilities and stockholders' equity $ 504,072 $ 513,971 ========= =========
Note A: The balance sheet at June 30, 2001 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. See notes to condensed consolidated financial statements. 3 NCS HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 2002 2001 2002 2001 --------- --------- --------- --------- Revenues $ 163,816 $ 154,890 $ 483,360 $ 471,373 Cost of revenues 137,398 127,214 403,381 386,987 --------- --------- --------- --------- Gross profit 26,418 27,676 79,979 84,386 Selling, general and administrative expenses 21,576 40,476 71,996 94,890 --------- --------- --------- --------- Operating income (loss) 4,842 (12,800) 7,983 (10,504) Interest expense, net 6,090 7,907 19,499 24,319 --------- --------- --------- --------- Loss before income taxes (1,248) (20,707) (11,516) (34,823) Income tax expense 75 100 225 300 --------- --------- --------- --------- Net loss $ (1,323) $ (20,807) $ (11,741) $ (35,123) ========= ========= ========= ========= Net loss per share - basic $ (0.06) $ (0.88) $ (0.50) $ (1.50) ========= ========= ========= ========= Net loss per share - diluted $ (0.06) $ (0.88) $ (0.50) $ (1.50) ========= ========= ========= ========= Shares used in the computation - basic 23,717 23,717 23,717 23,475 Shares used in the computation - diluted 23,717 23,717 23,717 23,475
See notes to condensed consolidated financial statements. 4 NCS HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED MARCH 31, 2002 2001 -------- -------- OPERATING ACTIVITIES Net loss $(11,741) $(35,123) Adjustments to reconcile net loss to net cash provided by operating activities: Non-cash portion of fixed asset impairment charge -- 2,106 Loss on sale of exited business 537 -- Depreciation and amortization 9,828 18,642 Changes in assets and liabilities, net of effects of assets and liabilities acquired: Accounts receivable, net (1,704) 17,539 Accounts payable and other liabilities 7,405 19,404 Other, net 2,023 6,675 -------- -------- Net cash provided by operating activities 6,348 29,243 -------- -------- INVESTING ACTIVITIES Capital expenditures for property and equipment, net (3,912) (2,790) Other 677 (177) -------- -------- Net cash used in investing activities (3,235) (2,967) -------- -------- FINANCING ACTIVITIES Repayment of long-term debt (339) (501) -------- -------- Net cash used in financing activities (339) (501) -------- -------- Net increase in cash and cash equivalents 2,774 25,775 Cash and cash equivalents at beginning of period 39,464 16,387 -------- -------- Cash and cash equivalents at end of period $ 42,238 $ 42,162 ======== ========
See notes to condensed consolidated financial statements. 5 NCS HEALTHCARE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2002 (UNAUDITED) 1. 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 Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending June 30, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended June 30, 2001. 2. In June 1998, the Company entered into a four-year revolving credit agreement (Credit Facility). The Credit Facility, as amended, has an available commitment of $207 million, provides all Company assets as security, limits the availability of the Credit Facility to use for working capital only, requires Lender approval on future acquisitions, bears interest at a variable rate and contains certain debt covenants including an Interest Coverage Ratio and minimum consolidated net worth requirements. At March 31, 2002, the Company is in violation of certain financial covenants of the Credit Facility. On April 21, 2000, the Company received a formal notice of default from the senior lenders. As a result of the notice of default, the interest rate on the Credit Facility (excluding facility fee) increased to the Prime Rate plus 2.25% (7.0% at March 31, 2002). In addition, the Company will not be permitted to obtain any further funds under the Credit Facility until the defaults have been waived by the senior lenders. The Company is currently in discussions to obtain waivers of the covenant violations and to amend the credit agreement. Until the amendment to the credit agreement is obtained, the borrowings of $206.1 million under the Credit Facility at March 31, 2002 will be classified as a current liability. Failure to obtain the waiver and amendment could have a material adverse effect on the Company. If the waiver and amendment are not obtained, the Company's lenders may accelerate the maturity of the Company's obligations and/or exercise other remedies under the credit agreement including exercising their rights with respect to the pledged collateral. The Company elected to not make the semi-annual $2.875 million interest payments due February 15 and August 15, 2001 and February 15, 2002 on the Company's 5 3/4% Convertible Subordinated Debentures due 2004 (Debentures). On April 6, 2001, the Company received a formal Notice of Default and Acceleration and Demand for Payment from the Indenture Trustee. The Indenture Trustee declared the entire principal and any accrued interest thereon to be immediately due and payable and demanded immediate payment of such amounts. If such payments are not made, the Indenture Trustee reserves the right to pursue remedial measures in accordance with the Indenture, including, without limitation, collection activities. As of March 31, 2002, the amount of principal and accrued interest is $109.3 million. The Company is currently in discussions with an ad hoc committee of debenture holders regarding a possible restructuring of this indebtedness. The timing and ultimate outcome of these negotiations is uncertain and could have a material adverse effect on the Company. As a result of the above noted Debentures being in default, an additional $2.4 million of the Company's 5 3/4% Convertible Subordinated Debentures due 2004 are also in default. Until the defaults are resolved, convertible subordinated debentures of $102.4 million and the related accrued interest will be classified as a current liability. 6 3. The following table sets forth the computation of basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128):
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, -------------------- -------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Numerator: Numerator for basic earnings per share - net income $ (1,323) $(20,807) $(11,741) $(35,123) Effect of dilutive securities: Convertible debentures -- -- -- -- -------- -------- -------- -------- Numerator for diluted earnings per share $ (1,323) $(20,807) $(11,741) $(35,123) ======== ======== ======== ======== Denominator: Denominator for basic earnings per share - Weighted average common shares 23,717 23,717 23,717 23,475 -------- -------- -------- -------- Effect of dilutive securities: Stock options -- -- -- -- Convertible debentures -- -- -- -- -------- -------- -------- -------- Dilutive potential common shares -- -- -- -- -------- -------- -------- -------- Denominator for diluted earnings per share 23,717 23,717 23,717 23,475 ======== ======== ======== ======== Basic earnings per share $ (0.06) $ (0.88) $ (0.50) $ (1.50) ======== ======== ======== ======== Diluted earnings per share $ (0.06) $ (0.88) $ (0.50) $ (1.50) ======== ======== ======== ========
At March 31, 2002 and 2001, respectfully, the Company has 2,522,582 and 1,958,632 employee stock options that are potentially dilutive that were not included in the computation of diluted earnings per share as their effect would be antidilutive for all periods presented. The Company had $102,361,000 and $102,116,000 of convertible subordinated debentures outstanding at March 31, 2002 and 2001, respectively, that were convertible into 3,258,104 shares of Class A Common Stock, respectively, that were not included in the computation of diluted earnings per share as their effect would be antidilutive for all periods presented. 4. In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001. The Company adopted SFAS No. 141 on July 1, 2001. The Company has elected early adoption of SFAS No. 142 effective July 1, 2001. Under SFAS No. 142, goodwill and other indefinite lived intangible assets will no longer be amortized. Under this non-amortization approach, goodwill and other indefinite lived intangible assets will be reviewed for impairment using a fair value based approach as of the beginning of the year in which SFAS No. 142 is adopted. The Company was required to complete the initial step of the transitional impairment test by December 31, 2001 and is required to complete the final step of the transitional impairment test by the end of the current fiscal year. Going forward, these assets will be tested for impairment on an annual basis or upon the occurrence of certain triggering events as defined by SFAS No. 142. Any impairment loss resulting from the transitional impairment test will be recorded as a 7 cumulative effect of a change in accounting principle as of the beginning of the current fiscal year. The Company has completed the initial step of the transitional impairment test, which indicates that the goodwill of the Company is potentially impaired. As a result, the Company is required to complete the final step of the transitional impairment test. The Company does expect that it will be required to recognize an impairment loss as a result of the adoption of SFAS No. 142. The amount of the impairment loss is not known at this time; however, it could be material to the Company's financial position. In accordance with SFAS No. 142, the Company discontinued the amortization of goodwill effective July 1, 2001. A reconciliation of previously reported net loss and loss per share to the amounts adjusted for the exclusion of goodwill amortization net of the related income tax effect follows:
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 2002 2001 2002 2001 ---------- ---------- ---------- ---------- (IN THOUSANDS) Net Loss: As reported $ (1,323) $ (20,807) (11,741) $ (35,123) Goodwill amortization -- 2,544 -- 7,780 ---------- ---------- ---------- ---------- As adjusted $ (1,323) $ (18,263) $ (11,741) $ (27,343) ========== ========== ========== ========== Basic and Diluted Loss Per Share: As reported $ (0.06) $ (0.88) $ (0.50) $ (1.50) ---------- ---------- ---------- ---------- Goodwill amortization -- 0.11 -- 0.34 ---------- ---------- ---------- ---------- As adjusted $ (0.06) $ (0.77) $ (0.50) $ (1.16) ========== ========== ========== ==========
The gross carrying amount and accumulated amortization of intangible assets subject to amortization was $11,284,000 and $8,188,000, respectively, at March 31, 2002. Intangible assets that will continue to be amortized under SFAS No. 142 consist primarily of non-compete covenants, deferred debenture issuance costs and capitalized loan fees. Amortization expense for the three and nine month periods ended March 31, 2002 was $437,000 and $1,515,000, respectively. The estimated amortization expense for each of the five fiscal years subsequent to June 30, 2001 is as follows: FISCAL YEAR ENDING JUNE 30, AMOUNT --------------- ------ 2002 $1,980,000 2003 1,082,000 2004 879,000 2005 394,000 2006 201,000 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Net loss for the three months ended March 31, 2002 was $1,323,000 or $0.06 per diluted share compared to net loss of $20,807,000 or $0.88 per diluted share for the three months ended March 31, 2001. Net loss for the nine months ended March 31, 2002 was $11,741,000 or $0.50 per diluted share compared to net loss of $35,123,000 or $1.50 per diluted share for the nine months ended March 31, 2001. Excluding bad debt expense for exited businesses, fixed asset impairment charges and additional expenses related to restructuring activities, net loss for the three and nine months ended March 31, 2001 would have been $7,624,000 and $21,940,000 and net loss per diluted share would have been $0.32 and $0.93, respectively. The results for the three and nine month periods ended March 31, 2002 reflect the adoption of Statements of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets," which resulted in discontinuing the amortization of goodwill. If SFAS No. 142 would have been effective for the quarter ended March 31, 2001, net loss would have been $18,263,000 and net loss per share would have been $0.77, excluding $2,544,000 of goodwill amortization. If SFAS No. 142 would have been effective for the nine months ended March 31, 2001, net loss would have been $27,343,000 and net loss per share would have been $1.16, excluding $7,780,000 of goodwill amortization. Revenues for the three months ended March 31, 2002 increased $8,926,000 or 5.8% to $163,816,000 from $154,890,000 recorded in the comparable period in fiscal 2001. Revenues for the nine months ended March 31, 2002 increased $11,987,000 or 2.5% to $483,360,000 from $471,373,000 recorded in the comparable period in fiscal 2001. The increase in revenue from the prior fiscal year is primarily attributable to pharmaceutical inflation over the last year and the increased utilization of higher priced drugs. Cost of revenues for the three months ended March 31, 2002 increased $10,184,000 or 8.0% to $137,398,000 from $127,214,000 recorded in the comparable period in fiscal 2001. Cost of revenues for the nine months ended March 31, 2002 increased $16,394,000 or 4.2% to $403,381,000 from $386,987,000 recorded in the comparable period in fiscal 2001. Cost of revenues as a percentage of revenues for the three and nine months ended March 31, 2002 was 83.9% and 83.5%, respectively, compared to 82.1% and 82.1%, respectively, for the comparable periods during the prior fiscal year. The decline in gross margin as a percentage of revenues was primarily due to an unfavorable change in product mix, the continued shift toward lower margin payer sources such as Medicaid and third party insurance plans, and lower Medicaid and third party insurance reimbursement levels. Medicaid and third party insurance revenues accounted for 60.1% of revenues in the three months ended March 31, 2002 versus 58.5% for the same period during the prior fiscal year. Medicaid and third party insurance revenues accounted for 59.8% of revenues in the nine months ended March 31, 2002 versus 56.8% for the same period during the prior fiscal year. Selling, general and administrative expenses for the three months ended March 31, 2002 decreased by $18,900,000 or 46.7% to $21,576,000 from $40,476,000 recorded in the comparable period in fiscal 2001. Selling, general and administrative expenses for the nine months ended March 31, 2002 decreased by $22,894,000 or 24.1% to $71,996,000 from $94,890,000 recorded in the comparable period in fiscal 2001. Selling, general and administrative expenses as a percentage of revenues was 13.2% and 14.9% for the three and nine month periods ended March 31, 2002, respectively, compared to 26.1% and 20.1% during the comparable periods in fiscal 2001. Selling, general and administrative expenses for the three and nine months ended March 31, 2001 included $13,183,000 for bad debt expense for exited businesses, fixed asset impairment charges and additional expenses related to restructuring activities. The Company recorded $10,043,000 of additional bad debt expense to fully reserve for remaining accounts receivable of non-core and non-strategic businesses exited during the twelve months ended March 31, 2001. These businesses were ancillary to the core pharmacy operations and as part of the restructuring activities were either sold, if there was an available buyer, or shut down. While the Company has continued collection efforts on these receivables, collection has been much more difficult than anticipated. The Company recorded additional expenses related to restructuring activities of approximately $1,034,000, primarily for lease terminations associated with the continuing implementation and execution of strategic restructuring and consolidation activities. The Company recorded a fixed asset impairment charge of $2,106,000 in accordance with 9 Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed Of" (SFAS No. 121). This charge relates primarily to changes in asset values resulting from the impact of restructuring activities and changes in operational processes under restructured operations. As discussed above, the Company adopted SFAS No. 142 effective July 1, 2001 and accordingly discontinued the amortization of goodwill. If SFAS No. 142 would have been effective for the three and nine months ended March 31, 2001, selling, general and administrative expenses would have been $37,932,000 and $87,110,000, respectively. Excluding the impact of the adoption of SFAS No. 142 and bad debt expense for exited businesses, fixed asset impairment charges and additional expenses related to restructuring activities, selling, general and administrative expenses for the three months ended March 31, 2001 would have been $24,749,000 or 16.0% of sales compared to $21,576,000 or 13.2% of sales for the three months ended March 31, 2002. Excluding the impact of the adoption of SFAS No. 142 and bad debt expense for exited businesses, fixed asset impairment charges and additional expenses related to restructuring activities, selling, general and administrative expenses for the nine months ended March 31, 2001 would have been $73,927,000 or 15.7% of sales compared to $71,996,000 or 14.9% of sales for the nine months ended March 31, 2002. The decrease in expenses from the prior year is a result of efforts by the Company to reduce operating and overhead costs and a decrease in bad debt expense, partially offset by an increase in professional fees related to restructuring activities. The decrease in bad debt expense is primarily a result of improved collection trends and improved accounts receivable aging characteristics. Days sales outstanding on net accounts receivable decreased to 49 days at March 31, 2002 from 52 days at December 31, 2001 and 55 days at June 30, 2001. The Company had net interest expense of $6,090,000 and $19,499,000 for the three and nine months ended March 31, 2002, respectively, compared to net interest expense of $7,907,000 and $24,319,000 during the comparable periods in fiscal 2001. The decrease is primarily attributable to a decrease in interest rates during the past year. As discussed below, the Company is in default on its line of credit agreement and is currently being charged a default interest rate. The Company will continue to pay the default interest rate as long as it is in default of its line of credit agreement. Liquidity and Capital Resources Net cash provided by operating activities decreased to $6,348,000 during the nine months ended March 31, 2002 from $29,243,000 recorded in the comparable period in fiscal 2001. The decrease in net cash provided by operating activities resulted primarily from an increase in accounts payable in the prior year due to an interim modification of payment terms negotiated with a major Company supplier. The Company is continuing its negotiations with this supplier to achieve a permanent modification in payment terms. In addition, there are other contractual obligations between the Company and this supplier under which the supplier owes the Company certain amounts. These amounts are currently being withheld by the supplier causing the Company to have receivables from the supplier. These receivables have been netted against accounts payable to the supplier for financial reporting purposes. While the Company believes that the receivables arising from these contractual obligations are collectible, they are being withheld as part of the continuing negotiations. The timing and ultimate outcome of these negotiations are uncertain and could have a material adverse effect on the Company. Net cash used in investing activities increased to $3,235,000 during the nine months ended March 31, 2002 from $2,967,000 recorded in the comparable period in fiscal 2001. The increase is primarily the result of increased capital expenditures during the current period. Net cash used in financing activities decreased to $339,000 during the nine months ended March 31, 2002 from $501,000 recorded in the comparable period in fiscal 2001. In August 1997, the Company issued $100 million of convertible subordinated debentures due 2004. The debentures carry an interest rate of 5 3/4%. The debentures are obligations of the Company. The operations of the Company are currently conducted principally through subsidiaries, which are separate and distinct legal entities. The Company's ability to make payments of principal and interest on the debentures will depend on its ability to 10 receive distributions of cash from its subsidiaries. Each of the Company's wholly-owned subsidiaries has guaranteed the Company's payment obligations under the debentures, so long as such subsidiary is a member of an affiliated group (within the meaning of Section 279(g) of the Internal Revenue Code of 1986, as amended) that includes the Company. The satisfaction by the Company's subsidiaries of their contractual guarantees, as well as the payment of dividends and certain loans and advances to the Company by such subsidiaries, may be subject to certain statutory or contractual restrictions, are contingent upon the earnings of such subsidiaries and are subject to various business considerations. The Company elected to not make the semi-annual $2.875 million interest payments due February 15 and August 15, 2001 and February 15, 2002 on the Company's 5 3/4% Convertible Subordinated Debentures due 2004 (Debentures). On April 6, 2001, the Company received a formal Notice of Default and Acceleration and Demand for Payment from the Indenture Trustee. The Indenture Trustee declared the entire principal and any accrued interest thereon to be immediately due and payable and demanded immediate payment of such amounts. If such payments are not made, the Indenture Trustee reserves the right to pursue remedial measures in accordance with the Indenture, including, without limitation, collection activities. As of March 31, 2002, the amount of principal and accrued interest is $109.3 million. The Company is currently in discussions with an ad hoc committee of debenture holders regarding a possible restructuring of this indebtedness. The timing and ultimate outcome of these negotiations is uncertain and could have a material adverse effect on the Company. As a result of the above noted Debentures being in default, an additional $2.4 million of the Company's 5 3/4% Convertible Subordinated Debentures due 2004 are also in default. Until the defaults are resolved, convertible subordinated debentures of $102.4 million and the related accrued interest will be classified as a current liability. In June 1998, the Company entered into a four-year revolving credit agreement (Credit Facility). The Credit Facility, as amended, has an available commitment of $207 million, provides all Company assets as security, limits the availability of the Credit Facility to use for working capital only, requires Lender approval on future acquisitions, bears interest at a variable rate and contains certain debt covenants including an Interest Coverage Ratio and minimum consolidated net worth requirements. At March 31, 2002, the Company is in violation of certain financial covenants of the Credit Facility. On April 21, 2000, the Company received a formal notice of default from the senior lenders. As a result of the notice of default, the interest rate on the Credit Facility (excluding facility fee) increased to the Prime Rate plus 2.25% (7.0% at March 31, 2002). In addition, the Company will not be permitted to obtain any further funds under the Credit Facility until the defaults have been waived by the senior lenders. The Company is currently in discussions to obtain waivers of the covenant violations and to amend the credit agreement. Until the amendment to the credit agreement is obtained, the borrowings of $206.1 million under the Credit Facility at March 31, 2002 will be classified as a current liability. Failure to obtain the waiver and amendment could have a material adverse effect on the Company. If the waiver and amendment are not obtained, the Company's lenders may accelerate the maturity of the Company's obligations and/or exercise other remedies under the credit agreement including exercising their rights with respect to the pledged collateral. Subject to obtaining the necessary waivers and amendments, the Company will be required to meet future financing needs principally through the use of cash generated from operations. During the past three years the Company has implemented measures to improve cash flows generated from operating activities, including reductions in operating and overhead costs by continuing the consolidation and/or closing of pharmacy locations, continuing its employee reduction plan, more aggressive collection activity and inventory reduction efforts, and an interim modification of payment terms negotiated with a major Company supplier. However, the Company may require additional capital resources for internal working capital needs and may need to incur additional indebtedness to meet these requirements. Additional funds are currently not available under the Credit Facility as described above and there can be no assurances that additional funds will be available. Brown, Gibbons, Lang & Company Securities, Inc. (BGL&Co.) is acting as the Company's financial advisor in its continuing discussions with the Company's senior lenders and with an ad hoc committee of holders of the 5 3/4% Convertible Subordinated Debentures due 2004, with respect to the defaults and to restructuring options. BGL&Co. is also discussing various strategic alternatives with third parties. No decision has been made to enter into any transaction or as to what form any transaction might take. NCS can give no assurance with respect to the outcome of these discussions or negotiations. 11 The Company's effective income tax rate for the three and nine months ended March 31, 2002 and 2001 differs from the federal statutory rate primarily as a result of the recording of a full valuation allowance against the Company's net deferred tax assets consisting primarily of net operating loss carryforwards. Recently Issued Accounting Standards In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001. The Company adopted SFAS No. 141 on July 1, 2001. The Company has elected early adoption of SFAS No. 142 effective July 1, 2001. Under SFAS No. 142, goodwill and other indefinite lived intangible assets will no longer be amortized. Under this non-amortization approach, goodwill and other indefinite lived intangible assets will be reviewed for impairment using a fair value based approach as of the beginning of the year in which SFAS No. 142 is adopted. The Company was required to complete the initial step of the transitional impairment test by December 31, 2001 and is required to complete the final step of the transitional impairment test by the end of the current fiscal year. Going forward, these assets will be tested for impairment on an annual basis or upon the occurrence of certain triggering events as defined by SFAS No. 142. Any impairment loss resulting from the transitional impairment test will be recorded as a cumulative effect of a change in accounting principle as of the beginning of the current fiscal year. The Company has completed the initial step of the transitional impairment test, which indicates that the goodwill of the Company is potentially impaired. As a result, the Company is required to complete the final step of the transitional impairment test. The Company does expect that it will be required to recognize an impairment loss as a result of the adoption of SFAS No. 142. The amount of the impairment loss is not known at this time; however, it could be material to the Company's financial position. Disclosure Regarding Forward-Looking Statements Certain statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q, including, but not limited to, those regarding the Company's financial position, business strategy and other plans and objectives for future operations and any other statements that are not historical facts constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, there can be no assurance that the actual results or developments anticipated by the Company will be realized or, even if substantially realized, that they will have expected effects on its business or operations. These forward-looking statements are made based on management's expectations and beliefs concerning future events impacting the Company and are subject to uncertainties and factors (including, but not limited to, those specified below) which are difficult to predict and, in many instances, are beyond the control of the Company. As a result, actual results of the Company may differ materially from those expressed or implied by any such forward-looking statements. Among the factors that could cause actual results to differ materially from the Company's expectations include continuation of various trends in the long-term care market (including the trend toward consolidation and the continued impact of the Balanced Budget Act of 1997), competition among providers of long-term care pharmacy services, changes in reimbursement levels from State Medicaid programs and third-party insurance plans, the Company's negotiations with its senior lenders regarding its revolving credit facility, the Company's negotiations with an ad hoc committee of holders of its 5 3/4% convertible subordinated debentures due 2004, negotiations regarding payment terms and contractual obligations with suppliers, changes in regulatory requirements and Federal and State reimbursement levels, reform of the health care delivery system, litigation matters, implementation of newly issued accounting standards, other factors and risks and uncertainties described in the Company's SEC reports. 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to certain market risks from transactions that are entered into during the normal course of business. The Company has not entered into derivative financial instruments for trading purposes. The Company's primary market risk exposure relates to interest rate risk. The Company has managed its interest rate risk by balancing its exposure between fixed and variable rates while attempting to minimize its interest costs. The Company has a balance of $206,130,000 on its revolving credit facility at March 31, 2002 which is currently subject to a variable rate of interest based on the Prime Rate. Assuming borrowings at March 31, 2002, a one-hundred basis point change in interest rates would impact net interest expense by approximately $2,061,300 per year. PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Reports on Form 8-K: No reports on Form 8-K were filed during the three months ended March 31, 2002. 13 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. NCS HealthCare, Inc. (Registrant) Date: May 15, 2002 By /s/ Kevin B. Shaw ----------------------------------- Kevin B. Shaw President, Chief Executive Officer and Director Date: May 15, 2002 By /s/ William B. Byrum ----------------------------------- William B. Byrum Executive Vice President and Chief Operating Officer Date: May 15, 2002 By /s/ Gerald D. Stethem ----------------------------------- Gerald D. Stethem Senior Vice President and Chief Financial Officer 14