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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
-----------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File No. 0-20348
D & K HEALTHCARE RESOURCES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 43-1465483
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8235 FORSYTH BOULEVARD, ST. LOUIS, MISSOURI
(Address of principal executive offices)
63105
(Zip Code)
(314) 727-3485
(Registrant's telephone number, including area code)
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.
X YES NO
----------- -----------
Indicate by check mark whether the registrant is an accelerated filer.
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.
Common Stock, $.01 par value 13,988,603
---------------------------- ----------
(class) (February 6, 2004)
Page 2 of 22
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Index
Page No.
---------
Part 1. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 2003 and June 30, 2003 3
Condensed Consolidated Statements of Operations for the
Three Months and Six Months Ended December 31, 2003
and December 31, 2002 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended December 31, 2003 and December 31, 2002 5
Notes to Condensed Consolidated Financial Statements 6 - 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
Item 4. Controls and Procedures 15
Part 11. Other Information
Item 1. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 6. Exhibits and Reports on Form 8-K 17
Page 3 of 22
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
- --------------------------------------------------------------------------------------------------------------
DECEMBER 31, JUNE 30,
2003 2003
------------ ------------
(unaudited)
ASSETS
Current Assets
Cash (including restricted cash of $14,367 and $14,301, respectively) $ 14,367 $ 14,301
Receivables, net of allowance for doubtful accounts of $6,864 and $1,604,
respectively 144,469 122,982
Inventories 638,109 257,984
Other current assets 26,196 8,862
------------ ------------
Total current assets 823,141 404,129
Property and Equipment, net of accumulated depreciation and amortization of
$11,604 and $10,673, respectively 23,870 11,140
Other Assets 8,057 11,511
Goodwill, net of accumulated amortization 63,184 44,105
Other Intangible Assets, net of accumulated amortization 6,928 1,810
------------ ------------
Total assets $ 925,180 $ 472,695
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 819 $ 1,677
Accounts payable 285,528 173,342
Accrued expenses 19,578 13,471
------------ ------------
Total current liabilities 305,925 188,490
Long-term Liabilities 7,146 3,703
Long-term Debt, excluding current maturities 441,048 110,423
------------ ------------
Total liabilities 754,119 302,616
Stockholders' Equity
Common stock 152 152
Paid-in capital 125,456 124,704
Accumulated other comprehensive loss (1,014) (1,371)
Deferred compensation - restricted stock (947) (411)
Retained earnings 59,640 58,415
Less treasury stock (12,226) (11,410)
------------ ------------
Total stockholders' equity 171,061 170,079
------------ ------------
Total liabilities and stockholders' equity $ 925,180 $ 472,695
============ ============
The accompanying notes are an integral part of these statements.
Page 4 of 22
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
(In thousands, except per share data) DECEMBER 31 DECEMBER 31
-------------------------------- --------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net Sales $ 510,945 $ 530,843 $ 989,493 $ 1,064,809
Cost of Sales 491,490 509,621 951,950 1,022,534
------------- ------------- ------------- -------------
Gross profit 19,455 21,222 37,543 42,275
Operating Expenses 15,847 13,506 29,035 27,050
------------- ------------- ------------- -------------
Income from operations 3,608 7,716 8,508 15,225
Other Income (Expense):
Interest expense, net (3,332) (2,899) (5,479) (5,412)
Other, net 295 17 331 (37)
------------- ------------- ------------- -------------
(3,037) (2,882) (5,148) (5,449)
------------- ------------- ------------- -------------
Income before income tax provision, minority
interest and cumulative effect of accounting
change 571 4,834 3,360 9,776
Income Tax Provision (223) (1,958) (1,311) (3,910)
Minority Interest (171) (201) (405) (329)
------------- ------------- ------------- -------------
Net income before cumulative effect of
accounting change 177 2,675 1,644 5,537
Cumulative effect of accounting change, net -- -- -- (4,249)
------------- ------------- ------------- -------------
Net income
$ 177 $ 2,675 $ 1,644 $ 1,288
============= ============= ============= =============
Earnings Per Share - Basic
Net income before cumulative effect of accounting
change $ 0.01 $ 0.18 $ 0.12 $ 0.38
Cumulative effect of accounting change -- -- -- (0.29)
------------- ------------- ------------- -------------
$ 0.01 $ 0.18 $ 0.12 $ 0.09
============= ============= ============= =============
Earnings Per Share - Diluted
Net income before cumulative effect of accounting
change $ 0.01 $ 0.18 $ 0.11 $ 0.37
Cumulative effect of accounting change -- -- -- (0.29)
------------- ------------- ------------- -------------
Net income $ 0.01 $ 0.18 $ 0.11 $ 0.08
============= ============= ============= =============
Basic common shares outstanding 13,928 14,470 13,941 14,512
Diluted common shares outstanding 14,134 14,583 14,163 14,717
The accompanying notes are an integral part of these statements.
Page 5 of 22
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the six months ended December 31, (in thousands)
- ---------------------------------------------------------------------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,644 $ 1,288
Adjustments to reconcile net income to net cash
flows from operating activities --
Depreciation and amortization 1,315 1,269
Amortization of debt issuance costs 815 587
Deferred income taxes 972 (1,897)
Cumulative effect of accounting change, net -- 4,249
Decrease in receivables, net 28,643 4,684
Increase in inventories (291,561) (88,082)
Increase in other current assets (3,432) (2,000)
Increase in accounts payable 37,573 801
(Decrease) increase in accrued expenses (1,333) 2,070
Other, net 2,206 474
----------- -----------
Net cash flows used in operating activities
(223,158) (76,557)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid for acquired company, net of cash acquired (102,869) --
Purchases of property and equipment (2,440) (1,772)
----------- -----------
Net cash flows used in investing activities
(105,309) (1,772)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving line of credit, net 330,764 78,144
Payments of long-term debt (996) (698)
Payment of dividends (419) (436)
Purchase of treasury stock (816) (877)
----------- -----------
Net cash flows provided by financing activities 328,533 76,133
----------- -----------
Increase (decrease) in cash 66 (2,196)
Cash, beginning of period 14,301 11,754
----------- -----------
Cash, end of period $ 14,367 $ 9,558
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for --
Interest $ 3,930 $ 4,527
Income taxes, net $ 432 $ 2,708
The accompanying notes are an integral part of these statements.
Page 6 of 22
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
D&K Healthcare Resources, Inc. (the "Company") is a full-service, regional
wholesale drug distributor, supplying customers from facilities in Missouri,
Kentucky, Minnesota, Texas, Arkansas, and South Dakota. The Company distributes
a broad range of pharmaceuticals and related products to its customers in 27
states primarily in the Midwest, Upper Midwest, and South. The Company focuses
primarily on a target market sector, which includes independent retail,
institutional, franchise, chain store and alternate site pharmacies. The Company
also offers a number of proprietary information systems software through two
wholly owned subsidiaries, Tykon, Inc. and VC Services, Inc. (dba Viking
Computer Services). In addition, the Company owns a 70% equity interest in
Pharmaceutical Buyers, Inc. ("PBI"), a leading alternate site group purchasing
organization.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and include all
of the information and disclosures required by accounting principles generally
accepted in the United States of America for interim reporting, which are less
than those required for annual reporting. In the opinion of management, all
adjustments (consisting only of normal recurring accruals) considered necessary
for a fair representation have been included. The results of operations for the
three-month and six-month periods ended December 31, 2003, are not necessarily
indicative of the results to be expected for the full fiscal year.
These condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and related notes
contained in the Company's 2003 Annual Report to Stockholders.
NOTE 2. ACQUISITION
On December 5, 2003, the Company acquired 100 percent of the outstanding
common stock of Walsh HealthCare Solutions, Inc. ("Walsh") of Texarkana, Texas.
Walsh is a full-service pharmaceutical distributor with distribution centers
located in San Antonio and Texarkana, Texas and Paragould, Arkansas. The results
of Walsh have been included in the condensed consolidated financial statements
since that date. The aggregate purchase price of $104.4 million in cash before
consideration of cash acquired includes the repayment of all Walsh bank debt and
other direct acquisition costs. D&K utilized its existing revolving credit
facility to finance the transaction.
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at the date of acquisition. The Company is in
the process of obtaining third-party valuations of certain fixed assets and
intangible assets. Thus, the allocation of the purchase price is subject to
refinement.
(in thousands) At December 5, 2003
-------------------
Current assets $ 154,392
Property and equipment 11,574
Other assets 994
Intangible assets 5,199
Goodwill 19,079
--------------
Total assets acquired 191,238
--------------
Current liabilities 82,053
Long-term liabilities 4,771
--------------
Total liabilities assumed 86,824
--------------
Net assets acquired $ 104,414
==============
The $5.2 million of acquired intangible assets has a weighted-average life of
approximately 10 years. The intangible assets that make up that amount include
customer relationships of $ 5.1 million (10-year weighted-average useful life)
and other assets of $ 0.1 million (3-year weighted-average useful life). The
$19.1 million of goodwill was assigned to the wholesale distribution segment. Of
that amount, none is expected to be deductible for tax purposes.
Page 7 of 22
The following unaudited pro forma information presents a summary of consolidated
results of operations of the Company and Walsh for the periods indicated as if
the acquisition had occurred at July 1, 2003 and July 1, 2002, respectively,
with pro forma adjustments to give effect to amortization of intangible assets,
interest expense on acquisition debt and certain other adjustments, together
with related income tax effects. The unaudited pro forma information has been
prepared for comparative purposes only and does not purport to be indicative of
results of operations had these transactions been completed as of the assumed
dates or which may be obtained in the future (in thousands, except per share
amounts).
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------------
2003 2002 2003 2002
---------- ---------- ------------- ------------
Net sales $ 661,598 $ 764,671 $ 1,330,031 $ 1,543,082
Net income before discontinued operations
and cumulative effect of accounting change $ (5,268) $ 5,923 $ (3,701) $ 9,789
Net income (loss) $ (6,663) $ 5,786 $ (5,257) $ 5,162
Diluted earnings per share $ (0.48) $ 0.39 $ (0.38) $ 0.35
The three and six month periods ended December 31, 2003 included adjustments of
$10.4 million ($6.3 million, net of tax) recorded by Walsh prior to acquisition
relating to, among other items, accounts receivable determined by Walsh to be
uncollectible, obsolete inventory, and costs Walsh incurred associated with
completing the transaction. The three and six month periods ended December
31,2002 include a gain of $4.1 million ($2.5 million, net of tax) related to the
sale by Walsh of its interest in Walsh Dohmen Southeast, LLC.
NOTE 3. STOCK-BASED COMPENSATION
The Company has adopted the disclosure requirements of Statement of
Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
compensation and also amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
methods of accounting for stock-based employee compensation and the effect of
the method used on reported results. As permitted by SFAS 148 and SFAS 123, the
Company continues to apply the accounting provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees."
Had the Company recorded compensation expense based on the estimated grant
date fair values, as defined by SFAS 123, for awards granted under its stock
option plans and stock purchase plan, the unaudited pro forma net income and pro
forma earnings per share would have been as follows (in thousands, except per
share data):
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income -- as reported $ 177 $ 2,675 $ 1,644 $ 1,288
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of tax (407) (347) (800) (686)
--------- --------- --------- ---------
Net income (loss) -- pro forma
$ (230) $ 2,328 $ 844 $ 602
Earnings (loss) per share:
Basic -- as reported $ 0.01 $ 0.18 $ 0.12 $ 0.09
Basic -- pro forma $ (0.02) $ 0.16 $ 0.06 $ 0.04
Diluted -- as reported $ 0.01 $ 0.18 $ 0.11 $ 0.08
Diluted -- pro forma $ (0.02) $ 0.16 $ 0.05 $ 0.04
These pro forma amounts may not be representative of the effects for future
years as options vest over several years and additional awards are generally
granted each year.
Page 8 of 22
NOTE 4. GOODWILL AND INTANGIBLE ASSETS
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
effective July 1, 2002. Under the new statement, impairment should be tested at
least annually at the reporting unit level using a two-step impairment test. The
reporting unit is the same as or one level below the operating segment level as
described in SFAS Statement 131, "Disclosures about Segments of an Enterprise
and Related Information" (see Note 9). Under step 1 of this approach, the fair
value of the reporting unit as a whole is compared to the book value of the
reporting unit (including goodwill) and, if a deficiency exists, impairment
would need to be calculated. In step 2, the impairment is measured as the
difference between the implied fair value of goodwill and its carrying amount.
The implied fair value of goodwill is the difference between the fair value of
the reporting unit as a whole less the fair value of the reporting unit's
individual assets and liabilities, including any unrecognized intangible assets.
Under this standard, goodwill and intangibles with indefinite lives are no
longer amortized. A discounted cash flow model was used to determine the fair
value of the Company's businesses for the purpose of testing goodwill for
impairment. The discount rate used was based on a risk-adjusted weighted average
cost of capital.
As a result of this adoption and assessment, the Company recognized an
impairment loss of approximately $7.0 million ($4.2 million net of tax) during
the first quarter of fiscal 2003. This was recognized as the cumulative effect
of a change in accounting principle. This impairment results from an appraisal
valuation and relates to goodwill originally established for the acquisition of
Jewett Drug Co., which is included in the Company's wholesale drug distribution
segment.
Changes to goodwill and intangible assets during the six-month period ended
December 31, 2003 are: (in thousands)
Goodwill Intangible Assets
----------- -------------------
Balance at June 30, 2003, net of
accumulated amortization $ 44,105 $ 1,810
Walsh acquisition 19,079 5,199
Amortization expense -- (81)
----------- -----------
Balance at December 31, 2003, net of
accumulated amortization $ 63,184 $ 6,928
=========== ===========
Intangible assets totaled $6.9 million, net of accumulated amortization of
$0.4 million, at December 31, 2003. Of this amount, $0.2 million represents
intangible assets with indefinite useful lives, consisting primarily of trade
names that are not being amortized under SFAS No. 142. The remaining intangibles
relate to customer or supplier relationships and licenses. Amortization expense
for intangible assets is expected to approximate $0.7 million each year between
2004 and 2014 and $0.2 million from 2015 to 2018.
(in millions) Goodwill Intangible Assets
------------------------- -------------------------
December 31, June 30, December 31, June 30,
SEGMENT: 2003 2003 2003 2003
------------- --------- ------------- ---------
Wholesale drug distribution $ 51.4 $ 32.3 $ 5.2 $ 0.2
PBI 10.4 10.4 1.7 1.7
Software 1.4 1.4 -- --
--------- --------- --------- ---------
Total $ 63.2 $ 44.1 $ 6.9 $ 1.9
========= ========= ========= =========
Page 9 of 22
NOTE 5. EARNINGS PER SHARE
SFAS No. 128, "Earnings Per Share", requires dual presentation of basic and
diluted earnings per share and requires a reconciliation of the numerators and
denominators of the basic and diluted earnings per share calculations. The
reconciliation of the numerator and denominator of the basic and diluted
earnings per share computations are as follows (in thousands, except for per
share amounts):
Three Months ended Three Months ended
December 31, 2003 December 31, 2002
------------------------------------------- ------------------------------------------
Income Shares Per-share Income Shares Per-share
(Numerator) (Denominator) (1) Amount (Numerator) (Denominator) (1) Amount
----------- ----------------- --------- ---------- ----------------- ---------
Basic Earnings per Share:
Net income available to common
stockholders $ 177 13,928 $ 0.01 $ 2,675 14,470 $ 0.18
Effect of Diluted Securities:
Options -- 206 -- 113
Convertible securities (54) -- (52) --
---------- ------------- ---------- -------------
Diluted Earnings per Share:
Net income available to common
stockholders plus assumed conversions $ 123 14,134 $ 0.01 $ 2,623 14,583 $ 0.18
========== ============= ========= ========== ============= =========
(1) Outstanding shares computed on a weighted average basis
Six Months ended Six Months ended
December 31, 2003 December 31, 2002
------------------------------------------- ------------------------------------------
Income Shares Per-share Income Shares Per-share
(Numerator) (Denominator) (1) Amount (Numerator) (Denominator) (1) Amount
----------- ----------------- --------- ---------- ----------------- ---------
Basic Earnings per Share:
Net income before cumulative effect of $ 1,644 13,941 $ 0.12 $ 5,537 14,512 $ 0.38
accounting change, net
Cumulative effect of accounting
change, net -- -- (4,249) -- (0.29)
---------- ------------- --------- ---------- ------------- ---------
Net income available to common
stockholders 1,644 13,941 0.12 1,288 14,512 0.09
Effect of Diluted Securities:
Options -- 222 -- 205
Convertible securities (117) -- (82) --
---------- ------------- ---------- -------------
Diluted Earnings per Share:
Net income available to common
stockholders plus assumed conversions $ 1,527 14,163 $ 0.11 $ 1,206 14,717 $ 0.08
========== ============= ========= ========== ============= =========
(1) Outstanding shares computed on a weighted average basis
NOTE 6. COMPREHENSIVE INCOME
The Company's comprehensive income consists of net income and the net
change in value of cash flow hedge instruments as follows: (in thousands)
Three Months Ended Six Months Ended
December 31, December 31,
----------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income $ 177 $ 2,675 $ 1,644 $ 1,288
Change in value of cash flow hedge, net of tax 165 9 357 (413)
--------- --------- --------- ---------
Total comprehensive income $ 342 $ 2,684 $ 2,001 $ 875
========= ========= ========= =========
Page 10 of 22
NOTE 7. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk, such as standby letters of credit and
other guarantees, which are not reflected in the accompanying balance sheets. At
December 31, 2003, the Company was party to a standby letter of credit of
$750,000 and was the guarantor of certain customer obligations totaling
approximately $300,000. Management does not expect any material losses to result
from these off-balance-sheet items.
On February 5, 2004, an individual named Gary Dutton filed a complaint in
the United States District Court for the Eastern District of Missouri against
the Company and its Chief Executive, Operating and Financial Officers
("Defendants") asserting a class action for alleged breach of fiduciary duties
and violations of Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. The complaint alleges that the
Company's press releases and reports filed with the Securities and Exchange
Commission between April 23, 2001 and September 16, 2002 were materially false
and misleading in that they failed to disclose that the Company's results were
based, in material part, on arrangements with a single supplier which the
Company allegedly knew could not be sustained. The complaint also claims that as
a result of the alleged omissions, the market prices of the Company's common
shares during the period were artificially inflated. The complaint seeks
unspecified compensatory damages. The Company believes that the complaint
contains a number of inaccurate statements, does not state any valid cause of
action and that the Company will have substantial meritorious defenses to the
complaint. The Defendants intend to vigorously defend the claims.
NOTE 8. LONG-TERM DEBT
On March 31, 2003, the Company announced that it had entered into a new
$600 million credit facility. The credit facility, an asset-based senior secured
revolving credit facility, increased its maximum available credit from $430
million to $600 million. The new single credit facility replaces a $230 million
revolving bank line of credit and a $200 million accounts receivable
securitization program. Under the credit facility, the total amount of loans and
letters of credit outstanding at any time cannot exceed the lesser of an amount
based on percentages of eligible receivables and inventories (the borrowing base
formula) and $600 million. Total credit available at December 31, 2003 was
approximately $500 million of which approximately $59 million was unused. The
interest rate on the credit facility is based on the 30-day London Interbank
Offering Rate (LIBOR) plus a factor based on certain financial criteria. The
interest rate was 3.38% at December 31, 2003. Borrowings under the credit
facility are reported as long-term debt in the Company's financial statements.
NOTE 9. BUSINESS SEGMENTS
Pursuant to SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the Company has three identifiable business segments:
Wholesale drug distribution, the Company's interest in PBI, and Software/Other.
Two wholly owned software subsidiaries, Tykon, Inc. and Viking Computer
Services, Inc., and the newly formed D&K Pharmacy Solutions constitute the
Software/Other segment. Viking markets a pharmacy management software system and
Tykon developed and markets a proprietary PC-based order entry/order
confirmation system to the drug distribution industry. Pharmacy Solutions
provides additional services to pharmacy customers including the marketing and
distributing Parata robotic dispensing systems.
Though the Wholesale drug distribution segment operates from several
different facilities, the nature of its products and services, the types of
customers and the methods used to distribute its products are similar and thus
they have been aggregated for presentation purposes. The Company operates
principally in the United States.
Page 11 of 22
(In thousands) For The Three Months Ended For the Six Months Ended
---------------------------------------- ---------------------------------------
December 31, 2003 December 31, 2002 December 31, 2003 December 31, 2002
------------------- ------------------- ------------------- -------------------
Net Sales -
Wholesale drug distribution $ 507,205 $ 528,076 $ 982,724 $ 1,059,733
PBI 2,278 2,090 4,597 3,702
Software/Other 1,462 677 2,172 1,374
-------------- -------------- -------------- --------------
Total $ 510,945 $ 530,843 $ 989,493 $ 1,064,809
Gross Profit -
Wholesale drug distribution $ 16,334 $ 18,592 $ 31,538 $ 37,486
PBI 2,278 2,090 4,597 3,702
Software/Other 843 540 1,408 1,087
-------------- -------------- -------------- --------------
Total $ 19,455 $ 21,222 $ 37,543 $ 42,275
Pre-tax income (loss) -
Wholesale drug distribution $ (862) $ 3,566 $ 510 $ 7,632
PBI 933 1,059 2,165 1,740
Software/Other 500 209 685 404
-------------- -------------- -------------- --------------
Total $ 571 $ 4,834 $ 3,360 $ 9,776
The increase in total assets from the last annual report relate primarily
to increased inventory levels and the acquisition of Walsh that are all included
in the wholesale drug distribution segment. Prior period segment information has
been reclassified to reflect PBI separately since PBI now exceeds certain
reporting criteria. There are no other differences in the basis of segmentation
or in the basis of measurement of segment profit or loss.
Page 12 of 22
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The discussion below is concerned with material changes in financial
condition and results of operations in the condensed consolidated balance sheets
as of December 31, 2003 and June 30, 2003, and in the condensed consolidated
statements of operations for the three-month and six-month periods ended
December 31, 2003 and December 31, 2002, respectively. We recommend that this
discussion be read in conjunction with the audited consolidated financial
statements and accompanying notes included in our 2003 Annual Report to
Stockholders.
Certain statements in this document regarding future events, prospects,
projections or financial performance are forward looking statements. Such
forward looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and may be identified by
words such as "anticipates," "believes," "estimates," "expects," "intends" and
similar expressions. Such forward-looking statements are inherently subject to
risks and uncertainties. The company's actual results could differ materially
from those currently anticipated due to a number of factors, including without
limitation, the competitive nature of the wholesale pharmaceutical distribution
industry with many competitors having substantially greater resources than D&K
Healthcare, the company's ability to maintain or improve its operating margins
with the industry's competitive pricing pressures, the company's customers and
suppliers generally having the right to terminate or reduce their purchases or
shipments on relatively short notice, the availability of investment purchasing
opportunities, the changing business and regulatory environment of the
healthcare industry in which the company operates, including manufacturer's
pricing or distribution policies or practices, changes in private and
governmental reimbursement or in the delivery systems for healthcare products,
changes in interest rates, ability to complete and integrate acquisitions
successfully, and other factors set forth in reports and other documents filed
by D&K Healthcare with the Securities and Exchange Commission from time to time.
The reader should not place undue reliance on forward-looking statements, which
speak only as of the date they are made. D&K Healthcare undertakes no obligation
to publicly update or revise any forward-looking statements.
We have renamed the national pharmacy chains trade class the `national
accounts' trade class. Given the changing composition of this class of trade we
feel this new name is more reflective of the broader nature of the business.
This is a name change only; we have not changed or restated the financial
results in any way.
RECENT TRENDS
Changing behavior on the part of pharmaceutical manufacturers is impacting
and will continue to impact how distributors generate earnings. Three important
changes we have noted include changes in the timing of product price increases,
which impacted our results this quarter, tightening of control over inventory in
the distribution channel resulting in fewer opportunities to purchase inventory
from sources other than the original manufacturer, and a transition to "fee for
service" compensation models which generally reduce the ability to accumulate
inventory positions ahead of price increases. With these changes, and with
others likely over time, we expect that our business model and earnings growth
will evolve to reflect that of our core business. We refer to our `Core'
operations as the combination of our `independent and regional pharmacies' trade
class and the `other healthcare providers' trade class. Customers in both of
these classes of trade rely on D&K as their primary pharmaceutical and OTC
products supplier. We are servicing these customers on a daily basis from one of
our seven full-service distribution centers. We have taken several important
steps to position D&K for this change in pharmaceutical manufacturers behavior.
We have strengthened and broadened our core business through the acquisition of
Walsh HealthCare Solutions. As a result of the Walsh acquisition, we expect to
our net sales and profits to increase. Walsh generated net sales of
approximately $900 million in their fiscal year ended April 30, 2003 and pre-tax
income of approximately $ 4.8 million, excluding non-recurring items. We feel
that the Walsh acquisition will provide modest earnings accretion in fiscal 2004
and significant accretion in fiscal 2005. We have positioned our national
accounts business with a flexible cost structure with minimal fixed costs, so
that we can maintain a presence and take advantage of opportunities if and when
they exist. We also anticipate continued industry consolidation which may
provide additional acquisition opportunities.
Page 13 of 22
RESULTS OF OPERATIONS
NET SALES Net sales decreased $19.9 million to $510.9 million, or 3.7%, for
the three months ended December 31, 2003, compared to the corresponding period
of the prior year. Sales to independent and regional pharmacies increased $103.4
million to $396.5 million, or 35.3%. Approximately 50% of the increase relates
to sales from the newly acquired Walsh subsidiary. Approximately 30% of the
increase relates to new business with the balance tied to same store growth.
National accounts sales decreased $115.5 million to $83.7 million, or 58.0%,
compared to last year primarily due to the timing of pharmaceutical
manufacturers' product price increases some of which historically occurred in
the December quarter, but did not take place until January 2004. This trade
class has historically benefited from the "buy and hold" industry profit model
where inventory purchases are made in advance of price increases and we benefit
when we sell the product after price increases are put in place. During the
quarter we were successful at building our inventory levels, but manufacturers
put fewer than anticipated product prices increases in place. The timing of
pharmaceutical manufacturers' product price increases limited our ability to
sell product at an acceptable margin.
Net sales decreased $75.3 million to $989.5 million, or 7.1%, for the six
months ended December 31, 2003, compared to the corresponding period of the
prior year. Sales to independent and regional pharmacies increased $142.1
million to $716.3 million, or 24.7%. Approximately 37% of the increase related
to Walsh sales. Approximately 40% of the increase relates to new business with
the balance tied to same store growth. National accounts sales decreased $210.8
million to $211.6 million, or 49.9%, compared to last year primarily as a result
of changes in pharmaceutical manufacturers' inventory management practices that
reduced the availability of attractively priced purchase opportunities. We
provide our national accounts customers bulk pharmaceuticals that we purchase,
if available, on favorable terms from the manufacturers. If we are unable to
obtain bulk inventory on favorable terms, our sales in this area will decline.
GROSS PROFIT Gross profit decreased $1.8 million to $19.5 million, or 8.3%,
for the three months ended December 31, 2003, compared to the corresponding
period of the prior year. As a percentage of net sales, gross margin decreased
from 4.00% to 3.81% for the quarter ended December 31, 2003, compared to the
corresponding period of the prior year. Walsh gross margin was consistent with
the rest of D&K's wholesale drug distribution segment. The decrease in gross
profit in the wholesale drug distribution segment was due to lower national
accounts sales and fewer product price increases, which resulted in lower gross
profit margins. This decrease was partially offset by a legal settlement
received during the second quarter totaling $0.8 million that reduced cost of
sales.
Gross profit decreased $4.7 million to $37.5 million, or 11.2%, for the six
months ended December 31, 2003, compared to the corresponding period of the
prior year. As a percentage of net sales, gross margin decreased from 3.97% to
3.79% for the quarter ended December 31, 2003, compared to the corresponding
period of the prior year. The decrease in gross profit in the wholesale drug
distribution segment was due to lower national accounts sales and fewer product
price increases, which resulted in lower gross profit margins. This decrease was
partially offset by a legal settlement received during the second quarter
totaling $0.8 million that reduced cost of sales.
OPERATING EXPENSES Operating expenses (including depreciation and
amortization) increased $2.3 million to $15.8 million, or 17.3%, for the three
months ended December 31, 2003 compared to the corresponding period of the prior
year. The ratio of operating expenses to net sales was 3.10%, a 56 basis point
increase from the comparable period of the prior year. The increase in operating
expenses resulted primarily from the inclusion of Walsh related operating
expenses during the quarter. The ratio of operating expense to net sales
increased due to the decrease in national accounts sales.
Operating expenses (including depreciation and amortization) increased $2.0
million to $29.0 million, or 7.3%, for the six months ended December 31, 2003
compared to the corresponding period of the prior year. The ratio of operating
expenses to net sales was 2.93%, a 39 basis point increase from the comparable
period of the prior year. The increase in operating expenses resulted primarily
from the inclusion of Walsh related operating expenses during the second
quarter. The ratio of operating expense to net sales increased due to the
decrease in national accounts sales.
Page 14 of 22
INTEREST EXPENSE, NET Net interest expense increased $0.4 million to $3.3
million, or 14.9%, for the three months ended December 31, 2003, compared to the
corresponding period of the prior year. As a percentage of net sales, net
interest expense increased to 0.65% from 0.55%, compared to the corresponding
period of the prior year. The increase in net interest expense was primarily the
result of higher average borrowing levels driven by financing the purchase of
Walsh in combination with higher average investment in inventory and a higher
average borrowing rate.
Net interest expense increased $0.1 million to $5.5 million, or 1.2%, for
the six months ended December 31, 2003, compared to the corresponding period of
the prior year. As a percentage of net sales, net interest expense increased to
0.55% from 0.51%, compared to the corresponding period of the prior year. The
increase in net interest expense was primarily the result of higher average
borrowing levels driven by financing the purchase of Walsh in combination with
higher average investment in inventory and a higher average borrowing rate.
INCOME TAX PROVISION Our effective income tax rate was 39.0% for the three
months and six months ended December 31, 2003, compared to 39.5% for the
corresponding period of the prior year. These rates were different from the
statutory blended Federal and state rates primarily because of the impact of
state income taxes. Our effective rate is lower than the corresponding period of
last year due to the impact of the sales mix on the blended state income tax
rate.
MINORITY INTEREST Minority interest was $0.2 million for the three months
ended December 31, 2003, and for the corresponding period of the prior year.
Minority interest was $0.4 million for the six months ended December 31, 2003
compared to $0.3 million in the corresponding period of the prior year. The
increase relates to higher earnings at PBI as a result of higher sales.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET As a result of the adoption of
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets", we recognized an impairment loss of approximately $7.0
million ($4.2 million net of tax) during the first quarter of fiscal 2003. This
impairment resulted from an appraisal valuation and related to goodwill
originally established for the acquisition of Jewett Drug Co. No such adjustment
was required in the current period.
LIQUIDITY AND CAPITAL RESOURCES
We generally meet our working capital requirements through a combination of
internally generated funds, borrowings under the revolving line of credit and
trade credit from our suppliers.
We use the following ratios as key indicators of our liquidity and working
capital management:
DECEMBER 31, JUNE 30,
2003 2003
--------------------------------
Working capital (000s) $ 517,026 $ 215,639
Current ratio 2.69 to 1 2.14 to 1
Working capital is total current assets less total current liabilities
on our balance sheet. The current ratio is calculated by dividing
total current assets by total current liabilities.
Working capital and current ratio at December 31, 2003 are higher than June
30, 2003 levels. The acquisition of Walsh added approximately $82.5 million of
working capital at December 31, 2003. Inventory levels increased at other
locations as a result of the normal seasonal builds that typically occur in the
December quarter and fewer than anticipated product price increases which kept
inventory levels higher than at June 30, 2003.
On March 31, 2003, we entered into a new $600 million credit facility. The
credit facility, an asset-based senior secured revolving credit facility,
increased our available credit from $430 million to $600 million. The new single
credit facility replaced a $230 million revolving bank line of credit and a $200
million accounts receivable securitization program. Under the credit facility,
the total amount of loans and letters of credit outstanding at any
Page 15 of 22
time cannot exceed the lesser of an amount based on percentages of eligible
receivables and inventories (the borrowing base formula) and $600 million. Total
credit available at December 31, 2003 was approximately $500 million of which
approximately $59 million was unused. The increase in the total credit available
relates to the additional inventory and receivables including those acquired in
the Walsh transaction. The Walsh acquisition and the increase in inventory
levels account for the increase in outstanding long term debt as the credit
facility was used as the source of funds. The interest rate on the credit
facility is based on the 30-day London Interbank Offering Rate (LIBOR) plus a
factor based on certain financial criteria. The interest rate was 3.38% at
December 31, 2003.
Under the terms of the credit facility, we are required to comply with
certain financial covenants, including those related to a fixed charge coverage
ratio and tangible net worth. We are also limited in our ability to make loans
and investments, enter into leases, or incur additional debt, among other
things, without the consent of our lenders. We are in compliance with the debt
covenants as of December 31, 2003.
Net cash used in operating activities totaled $223.2 million for the six
months ended December 31, 2003 with net cash used in operating activities of
$76.6 million in the prior year. This increase is primarily the result of
increases in inventory.
We invested $2.4 million in capital assets in the six months ended December
31, 2003 compared with $1.8 million in the previous year. Current year additions
relate primarily to the expansion of our Cape Girardeau distribution center. The
prior year expenditures were primarily related to leasehold improvements
associated with our new corporate offices that were completed during fiscal
2003. We believe that continuing investment in capital assets is necessary to
achieve our goal of improving operational efficiency, thereby enhancing our
productivity and profitability.
Net cash inflows provided by financing activities totaled $328.5 million
for the six months ended December 31, 2003 with net cash provided by financing
activities of $76.1 million for last year. Borrowings under our revolving line
of credit related to the purchase of Walsh and to support our inventory levels
produced this result.
Stockholders' equity increased $1.0 million to $171.1 million at December
31, 2003 from $170.1 million at June 30, 2003, due to the net earnings during
the period offset by the impact of our purchase of treasury stock during the
first quarter. As of December 31, 2003, 656,500 shares had been repurchased and
the board authorization has expired. We believe that funds available under the
credit facility, together with internally generated funds, will be sufficient to
meet our capital requirements for the foreseeable future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary exposure to market risk consists of changes in interest rates
on borrowings. An increase in interest rates would adversely affect the
operating results and the cash flow available to fund operations and expansion.
Based on the average variable borrowings during fiscal 2003, a change of 25
basis points in the average variable borrowing rate would result in a change of
approximately $0.6 million in annual interest expense. We continually monitor
this risk and review the potential benefits of entering into hedging
transactions, such as interest rate swap agreements, to mitigate the exposure to
interest rate fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
Based on an evaluation of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended) as of the end of the period covered by this
report, our Chief Executive Officer and our Chief Financial Officer have
concluded that such controls and procedures were effective as of the end of the
period covered by this report. In connection with such evaluation, no change in
the Company's internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended)
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
Page 16 of 22
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On February 5, 2004, an individual named Gary Dutton filed a complaint
in the United States District Court for the Eastern District of Missouri against
the Company and its Chief Executive, Operating and Financial Officers
("Defendants") asserting a class action for alleged breach of fiduciary duties
and violations of Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. The complaint alleges that the
Company's press releases and reports filed with the Securities and Exchange
Commission between April 23, 2001 and September 16, 2002 were materially false
and misleading in that they failed to disclose that the Company's results were
based, in material part, on arrangements with a single supplier which the
Company allegedly knew could not be sustained. The complaint also claims that as
a result of the alleged omissions, the market prices of the Company's common
shares during the period were artificially inflated. The complaint seeks
unspecified compensatory damages. The Company believes that the complaint
contains a number of inaccurate statements, does not state any valid cause of
action and that the Company will have substantial meritorious defenses to the
complaint. The Defendants intend to vigorously defend the claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) Registrant's 2003 Annual Meeting of Stockholders was held on
November 12, 2003.
(b) Proxies were solicited by Registrant's management pursuant to
Regulation 14A under the Securities Exchange Act of 1934; there
was no solicitation in opposition to management's nominees as
listed in the proxy statement; and all director nominees were
elected to the class indicated in the proxy statement pursuant to
the vote of the Registrant's stockholders.
(c) Matters voted upon at the Annual Meeting were as follows:
1. Election of Mr. Bryan Lawrence and Ms. Mary Ann Van Lokeren as
class II directors for a term expiring in 2006. The results of
the stockholder voting were as follows:
For Withheld
-------------- ---------------
Mr. Lawrence 13,068,552 160,801
Ms. Van Lokeren 13,078,756 150,597
2. Appointment of KPMG LLP as independent auditors for fiscal 2004.
The result of the stockholder voting was as follows:13,021,258
for, 201,046 against, and 7,049 withheld.
Page 17 of 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
See Exhibit Index on page 19.
(b) Reports on Form 8-K
1. On October 22, 2003, the registrant filed a Current Report on
Form 8-K under Item 12 with a press release announcing its
financial results for the first quarter of fiscal 2004 and
announcing the agreement to acquire Walsh HealthCare Solutions,
Inc.
2. On December 15, 2003, the registrant filed a Current Report on
Form 8-K under Item 2 announcing the completion of the
acquisition of Walsh HealthCare Solutions, Inc. Also, under Item
5, the registrant announced the continued revenue and earnings
weakness in the national accounts trade class.
Page 18 of 22
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.
D & K HEALTHCARE RESOURCES, INC.
Date: February 13, 2004 By: /s/ J. Hord Armstrong, III
----------------- --------------------------
J. Hord Armstrong, III
Chairman of the Board and
Chief Executive Officer
By: /s/ Thomas S. Hilton
--------------------------------
Thomas S. Hilton
Senior Vice President
Chief Financial Officer
(Principal Financial & Accounting
Officer)
Page 19 of 22
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1* Restated Certificate of Incorporation, filed as an exhibit to
registrant's Registration Statement on Form S-1 (Reg. No.
33-48730).
3.2* Certificate of Amendment to the Restated Certificate of
Incorporation of D&K Wholesale Drug, Inc filed as an exhibit
to the registrant's Annual Report on Form 10-K for the year
ended June 30, 1998.
3.3* Certificate of Designations for Series B Junior Participating
Preferred Stock of D&K Healthcare Resources, Inc. filed as an
exhibit to the registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2001.
3.4* By-laws of the registrant, as currently in effect, filed as an
exhibit to registrant's Registration Statement on Form S-1
(Reg. No. 33-48730).
3.5* Certificate of Amendment of Certificate of Incorporation of
D&K Healthcare Resources, Inc., filed as an exhibit to
registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002.
4.1* Form of certificate for Common Stock, filed as an exhibit to
registrant's Registration Statement on Form S-1 (Reg. No.
33-48730).
4.2* Form of Rights Agreement dated as of November 12, 1998 between
registrant and Harris Trust and Savings Bank as Rights Agent,
which includes as Exhibit B the form of Right Certificate,
filed as an exhibit to Form 8-K dated November 17, 1998.
4.3* Agreement and Plan of Merger dated as of October 21, 2003
between D&K Healthcare Resources, Inc., Walsh HealthCare
Solutions, Inc. and D&K Acquisition Corp, files as an exhibit
to registrant's Current Report on Form 8-K dated December 15,
2003.
31.1** Section 302 Certification of Chief Executive Officer.
31.2** Section 302 Certification of Chief Financial Officer.
32** Section 906 Certification of Chief Executive Officer and Chief
Financial Officer.
* Incorporated by reference.
** Filed herewith.