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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended June 30, 2004 Commission File Number 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01
Series B Junior Participating Preferred Stock Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates of
the registrant: approximately $135,319,457 as of September 7, 2004.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of September 07,
2004, 14,057,449 shares of Common Stock, par value $.01, were outstanding.
Indicate by check mark whether the registrant is an accelerated filer. Yes [X]
No [ ]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference in the Part of
this report indicated below:
Part II - Registrant's 2004 Annual Report to Stockholders
Part III - Registrant's Proxy Statement for its 2004 Annual Meeting of
Stockholders
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PART I
Item 1. Business
GENERAL
D&K Healthcare Resources, Inc. is a full-service wholesale distributor of
branded and generic pharmaceuticals and over-the-counter healthcare and beauty
aid products. We serve three classes of customers:
- INDEPENDENT AND REGIONAL PHARMACIES: Located in 27 states primarily
in the Midwest, Upper Midwest and South, these D&K customers
generally operate single or multisite locations in one or more
states.
- NATIONAL ACCOUNTS: D&K national account customers generally operate
a large number of locations in multiple regions of the United
States.
- OTHER HEALTHCARE PROVIDERS: These D&K customers include hospitals,
alternate-site care providers and pharmacy benefit management
companies located in our 27-state primary distribution territory.
We serve our customers by distributing a broad range of products through
eight distribution facilities located in Missouri, Kentucky, Minnesota,
Arkansas, South Dakota and Texas. We also offer a number of proprietary
information systems, marketing programs and other business management solutions
to assist customers in operating and growing their businesses. In addition, D&K
owns a 70 % equity stake in Pharmaceutical Buyers, Inc. ("PBI"), an industry
leader in alternate site group purchasing services located in Broomfield, CO. In
June 2004, the Company reached agreement to acquire the remaining 30% interest
in PBI, and is expected to close this transaction by September 30, 2004.
Sales to independent and regional pharmacies consist of branded
pharmaceuticals (approximately 89% of net sales in fiscal 2004), generic
pharmaceuticals (approximately 8% of net sales in fiscal 2004) and
over-the-counter health and beauty aid products (approximately 3% of net sales
in fiscal 2004). Our national accounts trade class sales are predominantly
branded pharmaceuticals.
On December 5, 2003, the Company acquired 100 % 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, Texas and Paragould, Arkansas.
On March 13, 2002, we declared a two-for-one stock split in the form of a
stock dividend effective April 12, 2002. We have adjusted all share and per
share amounts in this report and in the consolidated financial statements to
retroactively reflect this stock split.
On July 5, 2001, we completed a secondary stock offering of approximately
4.8 million shares of our common stock. We used the net proceeds of
approximately $77 million to repay debt.
In July 2001, as part of the secondary stock offering, we increased our
ownership percentage in PBI to 68%, and in August 2001 we increased our
ownership another 2%. We increased our ownership by exchanging PBI stock for
shares of D&K common stock as provided for in the acquisition agreement for our
initial 50% ownership interest. We describe these transactions more fully in
Note 2 to our consolidated financial statements.
On June 15, 2001, we acquired 100% of the outstanding stock of Diversified
Healthcare, LLC, a pharmaceutical distribution company based in Owensboro,
Kentucky that provides comprehensive pharmaceutical distribution services to
customers in the Midwest region.
On June 1, 1999, we acquired 100% of the outstanding stock of Jewett Drug
Co., a pharmaceutical distribution company based in Aberdeen, South Dakota that
provides comprehensive pharmaceutical distribution services to customers in the
Upper Midwest and Great Plains regions.
We believe that our size, decentralized operating structure and high level
of customer service provide us with competitive advantages and position us to
benefit from trends impacting our industry. The national wholesale distributors
are growing in size and scale as they pursue a strategy to become primary
distributors to national pharmacies and other large healthcare providers. We
believe their approach creates opportunities for us to effectively compete with
them based on our business focus and differentiated service offering.
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INDUSTRY OVERVIEW
Wholesale pharmaceutical distributors serve pharmacies and healthcare
providers as a single source for pharmaceutical and over-the-counter health and
beauty aid products from hundreds of different manufacturers. Wholesale
pharmaceutical distributors lower customer inventory costs, provide efficient
and timely product delivery, and provide valuable inventory and purchasing
information. Also, value-added programs developed by wholesale pharmaceutical
distributors, including packaging, stockless inventory and pharmacy computer
systems, help customers reduce costs and improve operating efficiencies.
Wholesale pharmaceutical distributors are an important distribution
channel for pharmaceutical manufacturers, accounting for approximately 73% of
the $212.7 billion of prescription drug sales to retailers and institutions
during 2003. Wholesale pharmaceutical distribution industry sales increased from
$2.4 billion in 1970 to an estimated $155.2 billion in 2003, growth we expect to
continue. Several principal factors contribute to this historical and
anticipated growth:
- AGING POPULATION: The number of individuals in the United States
over age 65 grew from approximately 12.3 million in 1950 to
approximately 35 million in 2000; the U.S. Census Bureau projects it
will increase to more than 70 million by the year 2030. This
demographic group represents the largest percentage of new
prescriptions filled and obtains more prescriptions per capita
annually than any other age group.
- INCREASED PHARMACEUTICAL USE: In recent years, a number of factors
have contributed to the growth in drug-based therapies to prevent
and treat disease. These include increased research and development
spending by manufacturers leading to new pharmaceutical
introductions, the lower costs of drug-based therapy relative to
surgery, and increased direct-to-consumer advertising by
manufacturers.
- IMPORTANCE OF WHOLESALE DISTRIBUTION CHANNEL: In response to the
rising costs and complexity of inventory management and product
distribution, pharmaceutical manufacturers are relying increasingly
on wholesale distributors to fill these functions more efficiently.
Over the past decade, as the cost and complexity of maintaining
inventories and arranging for delivery of pharmaceutical products
have risen, manufacturers of pharmaceuticals have significantly
increased the distribution of their products through wholesalers.
Drug wholesalers are generally able to offer their customers and
suppliers more efficient distribution and inventory management than
pharmaceutical manufacturers. As a result, from 1990 to 2003, the
percentage of total pharmaceutical sales through wholesale
distributors increased from approximately 57% to approximately 73%.
- RISING PHARMACEUTICAL PRICES. For more than a decade, the
manufacturers' price increases for branded pharmaceuticals have met
or exceeded the overall increases in the Consumer Price Index. We
believe this trend will continue largely because the relatively
inelastic demand for branded pharmaceuticals supports the higher
prices charged for patented drugs as manufacturers attempt to recoup
costs associated with developing, testing, and seeking U.S. Food and
Drug Administration approval of new products. From 1990 to 2003, the
average retail price of a prescription increased from $22.06 to
$57.48.
CUSTOMERS AND PRODUCTS
Our customer base consists of independent and regional pharmacies,
national pharmacy chains (national accounts), and other healthcare providers.
Independent pharmacies are generally community-based and, we believe, benefit
the most from our customized sales, information systems, and other value-added
services. Regional pharmacies generally focus on serving people from multiple
sites in one or more states. National accounts generally have stores located in
more than one region in the United States; they include supermarket and mass
merchandiser pharmacies. Other healthcare providers consist of hospitals, other
alternate-site care providers (including nursing homes, clinics, home health
services and managed care organizations), and pharmacy benefit management
companies.
We are committed to serving the unique needs of independent and regional
pharmacies and have structured our business and operating model to do this
efficiently and profitably.
We operate on a fiscal year-end of June 30. Unless otherwise indicated,
all further references to "2004," "2003," and "2002" in this document will mean
our fiscal years ended June 30, 2004, June 30, 2003, and June 30, 2002,
respectively.
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NET SALES
2004 2003 2002
--------------------- --------------------- ---------------------
(Dollars In Thousands) AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ------- ----------- ------- ----------- -------
Independent and regional pharmacies $ 1,820,312 71.6% $ 1,156,460 52.0% $ 1,089,326 44.4%
National accounts 593,733 23.4% 929,582 41.8% 1,246,654 50.8%
Other healthcare providers 113,697 4.5% 126,333 5.7% 107,517 4.4%
PBI / Software sales 13,448 0.5% 11,013 0.5% 10,251 0.4%
----------- ------ ----------- ------ ----------- ------
Total $ 2,541,190 100.0% $ 2,223,388 100.0% $ 2,453,748 100.0%
=========== ====== =========== ====== =========== ======
During 2004, 2003 and 2002, our 10 largest customers accounted for
approximately 28.4%, 43.1%, and 56.4%, respectively, of our net sales. Our
largest customer during 2004 accounted for approximately 7% of our net sales.
Our largest customer in 2003 and 2002 accounted for approximately 9% and 24% of
our net sales, respectively.
Independent and Regional Pharmacies
Since our inception, one of our primary strategies has been to focus on
serving the specialized needs of independent and regional pharmacies. While our
larger national competitors increasingly organize their businesses around
serving the primary needs of national pharmacy chains and national contracts
with group purchasing organizations and pharmacy benefit managers, we are
organized to profitably and efficiently provide all of our services to our
independent and regional pharmacy customers in 27 states, primarily in the
Midwest, Upper Midwest, and South from our seven full-service distribution
centers in six states. Our independent and regional pharmacy business grew from
$1,089.3 million in net sales in 2002 to $1,820.3 million in 2004.
Our product offerings to independent and regional pharmacies consist of
more than 40,000 SKUs, including branded and generic pharmaceuticals and
over-the-counter health and beauty aid products. We deliver these products
directly to the stores of our independent pharmacy customers and deliver both to
the stores and warehouses of our regional pharmacy customers if they maintain
centralized inventory.
Our decentralized organization allows our distribution centers to form
strong, attentive and responsive business relationships with our independent and
regional pharmacy customers. Each center has the personnel and capabilities to
autonomously provide customized distribution, information systems, inventory
management and other services to our local independent and regional pharmacy
customers. We fulfill our customers' orders with a high degree of speed and
accuracy and we believe that they value our flexibility and willingness to meet
and accommodate their special requests and needs. We believe that the large
national wholesale distributors, which are organized to serve primarily large
national pharmacies and national contracts, do not have the operating
flexibility to service independent and regional pharmacies as we do.
National Accounts
We have a significant business serving as a secondary supplier of
high-volume branded pharmaceuticals to national pharmacies and other national
accounts that is built on our strong independent and regional pharmacy business
and our competitive position and solid relationships with pharmaceutical
manufacturers. We provide our national account customers with more than 2,800
branded and generic bulk pharmaceuticals that we purchase from pharmaceutical
manufacturers on favorable terms. Our net revenues from these sales have fallen
from $1,246.7 million in 2002 to $593.7 million in 2004, primarily due to
changes in pharmaceutical manufacturers' inventory management practices that
reduced the availability of attractively priced purchase opportunities. As a
percentage of our total net sales, national accounts has fallen from 42% in 2003
to 23% in 2004. We anticipate that in future periods this percentage will be in
the 10-15% range of total net sales as independent and regional pharmacy sales
continue to grow. 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.
Our industry is subject to regulations that require organizations that
distribute or sell pharmaceuticals to trace the detailed history of products
back to the manufacturer or an authorized distributor. We purchase the vast
majority of our pharmaceuticals directly from manufacturers; the balance comes
directly from authorized distributors or otherwise
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is obtained in accordance with applicable law. We believe our reputation and
conservative business practices make us a desirable business partner for
pharmaceutical manufacturers and national pharmacy chains.
We use our longstanding manufacturer and national account relationships to
provide services that benefit both our customers and our suppliers. We have
developed and maintain the reputation and contacts that enable us to identify
opportunities to purchase branded pharmaceuticals from manufacturers at
attractive prices. In addition to our experience and expertise, we also employ
sophisticated information and inventory management systems to project the demand
for products in advance of purchasing them for distribution.
Additional Services
Consistent with our strategy to offer a high level of customer service to
our customers, we offer a number of proprietary information systems, marketing,
and other business management solutions to help customers operate and grow their
businesses profitably. Through our Tykon, Inc. subsidiary, we have developed and
market a proprietary order entry and confirmation system to the drug
distribution industry. We offer and fully support these services from our
distribution centers. Although we make these services available to all
customers, our independent pharmacy customers profit most from these services
and are the heaviest users. Our services and support provide independent and
regional pharmacies with resources normally available only to larger businesses.
In providing these resources, we believe that we enable them to operate more
efficiently and competitively and that we increase our value to them.
Principal elements of our service offering to our customers include:
- Order entry and confirmation systems: These include
DirectKonnect(SM), a proprietary order entry/order confirmation
system, that completely automates all order creation, transmission
and confirmation operations, and PARTNERS(SM), a fully automated and
customizable replenishment software system which helps pharmacies
more efficiently coordinate product supply and demand. These
proprietary order entry and confirmation systems help customers
improve their margins and significantly reduce their working capital
needs through effective inventory management.
- Dispensing management systems: SCRIPTMASTER(R) gives customers
computerized order entry, point-of-sale capabilities, inventory
control, patient histories, drug interactions and pharmacy
reimbursement. This service provides pharmacies with cost savings
and enhanced efficiencies as well as manufacturers with valuable
prescription histories.
- Merchandising and marketing services: Under our MedPlus(R) identity
program, we plan and coordinate cooperative advertising programs for
our customers and provide various promotional products, including
single-source generics from leading pharmaceutical manufacturers at
highly competitive prices. MedPlus(R) also offers new product
introduction programs, point-of-sale materials, calendars, blood
pressure testing units, automatic new product distribution, rack
jobbing, store fixtures and retail employee training programs. Other
services offered under MedPlus(R) include: retail merchandising,
inventory management systems, electronic order entry, shelf labels
and price stickers, private label products, monthly feature
promotions, home healthcare marketing programs, store layout
assistance, business management reports, pharmacy computer systems
and monthly catalogs.
OPERATIONS
We are an organization of locally managed pharmaceutical wholesale
distribution centers. Each distribution center has its own executive, sales and
operations staff. These operations use our corporate staff for procurement,
marketing, financial, legal, information systems and executive management
resources; the corporate staff also manages assets and working capital. Our
decentralized sales and distribution network, combined with our centralized
procurement and corporate support, enable us to provide high levels of
specialized customer service while minimizing administrative expenses and
maximizing volume discounts for product purchases.
Our distribution centers include computer systems and sophisticated
materials handling equipment for receiving, storing and distributing large
quantities and varieties of products. We continuously seek to improve our
warehouse automation technologies to maximize operational efficiencies on a
cost-effective basis. Our distribution centers receive virtually all orders
electronically and, upon receipt, the warehouse-management system produces
"picking documents" that contain product selection, loading and truck routing
information. The system also provides customized price information (geared to
the customers' local markets) or individual price stickers that accompany
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each shipment to facilitate the customers' item pricing. Our distribution
centers can ship virtually all orders in less than 24 hours after customers
place them. We deliver orders using our fleet of trucks and vans or contract
carriers.
During the fourth quarter of fiscal 2004, we completed the expansion of
our Cape Girardeau, Missouri distribution center. We added 60,000 square feet to
the existing building to nearly double the size of the facility. In addition to
expanding the facility size, we installed new automated machinery and equipment
including sophisticated materials handling equipment for receiving, storing and
distributing large quantities and varieties of products.
SALES AND MARKETING
We employ sales and customer service representatives at each of our
distribution centers. Our sales representatives receive regular training to
continuously improve customer service and to provide them with the skills and
resources for increasing business with existing customers and establishing new
customer relationships. Each distribution center also maintains a
telephone-based customer service department staffed with trained representatives
who answer customer questions and solve problems.
We focus our marketing efforts on developing and maintaining primary
relationships with customers. Our sales force emphasizes frequent personal
interaction with customers, who come to rely on our dependability and
responsiveness, order accuracy and the breadth of our product line. Our
customers also rely on our sales force for assistance with advertising,
merchandising, stocking and inventory management.
We believe that our distribution center-based service differentiates us
from our national competitors; it is a key element in our marketing program. Our
decentralized customer service staffs focus on developing relationships with
customers, responding quickly to customer inquiries, and placing orders
accurately and efficiently.
In July 2003, we 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. Faced with shortages of qualified pharmacists and pharmacy technicians,
the Parata RDS can be a significant tool to increase efficiency, effectiveness
and accuracy, and provide pharmacists with more time for interactions with
patients.
PURCHASING AND INVENTORY CONTROL
We use sophisticated inventory control and purchasing software to track
inventory, analyze demand history, and project future demand. Our system is
designed to enhance profit margins by eliminating the manual ordering process,
allowing for automatic inventory replenishment, and identifying inventory buying
opportunities.
We purchase products from approximately 1,200 suppliers. During 2004 and
2003, our 10 largest suppliers accounted for approximately 54% and 57%,
respectively, of our purchases by dollar volume. Our largest supplier accounted
for approximately 16% (by dollar volume) of our purchases during 2004 and
approximately 8% (by dollar volume) of our purchases during 2003. The increase
in percentage purchases from our largest single supplier between 2004 and 2003
was primarily the result of an industry merger. The majority of our supply
contracts are terminable by either party upon short notice and without penalty,
a common industry practice. We believe that our relationships with our suppliers
are strong.
MANAGEMENT INFORMATION SYSTEMS
Each of our distribution centers operates as a distinct business with
complete system functionality including sales order, inventory, and
transportation management; customer service; accounts payable and receivable;
general ledger; and financial reporting.
We use the PeopleSoft EnterpriseOne, formerly JD Edwards OneWorld(TM),
product as our Enterprise Resource Planning (ERP) software package to integrate
all these functions, which were previously maintained separately by each
distribution center. Completed in July 2003, the new system consolidates
operations in St. Louis and Cape Girardeau, Missouri, and provides us with
significantly improved operations management and financial reporting systems. We
are in process of converting the Walsh distribution centers to our system. The
Paragould location was converted in July 2004 and the San Antonio location is
scheduled to be converted in the second quarter of fiscal 2005.
6
BUYING GROUP
In November 1995, we purchased 50% of Pharmaceutical Buyers, Inc. (PBI), a
Colorado-based group purchasing organization. PBI, with over 3,600 member
organizations, is one of the largest pharmaceutical group purchasing
organizations in the United States. PBI's members include long-term care
providers, home infusion providers and medical equipment distributors. In
connection with our secondary stock offering in July 2001, we increased our
ownership in PBI to 68%, and acquired an additional 2% in a subsequent
transaction in August 2001. The resulting consolidation of PBI's operations
increased our gross profit and gross margin percentage but had no effect on
earnings per share. PBI represented 0.3% of our net sales in both 2004 and 2003
and 8.5% and 8.6% of our gross profit in 2004 and 2003, respectively.
In June 2004, the Company reached agreement to acquire the remaining 30%
interest in PBI for $12.4 million. This transaction is subject to certain
financing contingencies, but is expected to close by September 30, 2004.
COMPETITION
The wholesale distribution of branded and generic pharmaceuticals and
over-the-counter health and beauty aid products, is highly competitive. National
and regional distributors compete primarily on the basis of service and price.
Other competitive factors include delivery service, credit terms, breadth of
product line, customer support, merchandising and marketing programs. We compete
with national, regional, and other wholesale distributors, pharmaceutical
manufacturers, generic pharmaceutical telemarketers and specialty distributors
for product purchases and financial support in the form of trade credit from
manufacturers. Certain of our competitors, including McKesson Corporation,
AmerisourceBergen Corporation, and Cardinal Health, Inc., have significantly
greater financial and marketing resources.
EMPLOYEES
As of August 31, 2004, we employed 784 persons; 737 were full-time
employees. Approximately 31 employees at our Minneapolis distribution center are
covered by a collective bargaining agreement with the Miscellaneous Drivers,
Helpers and Warehousemen's Union, Local 638, which expires in March 2008.
Approximately 14 employees at our Jewett Drug Co. subsidiary are covered by a
collective bargaining agreement with the General Drivers and Helpers Union Local
749, affiliated with the International Brotherhood of Teamsters, which expires
February 29, 2008. We believe we have good employee relations.
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 such as those listed below and elsewhere in this report,
which among others, should be considered in evaluation our future financial
performance. 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.
FACTORS THAT MAY IMPACT FUTURE RESULTS
The risks and uncertainties described below are those that we
currently believe may materially affect our company. Other risks and
uncertainties that we do not presently consider to be material or of which we
are not presently aware may become important factors that affect our Company in
the future. If any of the risks discussed below actually occur, our business,
financial condition, operating results, cash flows or prospects could be
materially adversely affected.
INTENSE COMPETITION IN THE WHOLESALE PHARMACEUTICAL DISTRIBUTION
INDUSTRY COULD CAUSE OUR SALES AND MARGINS TO DECLINE. The wholesale
distribution of pharmaceuticals is highly competitive, with national and
regional distributors competing primarily on the basis of service and price.
Other competitive factors include delivery service, credit terms, breadth of
product line, customer support and merchandising, information system services
and marketing programs. We compete with:
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- large, national distributors;
- local and regional wholesalers;
- manufacturers;
- generic pharmaceutical telemarketers; and
- specialty distributors.
Our national competitors have significantly greater financial,
distribution and marketing resources than we do. Moreover, our industry has
experienced significant consolidation in recent years and, as a result, some of
our competitors have significantly increased their advantage in such resources.
Additionally, the products we distribute are generally available to our
customers from multiple sources and many of our customers also utilize other
wholesale distributors. Our competitors could obtain exclusive rights from
manufacturers to market particular products that currently are not subject to
exclusive distribution arrangements or which are currently distributed by us,
which could cause us to lose sales or customers and our margins could decline.
In addition, manufacturers could elect to sell a higher proportion of their
products directly to customers, which would decrease the demand for such
products from wholesale distributors and increase competition. We cannot assure
you that we will not encounter increased competition in the future or that we
will be able to keep our market share because of the high level of competition
in our industry.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF RELATIONS WITH ANY OF
OUR SIGNIFICANT SUPPLIERS ARE TERMINATED. Our ability to purchase
pharmaceuticals, or to expand the scope of pharmaceuticals purchased, from a
particular supplier is largely dependent upon such supplier's assessment of our
creditworthiness and our ability to resell the products we purchase. We are also
dependent upon our suppliers' continuing need for, and willingness to utilize,
our services. If we cease to be able to purchase pharmaceuticals from any of our
significant suppliers, such occurrence could have a material adverse effect on
our business, results of operations and financial condition because many
suppliers own exclusive patent rights and are the sole manufacturers of certain
pharmaceuticals. If we were to become unable to purchase patented products from
any such supplier, we would be required to purchase such products from other
distributors on less favorable terms, and our profit margin on the sale of such
products could be eliminated. Substantially all of our agreements with suppliers
are terminable by either party upon short notice and without penalty.
OUR INDUSTRY HAS EXPERIENCED DECLINING MARGIN PERCENTAGES IN RECENT
YEARS AND, IF THIS TREND CONTINUES, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Over the past decade, participants in the wholesale pharmaceutical distribution
industry have experienced declining gross and operating margin percentages.
Industry sources estimate that the average gross margin percentage of companies
in the industry has decreased from approximately 7.35% in calendar year 1990 to
approximately 4.33% in calendar year 2002. Our gross margin percentage decreased
from approximately 6.74% in fiscal year 1992 to approximately 4.07% in fiscal
year 2004, primarily as a result of pricing pressures reducing margins.
Currently, profitability of wholesale distributors, including us, is largely
dependent upon earning volume incentives, cash discounts and rebates from
pharmaceutical manufacturers. Our profitability is also partially dependent on
our ability to purchase inventory in advance of anticipated or known
manufacturer price increases. Although investment buying opportunities may
enable us to increase our gross margin percentage when manufacturers increase
prices, such buying requires subjective assessments of future price changes as
well as significant working capital. If our gross margin percentages decline
significantly, or if our assessments of future price changes are incorrect, or
if we do not have the necessary working capital to take advantage of buying
opportunities, our profitability could be materially adversely affected.
CHANGES IN VENDOR SUPPLY CHAIN MANAGEMENT POLICIES AND THE USE OF
INVENTORY MANAGEMENT AGREEMENTS IN THE PHARMACEUTICAL DISTRIBUTION INDUSTRY
COULD ADVERSELY IMPACT OUR RESULTS OF OPERATIONS. Our business is dependent on
our ability to purchase pharmaceutical products. We historically invested
capital in pharmaceutical inventory to take advantage of relevant market
dynamics, including anticipated manufacturer price increases. We have recently
seen changes in vendor supply chain management policies related to product
availability, including the use of inventory management agreements. Inventory
management agreements generally provide for the distributor to be compensated on
a negotiated basis to help manufacturers better match their shipments to meet
market demand, thereby resulting in less surplus inventory available to the
distributor. Continued changes in vendor policies related to product
availability may limit our ability to leverage our resources and could adversely
impact our business and results of operations.
THE LOSS OF ONE OR MORE OF OUR LARGEST CUSTOMERS OR A SIGNIFICANT
DECLINE IN THE LEVEL OF PURCHASES MADE BY ONE OR MORE OF OUR LARGEST CUSTOMERS
COULD HURT OUR BUSINESS BY REDUCING OUR REVENUES AND EARNINGS. Our 10 largest
customers accounted for approximately 28% (by dollar volume) of our revenues
during fiscal 2004 and approximately 43% (by dollar volume) of our revenues
during fiscal 2003. Our largest customer accounted for
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approximately 7% (by dollar volume) of our revenues during fiscal 2004 and
approximately 9% of our revenues during fiscal 2003. As is customary in our
industry, our customers are generally permitted to terminate our relationship or
reduce purchasing levels on relatively short notice and without penalty.
Termination of a relationship by a significant customer or a significant decline
in the level of purchases made by a significant customer could have a material
adverse effect on our business, results of operations and financial condition.
Additionally, an adverse change in the financial condition of a significant
customer, including an adverse change as a result of a change in governmental or
private reimbursement programs, could have a material adverse effect on our
ability to collect our receivables from the customer and the volume of our sales
to the customer.
OUR SALES COULD DECLINE IF WE WERE TO LOSE OUR PRIME VENDOR STATUS
WITH A COOPERATIVE PURCHASING GROUP. We have contracted with several cooperative
purchasing groups to be their primary vendor. While we continue to contract
directly with the members of these purchasing groups, members are entitled to
the pricing we have negotiated with the groups. The majority of our independent
and regional customers are members of these cooperative purchasing groups. If a
cooperative purchasing group elected not to renew its contract with us, we
cannot assure you that all or any of our individual customers that are members
of that purchasing group would continue to purchase products from us. If a
significant number of customers were to elect not to continue to purchase
products from us, our sales would decline.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE LOSE ANY MEMBERS OF
OUR KEY PERSONNEL. We are dependent on the services of our senior management and
on the relationships between our key personnel and our significant customers and
suppliers. We have entered into employment agreements or non-competition
agreements with four key members of our management team. The loss of certain
members of our senior management, particularly our Chief Executive Officer,
Chief Operating Officer or Chief Financial Officer, could have a material
adverse effect on our business, results of operations and financial condition.
We generally do not carry life insurance policies on the lives of our key senior
managers or key purchasing or sales personnel. As is generally true in the
industry, if any of our senior management or key personnel with an established
reputation within the industry were to leave our employ, we cannot assure you
that our customers or suppliers who have relationships with such person would
not purchase products from such person's new employer, rather than from us, or
would continue to sell products or inventory to us on terms at least as
favorable as before such person's departure.
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO COMPLETE AND INTEGRATE
ACQUISITIONS SUCCESSFULLY. One aspect of our growth and operating strategy is to
pursue strategic acquisitions of other pharmaceutical wholesalers and companies
that expand or complement our business. We cannot assure you that suitable
acquisition candidates will be identified, that acquisitions can be consummated
on acceptable terms, that any acquired companies can be integrated successfully
into our operations or that we will be able to retain an acquired company's
significant customer and supplier relationships or otherwise realize the
intended benefits of any acquisition. Any such expansion could require
significant capital resources and divert management's attention from our
existing business. Such acquisitions could also result in liabilities being
incurred that were not known at the time of acquisition or the creation of tax
and accounting issues. Failure to accomplish future acquisitions could limit our
revenues and earnings potential.
CHANGES IN THE HEALTHCARE INDUSTRY COULD ADVERSELY AFFECT US. The
healthcare industry has undergone significant change in recent years as a result
of various efforts to reduce costs, including proposed national healthcare
reform, trends toward managed care, spending cuts in Medicare, consolidation of
pharmaceutical and medical/surgery supply distributors, the development of
large, sophisticated purchasing groups and efforts by third party payors to
contain or reduce healthcare costs. Group purchasing organizations' contracting
practices, especially those of larger entities serving hospital clients, have
been subjected to government scrutiny and lawsuits in recent years, primarily
from an antitrust perspective. We cannot predict whether these trends will
continue or whether any other healthcare reform efforts will be enacted and what
effect any such reforms may have on our practices and products or our customers
and suppliers. Any future changes in the healthcare industry, including a
reduction in governmental financial support of healthcare services, adverse
changes in legislation or regulations governing the delivery or pricing of
prescription drugs, healthcare services or mandated benefits may cause
healthcare industry participants to significantly reduce the amount of our
products and services they purchase or the price they are willing to pay for our
products and services. Changes in pharmaceutical manufacturers' pricing or
distribution policies could also significantly and adversely affect our
revenues, margins and profitability.
FEDERAL AND STATE LAWS THAT PROTECT PATIENT HEALTH INFORMATION MAY
INCREASE OUR COSTS AND LIMIT OUR ABILITY TO COLLECT AND USE THAT INFORMATION.
Our activities subject us to numerous federal and state laws and regulations
governing the collection, dissemination, use, security and confidentiality of
patient-identifiable health information, including the federal Health Insurance
Portability and Accountability Act of 1996, or HIPAA, and related rules and
regulations. The issuance of these regulations and of future judicial or
regulatory guidance regarding the interpretation
9
of regulations, the states' ability to promulgate stricter rules, and continuing
uncertainty regarding many aspects of the regulations' implementation may make
compliance with the relatively new regulatory landscape difficult. For example,
our existing programs and systems may not enable us to comply in all respects
with the new security regulations. In order to comply with the regulatory
requirements, we will be required to employ additional or different programs and
systems. Further, compliance with these regulations would require changes to
many of the procedures we currently use to conduct our business, which may lead
to additional costs that we have not yet identified. The new regulations and the
related compliance costs could have a material adverse effect on our business.
WE COULD BE ADVERSELY AFFECTED IF THERE ARE CHANGES IN THE
REGULATIONS AFFECTING THE HEALTHCARE INDUSTRY OR IF WE FAIL TO COMPLY WITH
CURRENT REGULATIONS APPLICABLE TO OUR BUSINESS. The healthcare industry is more
heavily regulated than many other industries. As a distributor of certain
controlled substances and prescription pharmaceuticals, we are required to
register with and obtain licenses and permits from certain federal and state
agencies and must comply with operating and security measures prescribed by
those agencies. We are also subject to various regulations including the 1987
Prescription Drug Marketing Act, an amendment to the federal Food, Drug and
Cosmetic Act, which regulates the purchase, storage, security and distribution
of prescription pharmaceuticals. Our compliance with these regulations is
monitored through periodic site inspections conducted by various governmental
agencies. Any failure to comply with these regulations or to respond to changes
in these regulations could result in penalties on us such as fines, restrictions
on our operations or a temporary or permanent closure of our facilities. These
penalties could harm our operating results. We cannot assure you that future
changes in applicable laws or regulations will not materially increase the costs
of conducting business or otherwise have a material adverse effect on our
business, results of operations and financial condition.
OUR OPERATIONS AND QUARTERLY RESULTS ARE SUBJECT TO SEASONALITY AND
VARIABILITY. Historically, our operations have experienced certain seasonal
patterns. Generally, our net sales are highest in the third and fourth quarters
and lowest in the first quarter of our fiscal year. As a result, we have
historically achieved approximately 60% of our earnings in our third and fourth
fiscal quarters. These fluctuations are attributable, in part, to the timing of
product price increases enacted by manufacturers and to the winter cold and flu
season. Our earnings may continue to vary materially from quarter to quarter due
to these and other factors.
Item 2. Properties
We conduct our business from a total of twelve office and warehouse
facilities:
LOCATION DESCRIPTION SQUARE FOOTAGE
- ---------------------------- ------------------------------- --------------
Cape Girardeau, Missouri (1) Distribution and administration 126,000
Lexington, Kentucky (1) Distribution and administration 61,900
Minneapolis, Minnesota (2) Distribution and administration 63,000
Aberdeen, South Dakota (1) Distribution and administration 40,000
Flower Mound, Texas (1) Distribution and administration 70,100
Owensboro, Kentucky (2) Distribution and administration 34,000
Texarkana, Texas (1) Walsh headquarters 40,600
San Antonio, Texas (1) Distribution and administration 147,000
Paragould, Arkansas (2) Distribution and administration 78,000
Caguas, Puerto Rico (1) Distribution and administration 5,000
Boulder, Colorado (1) PBI headquarters 5,500
St. Louis, Missouri (1) Corporate offices 31,765
- -------------
1) Leased.
2) Owned.
During fiscal 2004 we completed the expansion of our Cape Girardeau
facility adding approximately 60,000 square feet to the current facility. In
addition, in August 2004, we entered into a lease for a 180,000 square foot
facility in McCalla, Alabama, which is near Birmingham. This facility is
scheduled to become fully operational in the first calendar quarter of 2005. We
believe our facilities are adequate to support our present business plans.
10
Item 3. 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 Court has not selected lead class counsel and the Company has not yet had an
opportunity to assert its defenses to the complaint. The Defendants intend to
vigorously defend the claims.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of our security holders during the
quarter ended June 30, 2004.
Item 4A. Executive Officers of the Registrant
The name, age and position of each of our executive officers are set forth
below.
J. Hord Armstrong, III, 63, has served as Chairman of the Board, Chief
Executive Officer and Treasurer, and a director since December 1987. Prior to
joining us, Mr. Armstrong served as Vice President and Chief Financial Officer
of Arch Mineral Corporation, a coal mining and sales corporation, from 1981 to
1987, and as its Treasurer from 1978 to 1981.
Martin D. Wilson, 43, has served as President and Chief Operating Officer
since January 1996, as Secretary from August 1993 to April 1999 and as a
director since 1997. Mr. Wilson served as Executive Vice President, Finance and
Administration from May 1995 to January 1996, as Vice President, Finance and
Administration from April 1991 to May 1995, and as Controller from March 1988 to
April 1991. Prior to joining us, Mr. Wilson was associated with KPMG Peat
Marwick, a public accounting firm. Mr. Wilson serves as a Trustee of the St.
Louis College of Pharmacy.
Thomas S. Hilton, 52, has served as Senior Vice President and Chief
Financial Officer since January 1999. Between May 1980 and June 1998, Mr. Hilton
was employed by the Peabody Group, a coal mining and sales corporation in a
variety of management positions including Vice President and Treasurer from
March 1993 to May 1995, and Vice President and Chief Financial Officer from May
1995 to June 1998.
Brian G. Landry, 48, has served as Senior Vice President of Operations and
Chief Information Officer since January 2004. . Mr. Landry previously served as
Vice President and Chief Information Officer from April 2000, Vice President,
information systems product management from April 1999 to April 2000 and as Vice
President and General Manager of our Minneapolis distribution center from
November 1996 to April 1999. From October 1992 to October 1996, Mr. Landry was
employed by Cardinal Health as a general manager of a distribution center.
11
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
The information set forth under the caption "Price Range Per Common Share"
on the inside back cover of the registrant's 2004 Annual Report to Stockholders
is incorporated herein by this reference.
The following table contains certain information concerning shares of
common stock of the company subject to options issued under our 1992 Long-term
Incentive Plan (as amended), 1993 Stock Option Plan (as amended) and 2001
Long-term Incentive Plan. Our stockholders approved the 1992 Long-term Incentive
Plan and the 2001 Long-term Incentive Plan. The 1993 Stock Option Plan (the 1993
Plan) is for employees and certain others (not company directors or executive
officers) who perform services for us and did not require shareholder approval.
Under the 1993 Plan, we can grant options that do not qualify as incentive stock
options at a price not less than fair market value of the company's common stock
at the time of grant. The term of the options cannot exceed 10 years from the
date of grant. There were 700,000 shares authorized under the 1993 Plan.
EQUITY COMPENSATION PLAN INFORMATION
- ---------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE ISSUANCE UNDER EQUITY
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING COMPENSATION PLANS
OUTSTANDING OPTIONS, OPTIONS, (EXCLUDING SECURITIES
WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
PLAN CATEGORY (a) (b) (C)
- ------------------------------ -------------------------- ------------------------- ------------------------
Equity compensation plans
approved by stockholders 1,376,466 $15.06 329,433
Equity compensation plans not
approved by stockholders 126,250 $11.64 --
--------- ------ -------
TOTAL 1,502,716 $14.78 329,433
========= ====== =======
ISSUER PURCHASES OF EQUITY SECURITIES
(d) MAXIMUM
(c) TOTAL NUMBER OF NUMBER OF
SHARES SHARES
(a) TOTAL NUMBER PURCHASED AS PART THAT MAY YET BE
OF (b) AVERAGE OF PURCHASED UNDER
SHARES PRICE PAID PUBLICLY ANNOUNCED THE PLANS OR
PERIOD PURCHASED PER SHARE PLANS OR PROGRAMS PROGRAMS
- -------------------------- ---------------- ----------- ------------------- ----------------
August 2003 56,500 $14.45 656,500 0
------ ------ ------- ---
Total 56,500 $14.45 656,500 0
====== ====== ======= ===
In September 2002, the board of directors authorized the repurchase of up to 1.0
million shares, which expired in September 2003. During fiscal 2004, an
additional 56,500 shares were repurchased under this authorization bring the
total number of shares repurchased to 656,500.
Item 6. Selected Financial Data
The information set forth under the caption "Financial Highlights" on the
inside front cover of the registrant's 2004 Annual Report to Stockholders is
incorporated herein by this reference.
12
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RECENT TRENDS
Sales in the national accounts trade class are continuing to fall below
expectations in the first two months of 2005, as fewer than anticipated product
price increases enacted by pharmaceutical manufacturers have resulted in lower
activity in this trade class. Changes in manufacturers' inventory management
practices resulting in reduced availability of product have also impacted
revenues in this trade class.
Fewer than anticipated product price increases also resulted in lower
gross profit margin in the independent and regional pharmacies trade class
during the first two months of 2005. However, during this period sales trends in
the trade class show continued growth which partially offset the effect of lower
gross profit margins. We believe this sales growth reflects improved regional
and independent retail pharmacy industry sales trends in the our service
territory and the impact of new business.
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 us
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
the 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. The Walsh acquisition provided modest
earnings accretion in fiscal 2004 and we feel that there will be 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.
The current environment makes it difficult to forecast the timing of sales
from national accounts. Factors such as higher scrutiny of the healthcare
industry in an election year, changes in manufacturers' inventory management
practices, changes in product pricing practices, the transition from a `buy and
hold' industry model to a `fee for service' model, are all making the current
environment difficult to predict. We believe that 2005 earnings results will
likely be `back-end' loaded, similar to 2004.
During the fiscal 2004 fourth quarter we expanded sales and distribution
activities in the Southeast United States. In August 2004, we leased an 180,000
square foot facility near Birmingham, Alabama to support customers in Alabama,
Georgia, South Carolina, Mississippi and the Florida panhandle. The Birmingham
distribution center is scheduled to become operational in the first calendar
quarter of 2005, with current deliveries to customers being accomplished by our
other distribution centers.
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.
RESULTS OF OPERATIONS
The table below sets forth certain statement of income data for the last
three fiscal years expressed as a percentage of net sales and in comparison with
the prior fiscal year. Unless otherwise indicated, for purposes of this
discussion, all references to "2004," "2003," and "2002" shall mean the
Company's fiscal years ended June 30, 2004, June 30, 2003, and June 30, 2002,
respectively.
13
The table below contains certain operations data for the last three years
expressed as a percentage of net sales and in comparison with the prior year:
PERCENTAGE CHANGE FROM
PERCENTAGE OF NET SALES PRIOR YEAR
----------------------------------------- ---------------------------
2004 2003 2002 2003-2004 2002-2003
------ ------ ------ --------- ---------
Net sales 100.00% 100.00% 100.00% 14.3% (9.4%)
Gross profit 4.07% 4.08% 4.19% 14.0% (11.8%)
Total operating expenses (2.82%) (2.44%) (2.30%) 31.9% (3.9%)
------ ------ ------
Income from operations 1.25% 1.64% 1.89% (12.8%) (21.5%)
Interest expense, net (0.55%) (0.48%) (0.40%) 30.5% 9.7%
Securitization termination costs -- (0.09%) -- NM NM
Other, net (0.00%) (0.00%) (0.03%) NM NM
Income tax provision (0.27%) (0.41%) (0.58%) (23.2%) (35.8%)
Minority interest (0.03%) (0.03%) (0.03%) 10.0% (3.4%)
------ ------ ------
Net income before cumulative
effect of accounting change 0.40% 0.63% 0.86% (26.7%) (33.8%)
Cumulative effect of
accounting change, net -- (0.19%) -- NM NM
------ ------ ------
Net income 0.40% 0.44% 0.86% 5.5% (54.0%)
====== ====== ======
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
2003
NET SALES Net sales increased $317.8 million to $2.541 billion, or 14.3%,
in 2004 compared to the corresponding period of the prior year. Sales to
independent and regional pharmacies increased $663.9 million to $1.820 billion,
or 57.4%. Approximately 69% of the increase related to Walsh sales included in
our results since the acquisition in December 2003. Approximately 25% of the
increase relates to new business with the balance driven by same store growth.
National accounts sales decreased $335.8 million to $593.7 million, or 36.1%,
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.
During 2004 and 2003 we made no dock-to-dock sales, which historically
were not included in net sales due to our accounting policy of recording only
the commission on such transactions as a reduction to cost of sales in our
consolidated statements of operations. Dock-to-dock sales represent bulk sales
of pharmaceuticals to self-warehousing chain pharmacies for which we act only as
an intermediary in the order and subsequent delivery of products to the
customers' warehouses. The commission on dock-to-dock sales is typically lower
than the gross profit realized on sales of products from inventory.
GROSS PROFIT Gross profit increased $12.7 million to $103.4 million, or
14.0%, compared to the corresponding period of the prior year. As a percentage
of net sales, gross margin decreased from 4.08% to 4.07% compared to the
corresponding period of the prior year. The increase in gross profit was in our
wholesale drug distribution segment due to the addition of Walsh sales and
additional sales related to new business and same store growth. The increase
also included gains from two class action legal settlements received during the
year totaling $3.1 million that reduced cost of sales. Without these
settlements, gross margin would have been 3.95%. The decrease in gross margin
relates to lower national accounts sales that typically had higher gross margin
realization than independent and regional pharmacy sales and continued pricing
pressure on new and existing business.
OPERATING EXPENSES Operating expenses (including depreciation and
amortization) increased $17.3 million to $71.7 million, or 31.9%, compared to
the corresponding period of the prior year. The ratio of operating expenses to
net sales was 2.82%, a 38 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 since the acquisition in December
2003. The ratio of operating expense to net sales increased due to the decrease
in national accounts sales.
14
INTEREST EXPENSE, NET Net interest expense increased $3.2 million to $13.9
million, or 30.5%, 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 38.7% for 2004
compared to 38.2% 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 slightly
higher 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 increased to $0.8 million for 2004
compared to $0.7 million in 2003. This represents our minority interest in PBI
with the slight increase related to PBI's performance during 2004.
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
2002
NET SALES Net sales decreased $230.4 million to $2.223 billion, or 9.4%,
in 2003, compared to the corresponding period of the prior year. The sales
decline was in the national accounts trade class and related to fewer
attractively priced purchase opportunities. Sales to independent and regional
pharmacies increased $67.1 million to $1.156 billion, or 6.2%, primarily as a
result of the net increase in sales to existing customers. National accounts
sales decreased $317.1 million to $929.6 million, or 25.4%, compared to 2002
related to fewer attractively priced purchase opportunities of approximately
$554 million partially offset by sales to new customers of approximately $235
million. Sales to other healthcare providers increased $18.8 million to $126.3
million, or 17.5% as a result of new customers.
During 2003 we made no dock-to-dock sales, which historically were not
included in net sales due to our accounting policy of recording only the
commission on such transactions as a reduction to cost of sales in our
consolidated statements of operations. Dock-to-dock sales represent bulk sales
of pharmaceuticals to self-warehousing chain pharmacies for which we act only as
an intermediary in the order and subsequent delivery of products to the
customers' warehouses. The commission on dock-to-dock sales is typically lower
than the gross profit realized on sales of products from inventory. Dock-to-dock
sales were $70.5 million during 2002.
GROSS PROFIT Gross profit decreased $12.1 million to $90.7 million, or
11.8%, for 2003, compared to the corresponding period of the prior year. As a
percentage of net sales, gross margin decreased from 4.19% to 4.08% for 2003,
compared to the corresponding period of the prior year. The decrease in gross
margin percentage was due to the impact on our prices of the competitive forces
in the business.
OPERATING EXPENSES Operating expenses (including depreciation and
amortization) decreased $2.2 million to $54.3 million, or 3.9%, for 2003
compared to the corresponding period of the prior year. The ratio of operating
expenses to net sales for 2003 was 2.44%, a 14 basis point increase from the
comparable period of the prior year. The decrease in operating expenses resulted
from the elimination of approximately $2.5 million of goodwill amortization
related to our adoption of SFAS 142, offset by higher depreciation expense of
approximately $0.4 million related to the new ERP computer system that was fully
implemented during 2003. The ratio of operating expense to net sales increased
due to the decrease in national accounts sales.
INTEREST EXPENSE, NET Net interest expense increased $0.9 million to $10.7
million, or 9.7%, for 2003, compared to the corresponding period of the prior
year. As a percentage of net sales, net interest expense increased to 0.48% from
0.40% for 2003, 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 higher average investment in inventory.
SECURITIZATION TERMINATION COSTS In March 2003, we entered into a new
credit facility that resulted in the termination of the existing accounts
receivable securitization agreement. As a result, a one-time charge of $2.0
million was incurred during the third quarter of 2003. These costs were
associated with eliminating a $50 million fixed rate component of the accounts
receivable securitization program.
INCOME TAX PROVISION Our effective income tax rate was 38.2% for 2003
compared to 39.3% 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.
15
MINORITY INTEREST Minority interest remained at $0.7 million for 2003. We
began recording minority interest during 2002 as a result of our additional
investment in PBI in July 2001.
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 2003. This
impairment results from an appraisal valuation and relates to goodwill
originally established for the acquisition of Jewett Drug Co.
LIQUIDITY AND CAPITAL RESOURCES
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). Total credit available at June 30,
2004 was approximately $390 million of which approximately $83 million was
unused. The interest rate on the new 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 3.59% at June 30, 2004. The agreement expires in
March 2007, and, therefore, the related debt has been classified as long-term.
We are required to pay an annual facility fee, which was $100,000 in 2004. In
addition, we are charged a monthly fee of 0.375% of the unused balance of the
facility.
We are required under the terms of our debt agreements to comply with
certain financial covenants, including those related to fixed charge coverage
ratio and tangible net worth. We are required to reduce borrowings by cash
received. We also are 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 our debt covenants as of June
30, 2004.
The new credit facility resulted in the termination of the existing
accounts receivable securitization agreement. As a result, a one-time charge of
$2.0 million was incurred during the third fiscal quarter of 2003. These costs
were associated with eliminating a $50 million fixed rate component of the
accounts receivable securitization program that had an interest rate of 4.85%.
Under the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," (as amended by SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities") the accounts receivable sold under the
agreement were removed from the consolidated balance sheet.
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:
JUNE 30, JUNE 30,
2004 2003
---------- -----------
Working capital (000s) $ 382,900 $ 215,639
Current ratio 2.52 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. As cash is collected on accounts
receivable, it is used to immediately reduce long term debt.
Working capital and current ratio at June 30, 2004 are higher than June
30, 2003 levels. The change was due mainly to increases in inventory levels and
the additional working capital provided by Walsh that amounted to $97.3 million
at June 30, 2004.
We invested $5.4 million in capital assets in 2004 compared with $2.4
million in 2003. The 2004 expenditures were primarily related to the expansion
at our Cape Girardeau distribution center. The 2003 expenditures were primarily
related to leasehold improvements associated with our new corporate offices. We
believe that continuing investment in capital assets is necessary to achieve our
goal of improving operational efficiency, thereby enhancing our productivity and
profitability.
16
Net cash inflows from financing activities totaled $193.3 million for 2004
with net cash outflows of $58.7 million in 2003. Borrowings under our revolving
line of credit related to the purchase of Walsh and to support our inventory
levels produced this result. During 2003, repayments under our revolving line of
credit related to the decrease in inventory levels combined with our purchase of
treasury stock produced this result.
Stockholders' equity increased to $179.3 million at June 30, 2004 from
$170.1 million at June 30, 2003, primarily due to the net earnings during the
period. We believe that funds available under the new credit facility, together
with internally generated funds, will be sufficient to meet our capital
requirements for the foreseeable future.
CONTRACTUAL OBLIGATIONS
The following table summarizes our outstanding contractual obligations as of
June 30, 2004:
PAYMENTS DUE BY PERIOD
FY 2006-FY FY 2009 - FY 2012 AND
CONTRACTUAL OBLIGATIONS TOTAL FY 2005 2008 FY 2011 THEREAFTER
- ------------------------------- ------- ------- ---------- --------- -----------
Long-Term Debt Obligations (1) $308.4 $ 0.7 $307.7 -- --
Capital Lease Obligations $ 0.4 $ 0.3 $ 0.1 -- --
Operating Lease Obligations (2) $ 30.9 $ 6.0 $ 14.3 $7.3 $3.3
Purchase Obligations (3) $ 31.8 $10.5 $ 21.3 -- --
Other Long-Term Liabilities $ 2.7 $ 0.3 $ 0.7 $0.2 $1.5
Total $374.2 $17.8 $344.1 $7.5 $4.8
(1) Includes repayment of revolving credit facility in March 2007
(2) Our future minimum rental commitments under noncancellable leases comprise
the category.
(3) Represents required purchases under our agreement with Parata Systems, LLC
INFLATION
We prepare our consolidated financial statements on the basis of
historical costs and they do not reflect changes in the relative purchasing
power of the dollar. Because we take advantage of purchasing opportunities in
anticipation of price increases (forward purchasing), we believe that our gross
profits generally increase when manufacturers increase the prices of products we
distribute. Our gross profits may decline if manufacturers increase prices more
slowly.
Generally, we pass price increases through to customers, therefore
reducing the negative effect of inflation. During the past three years, we have
offset other non-inventory cost increases such as payroll, supplies and services
by increasing volume and improving productivity.
CRITICAL ACCOUNTING POLICIES
The methods, estimates and judgments we use in applying the accounting
policies most critical to our financial statements have a significant impact on
our reported results. The U.S. Securities and Exchange Commission has defined
the most critical accounting policies as the ones that are most important to the
portrayal of our financial condition and results, and require us to make our
most difficult and subjective judgments. Based on this definition, our most
critical policies include the following: (1) inventory valuation; (2) accounts
receivable; (3) valuation of goodwill and other intangible assets (4) accounting
for stock options; and (5) income taxes. We also have other key accounting
policies including policies for revenue recognition. We believe that these other
policies either do not generally require us to make estimates and judgments that
are as difficult or as subjective as the others listed above, or are less likely
to have a significant impact on our reported results of operations for a given
period. For additional information, see Note 1 "Summary of Significant
Accounting Policies" in Item 8 of Part II, "Financial Statements and
Supplementary Data,"
17
of this report. Although we believe that our estimates and assumptions are
reasonable, they are based upon information available at the time the estimates
and assumptions were made. Actual results may differ significantly from our
estimates and our estimates could be different using different assumptions or
conditions.
Revenue Recognition
Revenue is recognized when products are shipped or services are provided
to customers and we have no further obligation with respect to such products or
services. Revenues as reflected in the accompanying consolidated statements of
operations are net of sales returns and allowances. We recognize sales returns
as a reduction of revenue and cost of sales for the sales price and cost,
respectively. Our customer return policy generally allows customers to return
products only if the products have the ability to be added back to inventory and
resold at full value or can be returned to suppliers for credit. Rebates
received from suppliers are recognized as a reduction in cost of sales at the
time the product is sold. Shipping and handling costs associated with the
shipment of goods are recorded as operating expenses in the consolidated
statements of operations.
Inventory Valuation
Inventories consist of pharmaceutical drugs and related over-the-counter
items, which are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. We establish reserves that permanently reduce
the cost basis of our inventory to reflect situations in which the cost of the
inventory is not expected to be recovered. We record provisions for inventory
reserves as part of cost of sales. During 2004, approximately $75,000 was
charged to cost of sales relating to inventory reserve adjustments. A change in
our inventory reserves of $250,000 would impact our diluted earnings per share
by approximately $0.01 based on shares outstanding at June 30, 2004.
Accounts Receivable
We perform ongoing credit evaluations of our customers, including reviews
of their current credit information, and we adjust credit limits based upon
their payment histories and current credit worthiness. We continuously monitor
collections and payments from customers and maintain a provision for estimated
credit losses based upon our historical experience and any specific customer
collection issues we have identified. However, our ultimate ability to collect
receivables depends on the individual customer's financial condition, which can
change rapidly and without warning.
Valuation of Goodwill and Intangible Assets
We review goodwill and certain identifiable intangible assets when events
or circumstances indicate that the net book value may not be recoverable.
Effective with our adoption of SFAS No. 142,"Goodwill and Other Intangible
Assets" in July 2002, we are no longer amortizing goodwill and intangible assets
that have indefinite lives but will test them annually for impairment, or more
frequently if circumstances indicate potential impairment. We will continue to
amortize other intangible assets over their estimated useful lives. As a result
of this adoption and assessment, we 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 our wholesale drug distribution segment.
Stock Options
We account for employee-based stock compensation in accordance with
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued
to Employees." Under APB No. 25, we record compensation expense based on a stock
option's intrinsic value, which is the difference between a stock's market value
and the exercise price at the date of grant. As we generally grant stock options
at market value at the date of the grant, our compensation expense as a result
of option grants has been nominal. An alternative to APB No. 25 used by many
companies in accounting for stock options is SFAS No.123, "Stock-Based
Compensation." SFAS No. 123 uses the fair value method in valuing stock options
and requires expensing of such values. Companies determine fair value based on
an option-pricing model, with the Black-Scholes model used most commonly. These
pricing models require using several estimates including the expected life of
the option, volatility of common stock, dividend yields (including estimates of
future dividends and market values of common stock), risk-free interest rates
and employee turnover. In December 2002, the FASB issued SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, An
Amendment of FASB Statement No. 123" ("SFAS 148"). This statement provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In
18
addition, SFAS 148 amends the disclosure requirements of Statement No. 123 to
require more prominent disclosures, in both interim and annual financial
statements, about the method of accounting for stock-based employee compensation
and the effect the method used has on reported results. The provisions of SFAS
148 are effective for fiscal years ending after December 15, 2002 and the
interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. We
will continue to account for stock-based compensation using the intrinsic value
method and have adopted the disclosure requirements prescribed by SFAS 148. The
additional required disclosures have been provided in Note 1 to the consolidated
financial statements.
Income taxes
Deferred tax assets and liabilities are determined by the differences
between the financial statement carrying amounts and the tax basis of assets and
liabilities. Please reference Note 11 entitled Income Taxes of "Notes to
Consolidated Financial Statements" for the types of items that give rise to
significant deferred income tax assets and liabilities. Deferred income taxes
are classified as assets or liabilities based on the classification of the
related asset or liability for financial reporting purposes. Deferred income
taxes that are not related to an asset or liability for financial reporting are
classified according to the expected reversal date. The recoverability of
deferred tax assets is dependent upon our assessment of whether it is
more-likely- than-not that sufficient future taxable income will be generated in
the relevant tax jurisdiction to utilize the deferred tax asset. A valuation
allowance is provided for the portion of deferred tax assets, which are
"more-likely-than-not" to be unrealized. We regularly review deferred tax assets
for recoverability based upon projected future taxable income and the expected
timing of the reversals of existing temporary differences. As a result of this
review, we have not established a valuation allowance against the deferred tax
assets.
We are periodically reviewed by domestic and foreign tax authorities
regarding the amount of taxes due. These reviews include questions regarding the
timing and amount of deductions and the allocation of income among various tax
jurisdictions. In evaluating the exposure associated with various filing
positions, we record reserves for probable exposures. Based on our evaluation of
current tax positions, we believe we have appropriately accrued for probable
exposures.
NEW ACCOUNTING STANDARDS
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No.
133 for decisions made as part of the FASB's Derivatives Implementation Group
process, other FASB projects dealing with financial instruments, and in
connection with implementation issues raised in relation to the application of
the definition of a derivative. This statement is generally effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did not
have a material impact on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 modifies the accounting for certain financial instruments
that, under previous guidance, issuers could account for as equity. SFAS 150
requires that those instruments be classified as liabilities in statements of
financial position and affects an issuer's accounting for (1) mandatorily
redeemable shares, which the issuing company is obligated to buy back in
exchange for cash or other assets, (2) instruments, other than outstanding
shares, that do or may require the issuer to buy back some of its shares in
exchange for cash or other assets, or (3) obligations that can be settled with
shares, the monetary value of which is fixed, tied solely or predominantly to a
variable such as a market index, or varies inversely with the value of the
issuer's shares. In addition to its requirements for the classification and
measurement of financial instruments within its scope, SFAS 150 also requires
disclosures about alternative ways of settling those instruments and the capital
structure of entities, all of whose shares are mandatorily redeemable. SFAS 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 did not have a material
impact on our consolidated financial statements.
19
Item 7A. 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 anticipated borrowings during 2005, a change of 25 basis
points in the average variable borrowing rate would result in a change of
approximately $0.7 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. Our hedging arrangements at June 30, 2004 are
described more fully in the footnotes to our consolidated financial statements.
Item 8. Financial Statements and Supplementary Data
PAGE
-------
Report of Independent Registered Public Accounting Firm Page 21
Consolidated Balance Sheets at June 30, 2004 and June 30, 2003 Page 22
Consolidated Statements of Operations for the years ended June 30, 2004,
June 30, 2003, and June 30, 2002 Page 23
Consolidated Statements of Stockholders' Equity for the years
Ended June 30, 2004, June 30, 2003, and June 30, 2002 Page 24
Consolidated Statements of Cash Flows for the years ended June 30, 2004,
June 30, 2003, and June 30, 2002 Page 25
Notes to Consolidated Financial Statements Page 26
20
Report of Independent Registered Public Accounting Firm
The Board of Directors
D&K Healthcare Resources, Inc.:
We have audited the accompanying consolidated balance sheets of D&K
Healthcare Resources, Inc. and subsidiaries (the Company) as of June 30, 2004
and 2003, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended June
30, 2004. In connection with our audits of the consolidated financial
statements, we also have audited the related financial statement schedule. These
consolidated financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of D&K
Healthcare Resources, Inc. and subsidiaries as of June 30, 2004 and 2003, and
the results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 2004 in conformity with U.S. generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
As described in Notes 1 and 3 to the consolidated financial statements,
the Company adopted Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets" effective July 1, 2002.
KPMG LLP
August 6, 2004
21
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of June 30, (in thousands, except share and per share data)
2004 2003
---------- ----------
ASSETS
Current Assets
Cash (including restricted cash of $12,499 and $14,301 respectively) $ 12,499 $ 14,301
Receivables, net of allowance for doubtful accounts of $5,444 and $1,604, respectively 130,770 122,982
Inventories 461,295 257,984
Deferred income taxes 7,874 2,322
Prepaid expenses and other current assets 21,862 6,540
---------- ----------
Total current assets 634,300 404,129
Property and Equipment, net of accumulated depreciation and amortization of
$12,274 and $10,673, respectively 24,494 11,140
Other Assets 14,298 11,511
Goodwill, net of accumulated amortization 64,233 44,105
Other Intangible Assets, net of accumulated amortization 6,546 1,810
---------- ----------
Total assets $ 743,871 $ 472,695
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 676 $ 1,677
Accounts payable 219,580 173,342
Accrued expenses 31,144 13,471
---------- ----------
Total current liabilities 251,400 188,490
Long-term Liabilities 2,663 3,703
Deferred Income Taxes 2,785 --
Long-term Debt 307,693 110,423
---------- ----------
Total liabilities 564,541 302,616
Stockholders' Equity
Preferred stock -- --
Common stock 152 152
Paid-in capital 125,552 124,704
Accumulated other comprehensive loss (1,208) (1,371)
Deferred compensation - restricted stock (730) (411)
Retained earnings 67,790 58,415
Less treasury stock (12,226) (11,410)
---------- ----------
Total stockholders' equity 179,330 170,079
---------- ----------
Total liabilities and stockholders' equity $ 743,871 $ 472,695
========== ==========
Preferred stock has no par value; 1 million shares are authorized. In 2004 and
2003, no shares were issued or outstanding.
Common stock has a par value of $.01 per share; 25 million shares are
authorized; 15,306,749 and 15,177,100 shares were issued at June 30,2004 and
2003, respectively. At June 30, 2004, 14,057,449 shares were outstanding and
1,249,300 shares were held in treasury. At June 30 2003, 13,984,300 shares were
outstanding and 1,192,800 shares were held in treasury.
The accompanying notes are an integral part of these statements.
22
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended June 30, (in thousands, except per share data)
2004 2003 2002
----------- ----------- -----------
Net Sales $ 2,541,190 $ 2,223,388 $ 2,453,748
Cost of Sales 2,437,795 2,132,689 2,350,917
----------- ----------- -----------
Gross profit 103,395 90,699 102,831
Depreciation and Amortization 3,782 2,492 4,453
Operating Expenses 67,874 51,820 52,039
----------- ----------- -----------
Income from operations 31,739 36,387 46,339
----------- ----------- -----------
Other Income (Expense):
Interest expense (14,531) (11,070) (10,386)
Interest income 622 410 667
Securitization termination costs -- (2,008) --
Other, net 124 (13) (710)
----------- ----------- -----------
(13,785) (12,681) (10,429)
----------- ----------- -----------
Income before income tax provision and minority interest 17,954 23,706 35,910
Income Tax Provision (6,956) (9,058) (14,113)
Minority Interest (784) (713) (738)
----------- ----------- -----------
Net income before cumulative effect of accounting change 10,214 13,935 21,059
----------- ----------- -----------
Cumulative effect of accounting change, net -- (4,249) --
----------- ----------- -----------
Net income $ 10,214 $ 9,686 $ 21,059
=========== =========== ===========
Earnings Per Share - Basic
Net income before cumulative effect of accounting change $ 0.73 $ 0.98 $ 1.48
Cumulative effect of accounting change -- (0.30) --
----------- ----------- -----------
Net income $ 0.73 $ 0.68 $ 1.48
=========== =========== ===========
Earnings Per Share - Diluted
Net income before cumulative effect of accounting change $ 0.71 $ 0.95 $ 1.42
Cumulative effect of accounting change -- (0.30) --
----------- ----------- -----------
Net income $ 0.71 $ 0.65 $ 1.42
=========== =========== ===========
The accompanying notes are an integral part of these statements.
23
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED DEFERRED
OTHER COMPENSATION-
COMMON PAID-IN COMPREHENSIVE RESTRICTED RETAINED TREASURY
(in thousands) STOCK CAPITAL LOSS STOCK EARNINGS STOCK TOTAL
------ -------- ------------- ------------- -------- -------- --------
BALANCE AT JUNE 30, 2001 $ 47 $ 34,006 $ (356) $ -- $ 29,359 $ (5,546) $ 57,510
Comprehensive income:
Net income -- -- -- -- 21,059 -- 21,059
Change in value of cash flow hedge,
net of $347 tax benefit -- -- (531) -- -- -- (531)
--------
Total comprehensive income 20,528
Secondary stock offering 24 76,838 -- -- -- -- 76,862
Shares issued upon acquisition of PBI 2 6,905 -- -- -- -- 6,907
Stock options exercised, including tax
benefit 3 6,340 -- -- -- -- 6,343
Stock split in the form of a stock dividend 75 -- -- -- (75) -- --
Dividends paid ($0.0525/share) -- -- -- -- (753) -- (753)
------ -------- ------------- ------------- -------- -------- --------
BALANCE AT JUNE 30, 2002 $ 151 $124,089 $ (887) $ -- $ 49,590 $ (5,546) $167,397
Comprehensive income:
Net income -- -- -- -- 9,686 -- 9,686
Change in value of cash flow hedge,
net of $318 tax benefit -- -- (484) -- -- -- (484)
--------
Total comprehensive income 9,202
Issuance of restricted stock 1 615 -- (616) -- -- --
Deferred compensation amortization -
restricted stock -- -- -- 205 -- -- 205
Treasury stock purchases -- -- -- -- -- (5,864) (5,864)
Dividends paid ($0.06/share) -- -- -- -- (861) -- (861)
------ -------- ------------- ------------- -------- -------- --------
BALANCE AT JUNE 30, 2003 $ 152 $124,704 $ (1,371) $ (411) $ 58,415 $(11,410) $170,079
Comprehensive income:
Net income -- -- -- -- 10,214 -- 10,214
Change in value of cash flow hedge,
net of $104 tax benefit -- -- 163 -- -- -- 163
--------
Total comprehensive income 10,377
Issuance of restricted stock -- 699 -- (699) -- -- --
Deferred compensation amortization -
restricted stock -- -- -- 380 -- -- 380
Stock options exercised, including tax
benefit -- 149 -- -- -- -- 149
Treasury stock purchases -- -- -- -- -- (816) (816)
Dividends paid ($0.06/share) -- -- -- -- (839) -- (839)
------ -------- ------------- ------------- -------- -------- --------
BALANCE AT JUNE 30, 2004 $ 152 $125,552 $ (1,208) $ (730) $ 67,790 $(12,226) $179,330
====== ======== ============= ============= ======== ======== ========
The accompanying notes are an integral part of these statements.
24
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30, (in thousands) 2004 2003 2002
------------ ------------ ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 10,214 $ 9,686 $ 21,059
Adjustments to reconcile net income to net cash
flows from operating activities --
Depreciation and amortization 3,788 2,492 4,453
Amortization of debt issuance costs 1,632 1,425 1,096
Loss / (gain) from sale of assets 73 (3) 333
Deferred income taxes 1,673 (3,463) (1,796)
Cumulative effect of accounting change, net -- 4,249 --
Decrease (increase) in receivables, net 42,341 (11,765) 15,478
(Increase) decrease in inventories (115,088) 106,260 (149,204)
Increase in prepaid expenses and other current assets (8,897) (1,816) (5,576)
Increase (decrease) in accounts payable (29,020) (42,435) 56,626
Increase in accrued expenses 11,221 3,006 4,419
Other, net (4,557) (3,839) (1,500)
------------ ------------ ----------
Net cash flows from operating activities (86,620) 63,797 (54,612)
------------ ------------ ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for acquisitions, net of cash acquired (102,868) -- 961
Investment in other assets (200) (200) (200)
Purchases of property and equipment (5,392) (2,371) (3,445)
Proceeds from sale of assets 4 3 543
------------ ------------ ----------
Net cash flows from investing activities (108,456) (2,568) (2,141)
------------ ------------ ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving line of credit 2,807,387 1,158,172 896,667
Repayments under revolving line of credit (2,609,861) (1,128,602) (912,752)
Repurchase of receivables under securitization agreement -- (80,000) --
Proceeds from secondary stock offering -- -- 76,862
Payments of long-term debt (985) (948) (757)
Payments of capital lease obligations (271) (249) (236)
Proceeds from exercise of stock options 96 -- 2,260
Payment for termination of derivative instrument (1,047) -- --
Payment of dividends (839) (861) (753)
Dividends paid by affiliate (390) (330) (300)
Purchase of treasury stock (816) (5,864) --
------------ ------------ ----------
Net cash flows from financing activities 193,274 (58,682) 60,991
------------ ------------ ----------
(Decrease) increase in cash (1,802) 2,547 4,238
Cash, beginning of period 14,301 11,754 7,516
------------ ------------ ----------
Cash, end of period $ 12,499 $ 14,301 $ 11,754
------------ ------------ ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for --
Interest $ 12,119 $ 9,605 $ 9,258
Income taxes, net $ 3,156 $ 7,241 $ 11,076
The accompanying notes are an integral part of these statements.
25
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The consolidated financial statements include the accounts of all
divisions and wholly owned and majority-owned subsidiaries of D&K Healthcare
Resources, Inc. (the Company). All significant intercompany accounts and
transactions are eliminated.
Fiscal Year
The Company's fiscal year end is June 30. References to years relate to
fiscal years rather than calendar years unless otherwise stated.
Concentration of Credit Risk
The Company is a full-service, regional wholesale pharmaceutical drug
distributor. From facilities in Missouri, Kentucky, Minnesota, Arkansas, South
Dakota and Texas, the Company distributes a broad range of branded and generic
pharmaceuticals and over-the-counter health and beauty aid products to its
customers in more than 27 states. The Company is focused on serving the unique
needs of independent and regional pharmacies.
In 2004, sales to one customer represented approximately 7% of total net
sales. In 2003, sales to one customer represented approximately 9% of total net
sales. In 2002, sales to one customer represented approximately 24% of total net
sales.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Revenue Recognition
Revenue is recognized when products are shipped or services are provided
to customers and the Company has no further obligation with respect to such
products or services. Revenues as reflected in the accompanying consolidated
statements of operations are net of sales returns and allowances. The Company
recognizes sales returns as a reduction of revenue and cost of sales for the
sales price and cost, respectively. Our customer return policy generally allows
customers to return products only if the products have the ability to be added
back to inventory and resold at full value or can be returned to suppliers for
credit. Rebates received from suppliers are recognized as a reduction in cost of
sales at the time the product is sold. Shipping and handling costs associated
with the shipment of goods are recorded as operating expenses in the
consolidated statements of operations, which amounted to $7.3 million, $4.6
million and $4.5 million in 2004, 2003, and 2002, respectively.
During 2002, the Company had $70.5 million of "dock-to-dock" sales, which
are excluded from net sales due to the Company's policy of recording only the
commission on such transactions as a reduction against cost of goods sold in the
consolidated statements of operations. The Company had no dock-to-dock sales in
2004 and 2003. Dock-to-dock sales represent large volume sales of
pharmaceuticals to major self-warehousing retail chain pharmacies whereby the
Company acts as an intermediary in the order and subsequent delivery of products
to the customers' warehouses.
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
26
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."
The Company generally grants its stock options at exercise prices equal to
the fair market value of the underlying stock on the date of grant and,
therefore, under APB 25, no compensation expense is recognized in the statements
of operations.
The fair value of each option grant was estimated on the date of the grant
using the Black-Scholes option-pricing model using the following
weighted-average assumptions:
2004 2003 2002
--------- --------- ---------
Risk free interest rates 2.91% 3.05% 4.19%
Expected life of options 4.0 years 4.0 years 5.0 years
Volatility of stock price 81% 61% 43%
Expected dividend yield 0.002% 0.002% 0.002%
Fair value of options granted $9.64 $10.82 $10.50
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 pro forma net income and earnings per
share would have been as follows (in thousands, except per share data):
2004 2003 2002
---------- ---------- ----------
Net income - as reported $ 10,214 $ 9,686 $ 21,059
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of tax (1,354) (1,454) (2,059)
Net income - pro forma $ 8,860 $ 8,232 $ 19,000
Earnings per share:
Basic - as reported $ 0.73 $ 0.68 $ 1.48
Basic - pro forma $ 0.64 $ 0.58 $ 1.33
Diluted - as reported $ 0.71 $ 0.65 $ 1.42
Diluted - pro forma $ 0.62 $ 0.56 $ 1.29
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.
Restricted Cash
Restricted cash of $12.5 million and $14.3 million, respectively, at June
30, 2004 and June 30, 2003, represents cash receipts from customers that must be
used to reduce borrowings under the credit facility and are included in cash.
Receivables
Receivables are recorded at the invoiced amount and do not bear interest.
The allowance for doubtful accounts is the Company's best estimate of the amount
of probable credit losses in the Company's existing receivables. The Company
determines the allowance based on historical write-off experience. The Company
reviews its allowance for doubtful accounts monthly. Account balances are
charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is remote.
Inventories
Inventories consist of pharmaceutical drugs and related over-the-counter
items, which are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. Reserves are established for our inventory to
reflect situations in which the cost of the inventory is not expected to be
recovered. Provisions for inventory reserves are recorded as part of cost of
sales.
27
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are charged to operations
primarily using the straight-line method over the shorter of the estimated
useful lives of the various classes of assets, which vary from two to 30 years,
or the lease term for leasehold improvements. For income tax purposes,
accelerated depreciation methods are used. Repairs and maintenance costs are
expensed as incurred.
Intangible Assets
Intangible assets are stated at cost less accumulated amortization.
Amortization is determined using the straight-line method over the estimated
useful lives of the related assets.
Impairment of Long-Lived Assets
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
Assets," establishes a single accounting model for long-lived assets to be
disposed of. Adopting this standard did not have a material impact on the
Company's consolidated financial statements.
In accordance with SFAS No. 144, long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to estimated undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Assets to be disposed
of would be separately presented in the balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet.
Goodwill
The Company accounts for goodwill under SFAS 142, "Goodwill and Other
Intangible Assets," which requires the Company to review for impairment of
goodwill on an annual basis, and between annual tests whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable. The
Company performed its goodwill impairment tests upon adoption of SFAS 142 and
again as of April 30, 2004. Upon adoption of SFAS 142 on July 1, 2002, the
Company ceased amortization of its existing net goodwill balance. Prior to
adoption of SFAS 142, goodwill was amortized on a straight-line basis over the
expected periods to be benefited and assessed for recoverability by determining
whether the amortization of the goodwill balance over its remaining life could
be recovered through undiscounted future operating cash flows of the acquired
operation. See Note 3 for further information regarding the adoption of SFAS 142
and the on-going impact.
Interest Rate Risk Management
In accordance with Statement of Financial Accounting Standard No. 133,
"Accounting for Derivatives and Hedging Activities", as amended by SFAS No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities",
all derivative instruments are recorded at fair value on the balance sheet and
all changes in fair value are recorded to earnings or to stockholders' equity
through other comprehensive income. The Company does not use derivative
instruments for trading or speculative purposes.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective basis
for income tax purposes. Deferred tax assets and liabilities are measured and
recorded using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled.
Book Overdrafts
28
Accounts payable includes book overdrafts (outstanding checks) of $12.2
million and $10.4 million at June 30, 2004 and June 30, 2003, respectively.
Stockholders' Equity
Treasury Stock. In May 1999, the board of directors authorized the
repurchase of up to 600,000 shares of the Company's outstanding common stock.
592,800 shares were acquired in the open market during the twelve-month period
from the date of authorization. In September 2002, the board of directors
authorized the repurchase of up to 1.0 million shares, which expired in
September 2003. During fiscal 2004, an additional 56,500 shares were repurchased
under this authorization bring the total number of shares repurchased to
656,500.
Authorization of additional shares of Common Stock. In January 2002, the
Board of Directors amended the Certificate of Incorporation of the Company to
increase the number of authorized shares of common stock to 25 million shares.
Stock Split. On March 13, 2002, the Company declared a two-for-one stock
split in the form of a stock dividend that was distributed on April 12, 2002 to
shareholders of record on March 29, 2002. All share and per share amounts
included in the consolidated financial statements have been adjusted to
retroactively reflect this stock split.
Deferred compensation - restricted stock. The Company issued restricted
shares of stock to certain key management personnel in 2004 and 2003. This stock
will vest three years from the date of grant. The Company recorded the cost of
the stock at the time of grant as deferred compensation and will amortize this
cost over the vesting period.
Earnings per Share
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS No. 128) requires a dual presentation of basic and diluted earnings per
share. Basic earnings per share excludes dilution and is computed by dividing
net income by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that would
occur if securities or other contracts to issue common stock were exercised or
converted into common stock. All share and per share amounts have been stated in
accordance with the provisions of SFAS No. 128 (see Note 13).
NOTE 2. ACQUISITIONS:
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, 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 finalizing the valuation of certain assets and liabilities
acquired. 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 19,485
--------
Total assets acquired 191,541
--------
Current liabilities 82,356
Long-term liabilities 4,771
--------
Total liabilities assumed 87,127
--------
Net assets acquired $104,414
========
29
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 $19.5 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).
Twelve Months Ended
June 30,
-----------------------------
2004 2003
------------ -----------
Net sales $ 2,881,728 $ 3,075,889
Net income before discontinued operations
and cumulative effect of accounting change $ 1,662 $ 18,256
Net income $ 106 $ 11,315
Diluted earnings per share $ 0.00 $ 0.77
Pro forma net income for the year ended June 30, 2004 included adjustments
of $11.0 million ($6.7 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 year ended June 30, 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
In July 2001, as part of the secondary stock offering, the Company
increased its ownership percentage in Pharmaceutical Buyers, Inc. (PBI) to 68%
and in August 2001, acquired an additional 2%. These additions were accomplished
with individuals exchanging PBI stock for shares of the Company's common stock.
The aggregate purchase price was valued at $6.9 million based on the initial
price of the secondary stock offering for the first increase and the closing
price of the stock for the second increase. This arrangement was part of the
original transaction when we acquired our initial 50% ownership interest. This
transaction was accounted for under the purchase method of accounting. Goodwill
recognized in this transaction amounted to $11.3 million, but is not deductible
for tax purposes. Intangible assets other than goodwill recognized in this
transaction amounted to $1.9 million and have a weighted-average useful life of
approximately 15 years.
In June 2004, the Company reached agreement to acquire the remaining 30%
interest in PBI for $12.4 million. This transaction is subject to certain
financing contingencies, but is expected to close by September 30, 2004. See
Note 5 for further information on PBI.
NOTE 3. GOODWILL AND INTANGIBLE ASSETS:
The Company adopted Statement of Financial Accounting Standard ("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. 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 and 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.
30
The effects of adopting the new standard on net income and earnings per
share for the years ended June 30, 2004, 2003 and 2002 are:
NET INCOME BASIC EPS DILUTED EPS
--------------------------- --------------------------- ----------------------------
(in thousands, except per share amounts) 2004 2003 2002 2004 2003 2002 2004 2003 2002
- ---------------------------------------- ------- ------- ------- ------- ------- ------- ------- -------- --------
Net income $10,214 $ 9,686 $21,059 $ 0.73 $ 0.68 $ 1.48 $ 0.71 $ 0.65 $ 1.42
Add: cumulative effect of
accounting change, net -- 4,249 -- -- 0.30 -- -- 0.30 --
--------------------------- --------------------------- ----------------------------
Income before cumulative effect
of accounting change 10,214 13,935 21,059 0.73 0.98 1.48 0.71 0.95 1.42
Add: goodwill amortization, net of tax -- -- 1,580 -- -- 0.11 -- -- 0.11
--------------------------- --------------------------- ----------------------------
Income before cumulative effect
of accounting change and
goodwill amortization $10,214 $13,935 $22,639 $ 0.73 $ 0.98 $ 1.59 $ 0.71 $ 0.95 $ 1.53
=========================== =========================== ============================
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 year ended June 30,
2004, including the effects of adopting the new accounting standard, are: (in
thousands)
INTANGIBLE
GOODWILL ASSETS
-------- ----------
Balance at June 30, 2003, net of accumulated amortization $44,105 $1,810
Acquisition 19,485 5,212
Adjustment to purchase price 643 --
Amortization expense -- (476)
------- ------
Balance at June 30, 2004, net of accumulated amortization $64,233 $6,546
======= ======
Intangible assets totaled $6.5 million, net of accumulated amortization of
$0.8 million, at June 30, 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 which are being
amortized using the straight-line method over periods of 5 to 15 years with an
approximate weighted-average amortization period of 11 years Amortization of
intangible assets totaled $0.5 million in 2004 and is estimated to be
approximately $0.7 million for the next five years.
Goodwill and other intangible assets, net of accumulated amortization, by
segment is as follows:
Goodwill Intangible Assets
------------------------ ------------------------
June 30, June 30, June 30, June 30,
(in millions) 2004 2003 2004 2003
---------- ---------- ---------- ----------
SEGMENT:
Wholesale drug distribution $ 51.8 $ 32.3 $ 5.0 $ 0.2
PBI 11.0 10.4 1.5 1.6
Software 1.4 1.4 -- --
---------- ---------- ---------- ----------
Total $ 64.2 $ 44.1 $ 6.5 $ 1.8
========== ========== ========== ==========
31
NOTE 4. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following (in thousands):
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Land $ 1,010 $ 320
Building and improvements 5,960 2,115
Fixtures and equipment 23,870 15,336
Leasehold improvements 5,514 3,634
Vehicles 414 408
------------- -------------
36,768 21,813
Less - Accumulated depreciation and amortization (12,274) (10,673)
------------- -------------
$ 24,494 $ 11,140
============= =============
Total depreciation and amortization relating to property and equipment was
$3.3 million in 2004, $2.3 million in 2003, and $2.1 million in 2002. The
Company leases certain properties under capital leases. Capital lease asset
balances consist of buildings and equipment of $1.3 million at both June 30,
2004 and 2003. Related accumulated amortization amounted to approximately
$680,000 and $502,000, respectively.
NOTE 5. INVESTMENT IN PBI:
In November 1995, the Company purchased approximately 50% of the capital
stock of Pharmaceutical Buyers, Inc. ("PBI"), a Colorado-based group purchasing
organization. Pursuant to the transaction, the Company acquired approximately
50% of the voting and non-voting common stock of PBI for $3.75 million in cash.
The Company's investment in PBI was accounted for under the equity method until
July 2001 at which time an additional 18% ownership interest was acquired and
PBI was consolidated for financial reporting purposes. An additional 2% was
acquired in August 2001 to bring the Company's total ownership to 70%. See Note
2 for further information on the acquisition of the additional 20% interest in
PBI in 2001.
In connection with its investment in PBI, the Company entered into an
agreement pursuant to which MassMutual, which holds 30% of the capital stock of
PBI, is entitled to exchange its capital stock of PBI with the Company at fair
market value. The Company has the right, and it is its intention, to satisfy
this exchange with cash. If the Company elects not to satisfy the exchange with
cash, the Company could satisfy the exchange with shares of its common stock, in
which case MassMutual would have certain registration rights. If the Company
were to acquire the remaining interest in PBI, the agreement would be for
MassMutual to exchange their interest in PBI for cash.
NOTE 6. LONG-TERM DEBT:
Long-term debt consists of the following (in thousands):
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Revolving line of credit with banks $ 306,241 $ 108,484
Other, including capital lease obligations 2,128 3,616
------------- -------------
308,369 112,100
Less -- Current maturities (676) (1,677)
------------- -------------
$ 307,693 $ 110,423
============= =============
On March 31, 2003, the Company entered into a new $600 million credit
facility. The credit facility, an asset-based senior secured revolving credit
facility, increased the Company's 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). Total credit available at June 30, 2004 was approximately $390 million
of which approximately $83 million was unused. The interest rate on the new
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 3.59%
at June 30, 2004. The agreement expires in March 2007 and contains no subjective
acceleration provision, and, therefore, the related debt has been classified as
long-term. The Company is required to pay an annual facility fee,
32
which was $100,000 in 2004. In addition, the Company is charged a monthly fee of
0.375% of the unused balance of the facility.
The Company is required under the terms of its debt agreements to comply
with certain financial covenants, including those related to fixed charge
coverage ratio and tangible net worth. The Company is required to reduce
borrowings by cash received. The Company also is limited in its ability to make
loans and investments, enter into leases, or incur additional debt, among other
things, without the consent of its lenders. The Company is in compliance with
its debt covenants as of June 30, 2004.
In June 2000, the Company entered into a $965,000 equipment financing
arrangement with a five-year term ending July 2005. The arrangement provides for
monthly payments bearing interest at LIBOR plus 1.95%. The equipment purchased
with the proceeds secures this arrangement.
At June 30, 2004, maturities of long-term debt, including capital lease
obligations, were as follows (in thousands):
FISCAL YEAR ENDING JUNE 30,
- ---------------------------
2005 $ 676
2006 1,374
2007 306,280
2008 --
2009 --
Thereafter 39
--------
$308,369
========
At June 30, 2004 and June 30, 2003, the fair value of long-term debt
approximated its current carrying value.
NOTE 7. ACCOUNTS RECEIVABLE SECURITIZATION:
During 1999, the Company and its wholly owned, bankruptcy-remote
subsidiary ("Seller") established an accounts receivable securitization program.
Under the program, undivided interests in a pool of eligible trade receivables,
which had been sold on a non-recourse basis by the Company to the Seller, were
then sold to a multi-seller, asset backed commercial paper conduit ("Conduit").
Purchases by the Conduit were financed with the sale of highly rated commercial
paper. The Company utilized proceeds from the sale of its accounts receivable to
repay long-term debt, effectively reducing its overall borrowing costs.
The Company's $600 million credit facility, entered into in March 2003, resulted
in the termination of the existing accounts receivable securitization agreement.
As a result, a one-time charge of $2.0 million was incurred during the third
fiscal quarter of 2003. These costs were associated with eliminating a $50
million fixed rate component of the accounts receivable securitization program
that had an interest rate of 4.85%.
NOTE 8. DERIVATIVE INSTRUMENTS:
In June, 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which was
amended by SFAS No. 138, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133", which
was required to be adopted in years beginning after June 15, 2000. At June 30,
2004, the Company had recorded a long-term asset of approximately $66,000 and a
long-term liability of approximately $233,000 relating to derivative
instruments. At June 30, 2003, the Company had recorded a long-term asset of
approximately $114,000 and a long-term liability of approximately $2,035,000
relating to derivative instruments.
Through an interest rate swap agreement, the Company effectively fixed the
interest rate on $100 million of its revolving line of credit at a nominal rate
of 3.15%. This interest rate derivative instrument has been designated as a cash
flow hedge. Such instruments are those that effectively convert variable
interest payments on debt instruments into fixed payments. For qualifying
hedges, SFAS No. 133 and No. 138 allow derivative gains and losses to offset
related results on hedged items in the consolidated statements of operations.
The Company formally documents, designates and assesses the effectiveness of
transactions that receive hedge accounting. Changes in the fair value of
33
interest rate agreements designated as hedging instruments of the variability of
cash flows associated with floating-rate debt obligations are reported in
accumulated other comprehensive loss. During fiscal 2004, approximately $163,000
(net of $104,000 of tax) was recorded as other comprehensive income and in
fiscal 2003, $484,000 (net of $318,000 of tax), was recorded as other
comprehensive loss.
In May 2004, the Company terminated an interest rate swap agreement that
effectively fixed the interest rate on $20 million of its revolving line of
credit at a nominal rate of 6.19%. The termination cost of $1,047,000 is being
amortized on a straight-line basis through August 2005, the original expiration
date of the agreement.
To hedge a portion of its exposure to variability in cash flows related to
interest payments under the revolving credit facility, on March 28, 2003, the
Company entered into a three-year interest rate cap agreement at a cost of $0.3
million. The notional amount of the instrument is $50 million and it caps the
30-day LIBOR rate at 3.5% in the first year, 4.25% in the second year and 5% in
the third year. The Company's analysis of this hedge under SFAS No. 133, shows
this to be an effective hedge. As such, any change in the intrinsic value of
this instrument will be reported in accumulated other comprehensive loss. Any
change in time value of this instrument will be reflected on the Company's
statement of operations.
NOTE 9. COMMITMENTS AND CONTINGENCIES:
The Company leases office and warehouse space and other equipment through
noncancelable operating leases. Rental expense under operating leases was $5.2
million, $3.4 million, and $2.9 million in 2004, 2003, and 2002, respectively.
Minimum rental payments under these leases with initial or remaining terms of
one year or more at June 30, 2004, are $30.9 million and payments during the
succeeding five years are: 2005, $6.0 million; 2006, $5.6 million; 2007, $4.7
million; 2008, $4.0 million; 2009, $3.5 million; and thereafter $7.1 million.
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
June 30, 2004, the Company was party to standby letters of credit of $0.75
million and was the guarantor of certain customer obligations totaling
approximately $260,000. 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 June 30, 2004, the
remaining purchase commitment was approximately $32 million.
During 2004, the Company recorded gains totaling $3.1 million ($1.9
million net of tax) related to the settlement of two class action lawsuits.
These gains were treated as a reduction to cost of sales in the period that they
occurred.
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 Court has not selected lead class counsel and the Company has not yet had an
opportunity to assert its defenses to the complaint. The Defendants intend to
vigorously defend the claims.
34
There are various pending claims and lawsuits arising out of the normal
course of the Company's business. In the opinion of management, the ultimate
outcome of these claims and lawsuits will not have a material adverse effect on
the financial position or results of operations of the Company. However, there
can be no assurance that these claims and lawsuits will not have such an impact.
NOTE 10. STOCK OPTIONS AND RESTRICTED STOCK:
In 1992, the Company adopted a Long-Term Incentive Plan that authorized
the Stock Option and Compensation Committee of the Board of Directors (the
Committee) to grant key employees and officers of the Company incentive or
non-qualified stock options, stock appreciation rights, performance shares,
restricted shares and performance units. Options to purchase up to 400,000
shares of common stock were authorized under the Long-Term Incentive Plan. The
Committee determines the price (which may not be less than fair market value on
the date of grant) and terms at which awards may be granted, along with the
duration of the restriction periods and performance targets. In 1999, the
Company's shareholders approved an Amended and Restated Long-Term Incentive Plan
(Long-Term Incentive Plan) that increased the number of shares available for
grant to 1,700,000 shares. Stock options granted under the Long-Term Incentive
Plan are not exercisable earlier than six months from the date of grant (except
in the case of death or disability of the employee holding the same), nor later
than ten years from the date of grant.
In February 1993, the Board of Directors of the Company adopted the D&K
Wholesale Drug, Inc. 1993 Stock Option Plan (the 1993 Plan) to grant key
employees of the Company non-qualified stock options to purchase up to 700,000
shares of the Company's common stock. The 1993 Plan is administered by the
Company's Board of Directors, which determines the price and terms at which
awards may be granted. Stock options granted under the 1993 Plan are immediately
exercisable from the date of grant and expire not later than ten years from the
date of grant. The exercise price of all options granted pursuant to the 1993
Plan was equal to the fair market value of stock on the respective dates of
grant.
In November 2001, the Board of Directors adopted, and the Company's
shareholders approved, the 2001 Long Term Incentive Plan (the 2001 Plan). Under
the 2001 Plan, the Committee may grant to directors, officers and key employees
of the Company up to an aggregate of 1,000,000 incentive or non-qualified stock
options, stock appreciation rights, performance shares, restricted shares and
performance units. The Committee determines the price of stock options, which
may not be less than the fair market value on the date of grant. Stock options
granted under the 2001 Plan vest over a three year period from the date of
grant, and may be exercised no later than five years from the date of grant.
The following tables summarize information about options at June 30, 2004:
Options Options Exercisable
------------------------------------------------- -------------------------------
Weighted Average
Number Remaining Weighted Average Number Weighted Average
Range of Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ----------------------- ----------- ---------------- ---------------- ----------- -----------------
$1.875 to $6.900 540,616 6.10 years $ 6.17 540,616 $ 6.17
$6.901 to $11.700 129,700 5.20 years $ 9.07 98,237 $ 9.00
$11.701 to $16.500 302,000 3.91 years $ 15.86 1,667 $ 14.10
$16.501 to $21.300 245,000 7.13 years $ 20.66 245,000 $ 20.66
$12.301 to $26.100 145,000 3.35 years $ 24.46 55,000 $ 24.42
$26.101 to $30.8550 140,400 2.68 years $ 30.59 93,600 $ 30.59
--------- --------
1,502,716 5.17 years $ 14.78 1,034,120 $ 13.06
========= =========
Changes in options outstanding under the Company's stock option plans are
as follows:
Number of Weighted Average
Shares Exercise Price
--------- ----------------
OUTSTANDING AT JUNE 30, 2001 1,053,396 5.69
Granted 477,000 24.09
Exercised (424,946) 4.75
Forfeitures (13,334) 6.50
--------- -----
OUTSTANDING AT JUNE 30, 2002 1,092,116 13.69
35
Granted 202,200 20.47
Exercised -- --
Forfeitures (6,000) 30.86
--------- -------
OUTSTANDING AT JUNE 30, 2003 1,288,316 $ 15.01
Granted 315,000 15.92
Exercised (15,000) 10.69
Forfeitures (85,600) 23.19
--------- -------
OUTSTANDING AT JUNE 30, 2004 1,502,716 $ 14.78
Stock options exercisable at June 30, 2004, June 30, 2003, and June 30,
2002 were 1,034,120, 940,785, and 874,773, respectively, with a weighted average
exercise price of $13.06, $12.28, and $11.95, respectively. Shares available to
be granted at June 30, 2004, June 30, 2003, and June 30, 2002 were 329,433,
604,636, and 841,000, respectively.
The Company issued restricted shares of stock to certain key management
personnel in 2004 and 2003. This stock will vest three years from the date of
grant. The Company recorded the cost of the stock at the time of grant as
deferred compensation and will amortize this cost over the vesting period. This
expense was $380,000 and $205,000 in 2004 and 2003, respectively.
NOTE 11. INCOME TAXES:
The components of the income tax provision were as follows (in thousands):
2004 2003 2002
-------- -------- ---------
Current tax provision $ 5,283 $ 9,394 $ 15,909
Deferred tax provision 1,673 (336) (1,796)
-------- -------- ---------
Income tax provision $ 6,956 $ 9,058 $ 14,113
======== ======== =========
The actual income tax provision differs from the expected income tax
provision, computed by applying the U.S. statutory Federal tax rates of 35.0% in
2004, 2003 and 2002, respectively, to income before income tax provision, as
follows (in thousands):
2004 2003 2002
------- ------- ---------
Expected income tax provision $ 6,284 $ 8,297 $ 12,569
Amortization of intangible assets not deductible for income tax purposes -- -- 120
State income taxes, net of Federal benefit 450 775 1,276
Other, net 222 (14) 148
------- ------- --------
$ 6,956 $ 9,058 $ 14,113
======= ======= ========
At June 30, 2004 and June 30, 2003, the tax effects of temporary
differences that give rise to significant portions of the Company's deferred tax
assets and liabilities are as follows (in thousands):
2004 2003
---- ----
Deferred tax assets:
Allowance for doubtful accounts $ 2,557 $ 641
Accrued expenses 4,022 1,463
Capital lease obligations 53 53
Inventories 2,800 909
Net operating loss and AMT carryforwards 2,543 641
Costs related to derivative instruments 360 814
Property and equipment 444 32
Intangibles -- 376
Other 369 334
--------- ---------
Total deferred tax assets $ 13,148 $ 5,263
--------- ---------
Deferred tax liabilities:
Property and equipment $ (2,807) $ --
36
Inventories -- --
Intangibles (3,422) --
Prepaid expenses (784) (600)
Accounts receivable -- --
Other (1,046) (552)
--------- ---------
Total deferred tax liabilities $ (8,059) $ (1,152)
--------- ---------
Net deferred tax assets $ 5,089 $ 4,111
========= =========
The use of pre-acquisition operating losses is subject to limitations
imposed by the Internal Revenue Code or individual states and if not utilized by
the Company, the net operating loss carryforwards will expire beginning in 2007.
The Company acquired net operating loss carryforwards of approximately $2.6
million and alternative minimum tax carryforwards of approximately $0.9 million
in the Walsh transaction. The net operating loss carryforwards expire in 2022
and the alternative minimum tax carryforwards have no expiration date. In
assessing the realization of deferred tax assets, the Company considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during periods in which
those temporary differences become deductible. The Company considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
periods in which the deferred tax assets are deductible, the Company believes it
is more likely than not that the benefit of these deductible differences will be
realized.
NOTE 12. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution 401(k) plan covering substantially
all of its employees. Plan participants may contribute up to 20% of their annual
compensation, subject to certain limitations. The Company contribution is
discretionary and was equivalent to 50% of employees' contributions up to a
maximum contribution based on 6% of eligible compensation. Company match
expenses related to the plan were $373,000 in 2004, $339,000 in 2003, and
$260,000 in 2002. Jewett Drug Company (Jewett) had a defined contribution
401(k)/profit sharing plan covering substantially all of its employees prior to
becoming part of the Company's 401(k) plan in January 2003. Jewett made a
discretionary contribution of $100,000 to its plan in 2002. Jewett also
participates in the Central States Pension, a multi-employer pension plan, on
behalf of its union employees in accordance with the union agreement. The
expenses relating to this plan during 2004, 2003 and 2002 were approximately
$27,000, $24,000 and $21,000, respectively.
The Company also has an executive retirement benefit plan, implemented in
1998, that provides supplemental pre-retirement life insurance plus supplemental
retirement income to key executives. The life insurance benefit is calculated at
three times the participant's annual salary. The retirement income benefit is
provided through discretionary contributions to each participant's account,
which vest 20% annually and are fully vested upon attaining age 65. Upon
retirement, the accumulated account balance is paid to the participant over 15
years in quarterly benefit payments. The Company's expense related to the plan
was $75,000 in 2002. In July 2002, this plan was terminated with participants
receiving their vested retirement income benefit balance in the plan. There was
no income statement impact as a result of this termination. The life insurance
benefit will continue for each participant.
NOTE 13. EARNINGS PER SHARE:
SFAS No. 128, "Earnings Per Share", requires dual presentation of basic
and diluted earnings per share and requires reconciliation of the numerators and
denominators of the basic and diluted earnings per share calculation. The
reconciliation of the numerator and denominator of the basic and diluted
earnings per common share computations are as follows (in thousands, except for
shares and per share amounts):
2004
-------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 10,214 13,934,546 $ 0.73
EFFECT OF DILUTED SECURITIES:
Options -- 202,498
Convertible securities (202) --
-------- ----------
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders plus
assumed conversions $ 10,012 14,137,044 $ 0.71
======== ==========
37
2003
------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
---------- ------------- ---------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 13,935 14,327,646 $0.98
Cumulative effect of accounting change, net (4,249) -- (0.30)
-------- ---------- -----
9,686 $0.68
EFFECT OF DILUTED SECURITIES:
Options -- 185,470
Convertible securities (182) --
-------- ----------
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders plus
assumed conversions $ 9,504 14,513,116 $0.65
======== ==========
2002
------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
---------- ------------- ---------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 21,059 14,246,751 $1.48
EFFECT OF DILUTED SECURITIES:
Options -- 419,852
Convertible securities (169) 11,178
-------- -------
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders plus
assumed conversions $ 20,890 14,677,781 $1.42
======== ==========
As of June 30, 2004 and 2003, stock options to purchase 0.8 million, 0.6
million shares respectively were not dilutive and therefore not included in the
diluted earnings per share calculation. At June 30, 2002, all shares were
dilutive.
NOTE 14. EFFECT OF NEW ACCOUNTING STANDARDS:
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No.
133 for decisions made as part of the FASB's Derivatives Implementation Group
process, other FASB projects dealing with financial instruments, and in
connection with implementation issues raised in relation to the application of
the definition of a derivative. This statement is generally effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did not
have a material impact on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 modifies the accounting for certain financial instruments
that, under previous guidance, issuers could account for as equity. SFAS 150
requires that those instruments be classified as liabilities in statements of
financial position and affects an issuer's accounting for (1) mandatorily
redeemable shares, which the issuing company is obligated to buy back in
exchange for cash or other assets, (2) instruments, other than outstanding
shares, that do or may require the issuer to buy back some of its shares in
exchange for cash or other assets, or (3) obligations that can be settled with
shares, the monetary value of which is fixed, tied solely or predominantly to a
variable such as a market index, or varies inversely with the value of the
issuer's shares. In addition to its requirements for the classification and
measurement of financial instruments within its scope, SFAS 150 also requires
disclosures about alternative ways of settling those instruments and the capital
structure of entities, all of whose shares are mandatorily redeemable. SFAS 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 did not have a material
impact on our consolidated financial statements.
NOTE 15. 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
38
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. Sales to independent and
regional pharmacies consist of branded pharmaceuticals (approximately 89% of net
sales in fiscal 2004), generic pharmaceuticals (approximately 8% of net sales in
fiscal 2004) and over-the-counter health and beauty aid products (approximately
3% of net sales in fiscal 2004). Our national accounts business deals
predominantly with branded pharmaceuticals. The Company operates principally in
the United States. Interest and corporate expenses are allocated to wholly owned
subsidiaries only. Assets have been identified with the segment to which they
relate.
For the Years Ended
-------------------------------------------------
(in thousands) JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2002
------------- ------------- -------------
Sales to unaffiliated customers -
Wholesale drug distribution $ 2,528,577 $ 2,213,257 $ 2,444,290
PBI 8,823 7,768 7,539
Software and Other 3,790 2,363 1,919
------------- ------------- -------------
TOTAL $ 2,541,190 $ 2,223,388 $ 2,453,748
Intersegment sales --
Wholesale drug distribution $ -- $ -- $ --
PBI -- -- --
Software and Other -- -- 1,197
Intersegment eliminations -- -- (1,197)
------------- ------------- -------------
TOTAL $ -- $ -- $ --
Gross profit --
Wholesale drug distribution $ 92,401 $ 81,193 $ 92,578
PBI (2) 8,823 7,768 7,539
Software and Other 2,171 1,738 2,714
------------- ------------- -------------
TOTAL $ 103,395 $ 90,699 $ 102,831
Depreciation and amortization --
Wholesale drug distribution $ 3,698 $ 2,410 $ 4,107
PBI 53 47 97
Software and Other 31 35 249
------------- ------------- -------------
TOTAL $ 3,782 $ 2,492 $ 4,453
Interest expense --
Wholesale drug distribution $ 14,241 $ 10,680 $ 9,955
PBI 240 336 380
Software and Other 50 54 51
------------- ------------- -------------
TOTAL $ 14,531 $ 11,070 $ 10,386
Earnings before income tax provision --
Wholesale drug distribution $ 13,079 $ 19,424 $ 31,271
PBI 4,152 3,833 4,029
Software and Other 723 449 610
------------- ------------- -------------
TOTAL $ 17,954 $ 23,706 $ 35,910
Purchases of property and equipment --
Wholesale drug distribution $ 4,411 $ 679 $ 988
PBI 363 33 40
Software and Other 126 5 23
Other unallocated Corporate amounts 492 1,654 2,394
------------- ------------- -------------
TOTAL $ 5,392 $ 2,371 $ 3,445
Identifiable assets --
Wholesale drug distribution $ 709,189 $ 450,263 $ 464,494
PBI 4,821 4,448 3,810
Software and Other 14,815 2,693 2,301
Other unallocated Corporate amounts (1) 14,880 15,291 12,533
------------- ------------- -------------
TOTAL $ 743,705 $ 472,695 $ 483,138
39
(1) Amounts represent assets at corporate headquarters consisting primarily
of deferred tax assets, property and equipment and deferred debt costs.
(2) Cost of operations recorded by PBI of $4.4 million, $3.6 million, and
$3.2 million, respectively, have been classified as operating expenses in
the Company's Consolidated Statements of Operations.
NOTE 16. QUARTERLY RESULTS (UNAUDITED)
Quarterly results are determined in accordance with annual accounting
policies. They include certain items based upon estimates for the entire year.
Summarized quarterly results for the last two years were as follows:
(in thousands, except per share data) 2004 QUARTER 2004
------------------------------------------------ ----------
FIRST SECOND THIRD FOURTH YEAR
-------- -------- -------- -------- ----------
Net sales $478,548 $510,945 $833,933 $717,764 $2,541,190
Gross profit 18,088 19,455 (1) 35,177 30,675 (1) 103,395
Net income 1,467 177 5,404 3,166 10,214
Basic earnings per share $ 0.11 $ 0.01 $ 0.39 $ 0.23 $ 0.73
Diluted earnings per share 0.10 0.01 0.38 0.22 0.71
(in thousands, except per share data) 2003 QUARTER 2003
------------------------------------------------- ----------
FIRST SECOND THIRD FOURTH YEAR
--------- -------- -------- -------- ----------
Net sales $533,966 $530,843 $628,618 $529,961 $2,223,388
Gross profit 21,053 21,222 27,018 21,406 90,699
Net income (1,387) 2,675 4,235 4,163 9,686
Basic earnings (loss) per share ($ 0.09) $ 0.18 $ 0.30 $ 0.30 $ 0.68
Diluted earnings (loss) per share (0.10) 0.18 0.29 0.29 0.65
(1) Include gains from legal settlements of $0.8 million in the second quarter
and $2.3 million in the fourth quarter.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A. Controls and Procedures
Under the supervision and with the participation of our management,
including the Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14(c) as of the end of
the period covered by this report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that these disclosure
controls and procedures are effective. There were no changes in our internal
control over financial reporting during the quarter ended June 30, 2004 that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.
Item 9B. Other Information.
None.
40
PART III
Item 10. Directors and Executive Officers of the Registrant
The information set forth under the caption "Election of Directors" in the
Proxy Statement for our 2004 Annual Meeting of Stockholders (the "2004 Proxy
Statement") is incorporated herein by this reference. We will file the 2004
Proxy Statement with the Securities and Exchange Commission pursuant to
Regulation 14A within 120 days after the close of the fiscal year.
Code of Business Conduct and Ethics
The Company has adopted a Code of Business Conduct and Ethics (the "Code")
that applies to all companies, their officers, directors and employees. This
Code and the charters of the Audit, Compensation and Nominating and Corporate
Governance committees are posted on the Company's website at
www.dkhealthcare.com. The Company intends to post any amendments to or waivers
from the Code on our website.
Item 11. Executive Compensation
The information set forth under the captions "Directors' Fees" and
"Compensation of Executive Officers" in the 2004 Proxy Statement, to be filed
with the SEC pursuant to Regulation 14A of the Exchange Act, is incorporated
herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the captions "Voting Securities and
Principal Holders Thereof" and "Security Ownership By Management" in the 2004
Proxy Statement, to be filed with the SEC pursuant to Regulation 14A of the
Exchange Act, is incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions
The information set forth under the caption "Certain Transactions" in the
2004 Proxy Statement, to be filed with the SEC pursuant to Regulation 14A of the
Exchange Act, is incorporated herein by this reference.
Item 14. Principal Accountant Fees and Services
A description of the fees paid to our independent auditors will be set
forth in the section titled "Independent Public Accountants" of the Proxy
Statement and is incorporated herein by reference.
41
PART IV
Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a) (1) Financial statements: See Item 8 above.
(2) The following financial statement schedule and auditors' report
thereon are included in Part IV of this report:
Page
Schedule II - Valuation and Qualifying Accounts 44
Schedules other than those listed above have been omitted
because they are either not required or not applicable or
because the information is presented in the consolidated
financial statements or the notes thereto.
(3) Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K
On April 21, 2004, the registrant filed a Current Report on Form 8-K
to furnish as an exhibit registrant's press release announcing its
results for its fiscal 2004 third quarter and first nine months.
(c) See Item 15(a)(3) above.
(d) See Item 15(a)(2) above.
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
(Registrant)
By /s/ J. Hord Armstrong, III
---------------------------------
J. Hord Armstrong, III, Chairman
of the Board,
Chief Executive Officer and Treasurer
Date: September 13, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ J. Hord Armstrong, III Chairman, Chief Executive Officer, September 13, 2004
- ------------------------------ Treasurer and Director
J. Hord Armstrong, III
/s/ Martin D. Wilson President, Chief Operating Officer September 13, 2004
- ------------------------------ and Director
Martin D. Wilson
/s/ Thomas S. Hilton Senior Vice President, Chief Financial September 13, 2004
- ------------------------------ Officer (Principal financial and
Thomas S. Hilton accounting officer)
/s/ Richard F. Ford Director September 13, 2004
- ------------------------------
Richard F. Ford
/s/ Bryan H. Lawrence Director September 13, 2004
- ------------------------------
Bryan H. Lawrence
/s/ Mary Ann Van Lokeren Director September 13, 2004
- ------------------------------
Mary Ann Van Lokeren
/s/ Thomas F. Patton Director September 13, 2004
- ------------------------------
Thomas F. Patton
/s/ Louis B. Susman Director September 13, 2004
- ------------------------------
Louis B. Susman
/s/ Harvey C. Jewett, IV Director September 13, 2004
- ------------------------------
Harvey C. Jewett, IV
43
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR FISCAL 2002, FISCAL 2003,
AND FISCAL 2004
Additions
------------------------------
Balance at Charged to Balance at
Beginning Costs and End of
Description of Period Expenses Acquisitions Deductions Period
----------- ---------- ---------- ------------ ---------- ----------
Valuation Allowances for
Doubtful Receivables:
Fiscal Year 2002 $ 2,197,000 $ 525,000 $ -- $ (1,348,000) $1,374,000
=========== ========= ============ ============= ==========
Fiscal Year 2003 $ 1,374,000 $ 230,000 $ -- $ -- $1,604,000
=========== ========= ============ ============= ==========
Fiscal Year 2004 $ 1,604,000 $ 333,000 $ 3,776,000 $ (269,000) $5,444,000
=========== ========= ============ ============= ==========
44
EXHIBIT INDEX
Exhibit No. Description
2.1* Stock Purchase and Redemption Agreement, dated as of November 30,
1995, by and among Pharmaceutical Buyers, Inc., J. David McCay, The
J. David McCay Living Trust, Robert E. Korenblat and the registrant
filed as an exhibit to the registrant's Annual Report on Form 10-K
for the year ended March 28, 1997.
2.2* Stock Purchase Agreement dated June 1, 1999 by and between the
registrant and Harvey C. Jewett, IV, filed as an exhibit to Form
8-K dated June 14, 1999.
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., dated March 13, 2002, filed as an
exhibit to the 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.
10.1* D & K Healthcare Resources, Inc., Amended and Restated 1992 Long
Term Incentive Plan, filed as Annex A to the registrant's 1999
Proxy Statement.
10.2* D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan and Trust,
dated January 1, 1995, filed as an exhibit to the registrant's
Annual Report on Form 10-K for the year ended March 29, 1996.
10.2a* Amendment Number 1 to D & K Wholesale Drug, Inc. 401(k) Profit
Sharing Plan and Trust, dated December 20, 1996, filed as an
exhibit to the registrant's Annual Report on Form 10-K for the year
ended June 30, 2000.
10.2b* Amendment Number 2 to D & K Wholesale Drug, Inc. 401(k) Profit
Sharing Plan and Trust, dated September 17, 1997, filed as an
exhibit to the registrant's Annual Report on Form 10-K for the year
ended June 30, 2000.
10.2c* Resolution to D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan
and Trust, dated March 27, 2000, filed as an exhibit to the
registrant's Annual Report on Form 10-K for the year ended June 30,
2000.
10.3* Amended and Restated Lease Agreement, dated as of January 16, 1996,
by and between Morhaert Development, L.L.C. and the registrant,
filed as an exhibit to the registrant's Annual Report on Form 10-K
for the year ended March 29, 1996.
10.4* Purchase and Sale Agreement dated as of August 7, 1998 between
registrant, certain of its subsidiaries and D&K Receivables
Corporation, filed as an exhibit to the registrant's Annual Report
on Form 10-K for the year ended June 30, 1998.
10.5* Sixth Amended and Restated Loan and Security Agreement, dated March
28, 2003, by and among Fleet Capital Corporation (individually and
as Agent for Lenders), registrant, Jewett Drug Co., Diversified
Healthcare, LLC, and Medical & Vaccine Products, Inc. filed as an
exhibit to the registrant's Current Report on Form 8-K dated March
31, 2003.
45
EXHIBIT INDEX
Exhibit No. Description
10.7* Prime Vendor Agreement dated as of August 25, 1999, between
Tennessee Pharmacy Purchasing Alliance and the registrant, filed as
an exhibit to the registrant's Annual Report on Form 10-K for the
year ended June 30, 1999.
10.7a* First Amendment to Prime Vendor Agreement dated effective as of
April 1, 2001 between The Pharmacy Cooperative formerly known as
Tennessee Pharmacy Purchasing Alliance and the registrant filed as
an exhibit to the registrant's Registration Statement, Amendment
No. 2 to Form S-3 dated June 27, 2001.
10.8* Lease Agreement, dated as of May 18, 1999, by and between BSRT
Lexington Trust and the registrant, filed as an exhibit to the
registrant's Annual Report on Form 10-K for the year ended June 30,
1999.
10.9* Lease Agreement, dated as of January 1, 1997, by and between Jewett
Family Investments, LLC and Jewett Drug Co, filed as an exhibit to
the registrant's Annual Report on Form 10-K for the year ended June
30, 1999.
10.10* First Amendment to Lease, dated as of June 1, 1999, by and between
Jewett Family Investments, LLC and Jewett Drug Co, filed as an
exhibit to the registrant's Annual Report on Form 10-K for the year
ended June 30, 1999.
10.11* Lease Agreement dated as of July 1, 1997 by and between Jewett
Family Investments, LLC and the registrant, filed as an exhibit to
the registrant's Annual Report on Form 10-K for the year ended June
30, 1999.
10.12* First Amendment to Lease, dated as of June 1, 1999, by and between
Jewett Family Investments, LLC and Jewett Drug Co, filed as an
exhibit to the registrant's Annual Report on Form 10-K for the year
ended June 30, 1999.
10.13* Employment agreement for J. Hord Armstrong, III dated September 15,
2000, filed as an exhibit to the registrant's Annual Report on Form
10-K for the year ended June 30, 2000.
10.14* Employment agreement for Martin D. Wilson dated August 28, 2000,
filed as an exhibit to the registrant's Annual Report on Form 10-K
for the year ended June 30, 2000.
10.15* Employment agreement for Thomas S. Hilton dated August 31, 2000,
filed as an exhibit to the registrant's Annual Report on Form 10-K
for the year ended June 30, 2000.
10.16* D&K Healthcare Resources, Inc. Executive Retirement Benefit Plan,
dated January 1, 1998. filed as an exhibit to the registrant's
Annual Report on Form 10-K for the year ended June 30, 2000.
10.17* D & K Healthcare Resources, Inc. 2001 Long Term Incentive Plan,
dated November, 2001, filed as an exhibit to the registrant's 2001
Proxy Statement.
10.18* Lease Agreement dated as of October 10, 2001 by and between Forsyth
Centre Associates, L.L.C., and the registrant filed as an exhibit
to the registrant's Annual Report on Form 10-K for the year ended
June 30, 2002.
10.18a* Amendment to Lease Agreement dated February 26, 2002 by and between
Forsyth Centre Associates, L.L.C., and the registrant filed as an
exhibit to the registrant's Annual Report on Form 10-K for the year
ended June 30, 2002.
10.19* Lease Agreement, dated February 7, 2001, by and between Industrial
Property Fund III, L.P. and the registrant, filed as an exhibit to
the registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001.
46
EXHIBIT INDEX
Exhibit No. Description
10.20* Lease Agreement, dated August 2003, by and between Hillwood Metro
No. 10, L.P., LCS Land Partners II, Ltd and the registrant, filed
as an exhibit to the registrants Annual Report on Form 10-K for the
year ended June 30, 2003.
10.21* 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 the registrant's
Current Report on Form 8-K dated December 15, 2003.
10.22** Lease Agreement, dated August 18, 2004, by and between Gazelle, LLC
and the registrant.
13** Registrant's 2004 Annual Report to Stockholders.
14** Registrant's Code of Business Conduct and Ethics.
21** Subsidiaries of the registrant.
23** Consent of Independent Registered Public Accounting Firm
31.1** Certification by Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2** Certification by Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32** Certification by Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference.
** Filed herewith.
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