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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 March 31, 2004
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 Identification No.)
incorporation or organization)
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 13,985,437
---------------------------- ----------
(class) (May 12, 2004)
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 2004 and June 30, 2003 3
Condensed Consolidated Statements of Operations for the
Three Months and Nine Months Ended March 31, 2004
and March 31, 2003 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended March 31, 2004 and March 31, 2003 5
Notes to Condensed Consolidated Financial Statements 6 - 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 16
Part II. Other Information
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 17
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30,
2004 2003
---------- ----------
(in thousands) (unaudited)
ASSETS
Current Assets
Cash (including restricted cash of $12,208 and $14,301, respectively) $ 12,208 $ 14,301
Receivables, net of allowance for doubtful accounts of $6,925 and $1,604, respectively 186,495 122,982
Inventories 502,008 257,984
Other current assets 26,848 8,862
---------- ----------
Total current assets 727,559 404,129
Property and Equipment, net of accumulated depreciation and amortization of
$11,428 and $10,673, respectively 23,473 11,140
Other Assets 14,992 11,511
Goodwill, net of accumulated amortization 63,416 44,105
Other Intangible Assets, net of accumulated amortization 6,722 1,810
---------- ----------
Total assets $ 836,162 $ 472,695
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 819 $ 1,677
Accounts payable 245,901 173,342
Accrued expenses 22,306 13,471
---------- ----------
Total current liabilities 269,026 188,490
Long-term Liabilities 6,641 3,703
Long-term Debt, excluding current maturities 384,017 110,423
---------- ----------
Total liabilities 659,684 302,616
Stockholders' Equity
Common stock 152 152
Paid-in capital 125,552 124,704
Accumulated other comprehensive loss (996) (1,371)
Deferred compensation - restricted stock (839) (411)
Retained earnings 64,835 58,415
Less treasury stock (12,226) (11,410)
---------- ----------
Total stockholders' equity 176,478 170,079
---------- ----------
Total liabilities and stockholders' equity $ 836,162 $ 472,695
========== ==========
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
MARCH 31 MARCH 31
--------------------------- ---------------------------
(in thousands, except per share data) 2004 2003 2004 2003
------------ ------------ ------------ ------------
Net Sales $ 833,933 $ 628,618 $ 1,823,426 $ 1,693,427
Cost of Sales 798,756 601,600 1,750,706 1,624,134
------------ ------------ ------------ ------------
Gross profit 35,177 27,018 72,720 69,293
Operating Expenses 21,436 14,881 50,471 41,931
------------ ------------ ------------ ------------
Income from operations 13,741 12,137 22,249 27,362
Other Income (Expense):
Interest expense, net (4,502) (2,765) (9,980) (8,178)
Securitization termination costs -- (2,008) -- (2,008)
Other, net (107) 3 224 (33)
------------ ------------ ------------ ------------
(4,607) (4,770) (9,756) (10,219)
------------ ------------ ------------ ------------
Income before income tax provision, minority interest
and cumulative effect of accounting change 9,132 7,367 12,493 17,143
Income Tax Provision (3,561) (2,947) (4,872) (6,857)
Minority Interest (167) (185) (573) (514)
------------ ------------ ------------ ------------
Net income before cumulative effect of accounting change 5,404 4,235 7,048 9,772
Cumulative effect of accounting change, net -- -- -- (4,249)
------------ ------------ ------------ ------------
Net income $ 5,404 $ 4,235 $ 7,048 $ 5,523
============ ============ ============ ============
Earnings Per Share - Basic
Net income before cumulative effect of accounting change $ 0.39 $ 0.30 $ 0.51 $ 0.67
Cumulative effect of accounting change -- -- -- (0.29)
------------ ------------ ------------ ------------
Net income $ 0.39 $ 0.30 $ 0.51 $ 0.38
============ ============ ============ ============
Earnings Per Share - Diluted
Net income before cumulative effect of accounting change $ 0.38 $ 0.29 $ 0.49 $ 0.66
Cumulative effect of accounting change -- -- -- (0.29)
------------ ------------ ------------ ------------
Net income $ 0.38 $ 0.29 $ 0.49 $ 0.37
============ ============ ============ ============
Basic common shares outstanding 13,928 14,334 13,937 14,453
Diluted common shares outstanding 14,108 14,459 14,144 14,632
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the nine months ended March 31 (in thousands) 2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,048 $ 5,523
Adjustments to reconcile net income to net cash
flows from operating activities --
Depreciation and amortization 2,722 1,900
Amortization of debt issuance costs 1,224 1,018
Deferred income taxes 394 (5,051)
Cumulative effect of accounting change, net -- 4,249
Increase in receivables, net (13,553) (34,209)
(Increase) decrease in inventories (155,461) 16,678
(Increase) decrease in other current assets (3,791) 344
Decrease in accounts payable (2,699) (11,902)
Increase in accrued expenses 3,550 2,794
Other, net (6,104) (4,260)
----------- -----------
Net cash flows used in operating activities (166,670) (22,916)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid for acquired company, net of cash acquired (102,869) --
Purchases of property and equipment (3,456) (2,021)
----------- -----------
Net cash flows used in investing activities (106,325) (2,021)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving line of credit, net 273,770 107,786
Repurchase of receivables under securitization agreement -- (80,000)
Payments of long-term debt (1,034) (949)
Payment of dividends (628) (651)
Cash dividends paid by affiliates (390) (330)
Purchase of treasury stock (816) (4,501)
----------- -----------
Net cash flows provided by financing activities 270,902 21,355
----------- -----------
Decrease in cash (2,093) (3,582)
Cash, beginning of period 14,301 11,754
----------- -----------
Cash, end of period $ 12,208 $ 8,172
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for --
Interest $ 8,211 $ 7,317
Income taxes $ 432 $ 5,864
The accompanying notes are an integral part of these statements.
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 nine-month periods ended March 31, 2004, 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 $ 154,289
Property and equipment 11,574
Other assets 994
Intangible assets 5,199
Goodwill 19,311
----------
Total assets acquired 191,367
----------
Current liabilities 82,182
Long-term liabilities 4,771
----------
Total liabilities assumed 86,953
----------
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 $19.3 million of
goodwill was assigned to the wholesale distribution segment. Of that amount,
none is expected to be deductible for tax purposes.
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, 2002, 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 Nine Months Ended
March 31, March 31,
------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net sales $ 833,933 $ 823,230 $ 2,163,964 $ 2,366,312
Net income (loss) before discontinued operations
and cumulative effect of accounting change $ 5,404 $ 5,758 $ (1,055) $ 15,547
Net income (loss) $ 5,404 $ 3,765 $ (2,611) $ 8,927
Diluted earnings (loss) per share $ 0.38 $ 0.26 $ (0.19) $ 0.60
The nine month period ended March 31, 2004 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, and obsolete inventory. The nine month period ended March 31,
2003 included 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:
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------- -----------------------
(in thousands, except per share data) 2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income - as reported $ 5,404 $ 4,235 $ 7,048 $ 5,523
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of tax (352) (347) (1,152) (1,033)
---------- ---------- ---------- ----------
Net income - pro forma $ 5,052 $ 3,888 $ 5,896 $ 4,490
Earnings per share:
Basic - as reported $ 0.39 $ 0.30 $ 0.51 $ 0.38
Basic - pro forma $ 0.36 $ 0.27 $ 0.42 $ 0.31
Diluted - as reported $ 0.38 $ 0.29 $ 0.49 $ 0.37
Diluted - pro forma $ 0.36 $ 0.27 $ 0.41 $ 0.30
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.
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 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 nine-month period
ended March 31, 2004 are:
(in thousands) Goodwill Intangible Assets
---------- -----------------
Balance at June 30, 2003, net of
accumulated amortization $ 44,105 $ 1,810
Walsh acquisition 19,311 5,199
Amortization expense -- (287)
---------- ----------
Balance at March 31, 2004, net of
accumulated amortization $ 63,416 $ 6,722
========== ==========
Intangible assets totaled $6.7 million, net of accumulated amortization of
$0.6 million, at March 31, 2004. 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.
Goodwill Intangible Assets
--------------------- ---------------------
March 31, June 30, March 31, June 30,
(in millions) 2004 2003 2004 2003
--------- --------- --------- ---------
SEGMENT:
Wholesale drug distribution $ 51.6 $ 32.3 $ 5.1 $ 0.2
PBI 10.4 10.4 1.6 1.7
Software 1.4 1.4 -- --
--------- --------- --------- ---------
Total $ 63.4 $ 44.1 $ 6.7 $ 1.9
========= ========= ========= =========
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 :
Three Months ended March 31, 2004 Three Months ended March 31, 2003
---------------------------------------- ----------------------------------------
Income Shares Per-share Income Shares Per-share
(in thousands, except for per share amounts) (Numerator) (Denominator)(1) Amount (Numerator) (Denominator)(1) Amount
---------------------------------------- ----------------------------------------
Basic Earnings per Share:
Net income available to common stockholders $ 5,404 13,928 $ 0.39 $ 4,235 14,334 $ 0.30
Effect of Diluted Securities:
Options -- 180 -- 125
Convertible securities (30) -- (47) --
----------------------- ----------------------
Diluted Earnings per Share:
Net income available to common stockholders
plus assumed conversions $ 5,374 14,108 $ 0.38 $ 4,188 14,459 $ 0.29
===================================== =====================================
(1) Outstanding shares computed on a weighted average basis
Nine Months ended March 31, 2004 Nine Months ended March 31, 2003
---------------------------------------- ----------------------------------------
Income Shares Per-share Income Shares Per-share
(in thousands, except for per share amounts) (Numerator) (Denominator)(1) Amount (Numerator) (Denominator)(1) Amount
---------------------------------------- ----------------------------------------
Basic Earnings per Share:
Net income before cumulative effect of
accounting change, net $ 7,048 13,937 $ 0.51 $ 9,772 14,453 $ 0.67
Cumulative effect of accounting change, net -- -- (4,249) -- (0.29)
--------------------------------------- ----------------------------------------
Net income available to common stockholders 7,048 13,937 0.51 5,523 14,453 0.38
Effect of Diluted Securities:
Options -- 207 -- 179
Convertible securities (147) -- (128) --
------------------------ ------------------------
Diluted Earnings per Share:
Net income available to common stockholders
plus assumed conversions $ 6,901 14,144 $ 0.49 $ 5,395 14,632 $ 0.37
======================================= ========================================
(1) Outstanding shares computed on a weighted average basis
As of March 31, 2004 and 2003, stock options to purchase 1.3 million and
1.1 million shares respectively were not dilutive and therefore not included in
the diluted earnings per share calculation.
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 Nine Months Ended
March 31, March 31,
-------------------- ----------------------
2004 2003 2004 2003
------- -------- -------- --------
Net income $ 5,404 $ 4,235 $ 7,048 $ 5,523
Change in value of cash flow hedge, net of tax 18 (6) 375 (419)
------- -------- -------- --------
Total comprehensive income $ 5,422 $ 4,229 $ 7,423 $ 5,104
======= ======== ======== ========
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
March 31, 2004, 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.
The Company has entered into an agreement with Parata Systems, LLC to
become the exclusive distributor of their robotic dispensing system (RDS) for
independent and regional pharmacies in a 23-state region and Puerto Rico. The
Parata RDS is specifically designed to meet the needs of retail pharmacies by
automating up to 150 prescriptions per hour. The RDS uses a bar-coded
maintenance system to ensure accuracy and eliminate potential for operator
error. The Parata RDS can be a significant tool to increase efficiency,
effectiveness and accuracy, and provide pharmacists with more time for
interactions with patients. As part of the agreement, the Company has committed
to purchase machines during a period that ends March 2006. At March 31, 2004,
the remaining purchase commitment is approximately $36 million.
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
describes types of transactions in which the Company has not engaged, 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 the Company's maximum 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 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 March 31, 2004 was
approximately $435 million of which approximately $52 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 3.34% at March 31, 2004. 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.
For The Three Months Ended For the Nine Months Ended
--------------------------------- ---------------------------------
(in thousands) March 31, 2004 March 31, 2003 March 31, 2004 March 31, 2003
--------------------------------- ---------------------------------
Net Sales -
Wholesale drug distribution $ 831,071 $ 625,965 $1,813,795 $1,685,698
PBI 2,100 1,979 6,697 5,682
Software/Other 762 674 2,934 2,047
----------------------------- -----------------------------
Total $ 833,933 $ 628,618 $1,823,426 $1,693,427
Gross Profit -
Wholesale drug distribution $ 32,422 $ 24,501 $ 63,960 $ 61,986
PBI 2,100 1,979 6,697 5,682
Software/Other 655 538 2,063 1,625
----------------------------- -----------------------------
Total $ 35,177 $ 27,018 $ 72,720 $ 69,293
Pre-tax earnings -
Wholesale drug distribution $ 8,060 $ 6,187 $ 8,560 $ 13,820
PBI 878 1,001 3,043 2,741
Software/Other 194 179 890 582
----------------------------- -----------------------------
Total $ 9,132 $ 7,367 $ 12,493 $ 17,143
The increase in total assets from the Company's 2003 Annual Report relates
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.
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 March 31, 2004 and June 30, 2003, and in the condensed consolidated
statements of operations for the three-month and nine-month periods ended March
31, 2004 and March 31, 2003, 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.
FORWARD LOOKING STATEMENTS
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, changes in the Company's prime vendor
status with cooperative purchasing groups, the availability of investment
purchasing opportunities, the changing business and regulatory environment of
the healthcare industry in which the Company operates, including manufacturers'
pricing or distribution policies or practices, the loss of one or more key
suppliers for which alternative sources may not be available, 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 AND EVENTS
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,
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 over-the-counter 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 our net sales and
profits to increase. Walsh generated net sales of approximately $900 million in
its 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.
On March 26, 2004, our Texarkana distribution center ceased operations.
This facility was acquired as part of the Walsh HealthCare Solutions transaction
in December 2003. The closing of this facility will not have a material impact
on our financial statements.
On April 26, 2004, we filed a Form S-3 shelf registration statement that
will allow us to sell, from time to time in one or more offerings, up to $200
million of any combination of debt and equity securities described in the
registration statement. At this time, we do not have any plans to sell any of
these securities. This disclosure does not constitute an offer to sell or the
solicitation of an offer to buy any securities.
In April 2004, we received proceeds for the settlement of an antitrust
class action lawsuit amounting to $2.3 million ($1.4 million, after tax) that
will reduce cost of sales in our fourth fiscal quarter.
RESULTS OF OPERATIONS
NET SALES Net sales increased $205.3 million to $833.9 million, or 32.7%,
for the three months ended March 31, 2004, compared to the corresponding period
of the prior year. Sales to independent and regional pharmacies increased $255.0
million to $541.0 million, or 89.2%. Approximately 78% of the increase relates
to sales from the newly acquired Walsh subsidiary. Approximately 15% of the
increase relates to new business with the balance tied to same store growth.
National accounts sales decreased $42.6 million to $261.2 million, or 14.0%,
compared to last year primarily due to 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 continue to decline.
Net sales increased $130.0 million to $1,823.4 million, or 7.7%, for the
nine months ended March 31, 2004, compared to the corresponding period of the
prior year. Sales to independent and regional pharmacies increased $397.1
million to $1,257.3 million, or 46.2%. Approximately 63% of the increase related
to Walsh sales. Approximately 25% of the increase relates to new business with
the balance tied to same store growth. National accounts sales decreased $253.4
million to $472.8 million, or 34.9%, 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 continue
to decline.
GROSS PROFIT Gross profit increased $8.2 million to $35.2 million, or
30.2%, for the three months ended March 31, 2004, compared to the corresponding
period of the prior year. As a percentage of net sales, gross margin decreased
from 4.30% to 4.22% for the quarter ended March 31, 2004, 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 increase in gross
profit in the wholesale drug distribution segment was due to the addition of
Walsh and additional sales related to new business and same store growth offset
by lower national accounts sales and continued pricing pressure on new and
existing business.
Gross profit increased $3.4 million to $72.7 million, or 4.9%, for the
nine months ended March 31, 2004, compared to the corresponding period of the
prior year. As a percentage of net sales, gross margin decreased from 4.09% to
3.99% for the quarter ended March 31, 2004, compared to the corresponding period
of the prior year. The increase in gross profit in the wholesale drug
distribution segment was due to the addition of Walsh and additional sales
related to new business and same store growth. The increase also included a
legal settlement received during the second quarter totaling $0.8 million that
reduced cost of sales. The decrease in gross margin relates to lower national
accounts sales and continued pricing pressure on new and existing business.
OPERATING EXPENSES Operating expenses (including depreciation and
amortization) increased $6.6 million to $21.4 million, or 44.1%, for the three
months ended March 31, 2004 compared to the corresponding period of the prior
year. The ratio of operating expenses to net sales was 2.57%, a 20 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.
Operating expenses (including depreciation and amortization) increased
$8.5 million to $50.5 million, or 20.4%, for the nine months ended March 31,
2004 compared to the corresponding period of the prior year. The ratio of
operating expenses to net sales was 2.77%, a 29 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.
INTEREST EXPENSE, NET Net interest expense increased $1.7 million to $4.5
million, or 62.8%, for the three months ended March 31, 2004, compared to the
corresponding period of the prior year. As a percentage of net sales, net
interest expense increased to 0.54% from 0.44%, 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.
Net interest expense increased $1.8 million to $10.0 million, or 22.1%,
for the nine months ended March 31, 2004, compared to the corresponding period
of the prior year. As a percentage of net sales, net interest expense increased
to 0.55% from 0.48%, 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.
INCOME TAX PROVISION Our effective income tax rate was 39.0% for the three
months and nine months ended March 31, 2004, 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 March 31, 2004, and for the corresponding period of the prior year.
Minority interest was $0.6 million for the nine months ended March 31, 2004
compared to $0.5 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:
MARCH 31, JUNE 30,
2004 2003
---------- ----------
Working capital (1) (000s) $ 458,533 $ 215,639
Current ratio 2.70 to 1 2.14 to 1
(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 March 31, 2004 are higher than June
30, 2003 levels. The acquisition of Walsh added approximately $97.2 million of
working capital at March 31, 2004. Inventory levels increased at other locations
due to higher inventory requirements as the result of increased sales and the
impact of increased product cost due to normal inflation.
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 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 March 31, 2004 was approximately $435 million of which
approximately $52 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 3.34% at March
31, 2004.
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 March 31, 2004.
Net cash used in operating activities totaled $166.7 million for the nine
months ended March 31, 2004 with net cash used in operating activities of $22.9
million in the prior year. This increase is primarily the result of increases in
inventory.
We invested $3.5 million in capital assets in the nine months ended March
31, 2004 compared with $2.0 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 $270.9 million
for the nine months ended March 31, 2004 with net cash provided by financing
activities of $21.4 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. The prior year also included $80.0 million related to the
repurchase of receivables upon the termination of the accounts receivable
securitization program.
Stockholders' equity increased $6.4 million to $176.5 million at March 31,
2004 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 March 31, 2004, 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.
In May 2004, we entered into an interest rate swap agreement that
effectively fixes the interest rate on $100 million of our revolving line of
credit at a nominal rate of 3.15% through June 30, 2006. There was no up-front
cost associated with this agreement.
CRITICAL ACCOUNTING POLICIES
Refer to "Critical Accounting Policies" in our 2003 Annual Report on Form
10-K for information on accounting policies that we consider critical in
preparing our consolidated financial statements. These policies include
significant estimates made by management using information available at the time
the estimates are made. However, these estimates could change materially if
different information or assumptions were used.
NEW ACCOUNTING STANDARDS
Refer to Note 14 of Notes to Consolidated Financial Statements in our 2003
Annual Report on Form 10-K for a discussion of recently issued accounting
standards. Our adoption of these new accounting standards did not have a
material effect on our financial position or results of operations.
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 our
operating results and the cash flow available to fund operations and expansion.
Based on the average variable borrowings during fiscal 2003 plus an estimate of
the amount borrowing will increase as a result of the Walsh acquisition, a
change of 25 basis points in the average variable borrowing rate would result in
a change of approximately $0.8 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.
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
PART LL. 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
describes types of transactions in which the Company has not engaged, 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
See Exhibit Index on page 19.
(b) Reports on Form 8-K
1. On February 13, 2004, the registrant filed a Current Report on
Form 8-K/A under Item 7 which provided the required financial
information relating to its acquisition of Walsh HealthCare
Solutions, Inc.
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: May 12, 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)
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, filed 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.