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Page 1 of 17
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 0-20348
D & K HEALTHCARE RESOURCES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 43-1465483
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8235 FORSYTH BOULEVARD, ST. LOUIS, MISSOURI
(Address of principal executive offices)
63105
(Zip Code)
(314) 727-3485
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] YES [ ] NO
Indicate by check mark whether the registrant is an accelerated filer. Yes
[X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, $.01 par value 14,102,449
---------------------------- ----------
(class) (November 02, 2004)
Page 2 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Index
Page No.
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2004 and June 30, 2004 3
Condensed Consolidated Statements of Operations for the
Three Months Ended September 30, 2004
and September 30, 2003 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended September 30, 2004
and September 30, 2003 5
Notes to Condensed Consolidated Financial Statements 6 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 14
Part II. Other Information
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
Page 3 of 17
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
SEPTEMBER 30, JUNE 30,
2004 2004
------------ ---------
(unaudited)
ASSETS
Current Assets
Cash (including restricted cash of $8,381 and $12,499, respectively) $ 8,381 $ 12,499
Receivables, net of allowance for doubtful accounts of $4,976 and $5,444, respectively 126,444 130,770
Inventories 550,747 461,295
Other current assets 30,606 29,736
--------- ---------
Total current assets 716,178 634,300
Property and Equipment, net of accumulated depreciation and amortization of
$13,086 and $12,274, respectively 24,569 24,494
Other Assets 17,972 14,298
Goodwill, net of accumulated amortization 71,858 64,233
Other Intangible Assets, net of accumulated amortization 10,127 6,546
--------- ---------
Total assets $ 840,704 $ 743,871
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 926 $ 676
Accounts payable 311,232 219,580
Accrued expenses 22,539 31,144
--------- ---------
Total current liabilities 334,697 251,400
Long-term Liabilities 3,053 2,663
Long-term Debt, excluding current maturities 321,886 307,693
Deferred Income Taxes 3,768 2,785
--------- ---------
Total liabilities 663,404 564,541
Stockholders' Equity
Common stock 153 152
Paid-in capital 126,370 125,552
Accumulated other comprehensive loss (1,294) (1,208)
Deferred compensation - restricted stock (1,341) (730)
Retained earnings 65,638 67,790
Less treasury stock (12,226) (12,226)
--------- ---------
Total stockholders' equity 177,300 179,330
--------- ---------
Total liabilities and stockholders' equity $ 840,704 $ 743,871
========= =========
The accompanying notes are an integral part of these statements.
Page 4 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the three months ended September 30, (in thousands, except per share data)
2004 2003
--------- ---------
Net Sales $ 725,676 $ 478,548
Cost of Sales 702,613 460,460
--------- ---------
Gross profit 23,063 18,088
Operating Expenses 21,816 13,188
--------- ---------
Income from operations 1,247 4,900
Other Income (Expense):
Interest expense, net (4,091) (2,147)
Other, net (35) 36
--------- ---------
(4,126) (2,111)
--------- ---------
Income (Loss) before income tax provision and minority interest (2,879) 2,789
Income Tax Benefit (Provision) 1,123 (1,088)
Minority Interest (185) (234)
--------- ---------
Net income (Loss) $ (1,941) $ 1,467
========= =========
Earnings (Loss) Per Share - Basic $ (0.14) $ 0.11
Earnings (Loss) Per Share - Diluted $ (0.14) $ 0.10
Basic common shares outstanding 14,058 13,956
Diluted common shares outstanding 14,058 14,194
The accompanying notes are an integral part of these statements.
Page 5 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the 3 months ended September 30, (in thousands)
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (1,941) $ 1,467
Adjustments to reconcile net income (loss) to net cash
flows from operating activities --
Depreciation and amortization 1,355 656
Amortization of debt issuance costs 424 407
Deferred income taxes (147) 862
Decrease in receivables, net 4,726 22,475
Increase in inventories (89,452) (63,872)
Increase in other current assets (430) (2,480)
Increase in accounts payable 91,652 1,015
Decrease in accrued expenses (9,393) (1,936)
Other, net (308) 1,837
-------- --------
Net cash flows used in operating activities (3,514) (39,569)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid for acquired company (12,400) --
Purchases of property and equipment (1,564) (289)
-------- --------
Net cash flows used in investing activities (13,964) (289)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving line of credit, net 13,018 39,337
Proceeds from secured financing 860 --
Payments of long-term debt (307) (238)
Payment of dividends (211) (209)
Purchase of treasury stock -- (816)
-------- --------
Net cash flows provided by financing activities 13,360 38,074
-------- --------
Decrease in cash (4,118) (1,784)
Cash, beginning of period 12,499 14,301
-------- --------
Cash, end of period $ 8,381 $ 12,517
-------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for --
Interest $ 3,662 $ 1,760
Income taxes, net $ 2,126 $ 207
The accompanying notes are an integral part of these statements.
Page 6 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
D & K Healthcare Resources, Inc. (the "Company") is a full-service,
regional wholesale drug distributor, supplying customers from facilities in
Missouri, Kentucky, Minnesota, Texas, Arkansas, and South Dakota. The Company
distributes a broad range of pharmaceuticals and related products to its
customers in 27 states primarily in the Midwest, Upper Midwest, and South. The
Company focuses primarily on a target market sector, which includes independent
retail, institutional, franchise, chain store and alternate site pharmacies. The
Company also offers a number of proprietary information systems software
products through two wholly owned subsidiaries, Tykon, Inc. and VC Services,
Inc. (dba Viking Computer Services). In addition, the Company owns
Pharmaceutical Buyers, Inc. ("PBI"), a leading alternate site group purchasing
organization.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and include
all of the information and disclosures required by accounting principles
generally accepted in the United States of America for interim reporting, which
are less than those required for annual reporting. In the opinion of management,
all adjustments (consisting only of normal recurring accruals) considered
necessary for a fair representation have been included. The results of
operations for the three-month period ended September 30, 2004, are not
necessarily indicative of the results to be expected for the full fiscal year.
These condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and related notes
contained in the Company's 2004 Annual Report to Stockholders.
NOTE 2. ACQUISITION
On September 30, 2004, the Company completed the acquisition of the
remaining 30% of Pharmaceutical Buyers, Inc. (PBI), a Colorado-based group
purchasing organization for alternate-site providers whose members include
long-term care providers, home infusion providers and medical equipment
distributors. The purchase price was $12.4 million. The transaction resulted in
recognition of $7.7 million of goodwill, which was assigned to the PBI segment.
Of that amount, none is expected to be deductible for tax purposes. Intangible
assets of $3.8 million were also recorded with a weighted-average life of
approximately 15 years. The intangible assets that make up that amount include
customer relationships of $3.2 million (15-year weighted-average useful life)
and other assets of $0.2 million (10-year weighted-average useful life). In
addition, $0.4 million of intangible assets were determined to have indefinite
lives.
On December 5, 2003, the Company acquired 100 percent of the outstanding
common stock of Walsh HealthCare Solutions, Inc. ("Walsh") of Texarkana, Texas.
Walsh is a full-service pharmaceutical distributor with distribution centers
located in San Antonio and Texarkana, Texas and Paragould, Arkansas. The results
of Walsh have been included in the condensed consolidated financial statements
since that date. The aggregate purchase price of $104.4 million in cash before
consideration of cash acquired includes the repayment of all Walsh bank debt and
other direct acquisition costs. D & K utilized its existing revolving credit
facility to finance the transaction.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company, PBI and Walsh for the three
months ended September 30, 2004 and 2003, as if the Walsh and PBI acquisitions
had occurred at July 1, 2003, with pro forma adjustments to give effect to
amortization of intangible assets, interest expense on acquisition debt,
minority interest, 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).
Page 7 of 17
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2004 2003
--------- ---------
Net sales $ 725,676 $ 688,433
Net income (loss) before discontinued operations $ (1,791) $ 1,767
Net income (loss) $ (1,791) $ 1,607
Diluted earnings (loss) per share $ (0.13) $ 0.11
NOTE 3. STOCK-BASED COMPENSATION
The Company has adopted the disclosure requirements of Statement of
Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
compensation and also amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
methods of accounting for stock-based employee compensation and the effect of
the method used on reported results. As permitted by SFAS 148 and SFAS 123, the
Company continues to apply the accounting provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees."
The Company generally grants its stock options at exercise prices equal to
the fair 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.
Had the Company recorded compensation expense based on the estimated grant
date fair values, as defined by SFAS 123, for awards granted under its stock
option plans and stock purchase plan, the unaudited pro forma net income and pro
forma earnings per share would have been as follows:
Three Months Ended
September 30,
--------------------------
(in thousands, except per share data) 2004 2003
--------- ---------
Net income (loss) - as reported $ (1,941) $ 1,467
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of tax (44) (393)
--------- ---------
Net income (loss) - pro forma $ (1,985) $ 1,074
Earnings (loss) per share:
Basic - as reported $ (0.14) $ 0.11
Basic - pro forma $ (0.14) $ 0.08
Diluted - as reported $ (0.14) $ 0.10
Diluted - pro forma $ (0.14) $ 0.07
These pro forma amounts may not be representative of the effects for
future years as options vest over several years and additional awards are
generally granted each year.
Page 8 of 17
NOTE 4. GOODWILL AND INTANGIBLE ASSETS
Changes to goodwill and intangible assets during the three-month period
ended September 30, 2004 are:
(in thousands) Goodwill Intangible Assets
-------- -----------------
Balance at June 30, 2004, net of
accumulated amortization $ 64,233 $ 6,546
Acquisition 7,679 3,756
Adjustment to Walsh purchase price (54) --
Amortization expense -- (175)
-------- --------
Balance at September 30, 2004, net of
accumulated amortization $ 71,858 $ 10,127
======== ========
Intangible assets totaled $10.1 million, net of accumulated amortization
of $1.0 million, at September 30, 2004. Of this amount, $0.6 million represents
intangible assets with indefinite useful lives, consisting primarily of trade
names that are not being amortized under SFAS No. 142. The remaining intangibles
relate to customer or supplier relationships and licenses. Amortization expense
for intangible assets is expected to approximate $0.7 million each year between
2004 and 2014 and $0.2 million from 2015 to 2018.
Goodwill Intangible Assets
------------------------- ------------------------
September 30, June 30, September 30, June 30,
(in millions) 2004 2004 2004 2004
------------- -------- ------------- ---------
SEGMENT:
Wholesale drug distribution $ 51.8 $ 51.8 $ 4.9 $ 5.0
PBI 18.7 11.0 5.2 1.5
Software 1.4 1.4 -- --
------- ------- ------- -------
Total $ 71.9 $ 64.2 $ 10.1 $ 6.5
======= ======= ======= =======
The Company tests goodwill annually as of April 30. A discounted cash flow
model is used to determine the fair value of the Company's businesses for the
purpose of testing goodwill for impairment. The discount rate used is based on a
risk-adjusted weighted average cost of capital.
NOTE 5. EARNINGS PER SHARE
SFAS No. 128, "Earnings Per Share," requires dual presentation of basic
and diluted earnings per share and requires a reconciliation of the numerators
and denominators of the basic and diluted earnings per share calculations. The
reconciliation of the numerator and denominator of the basic and diluted
earnings per share computations are as follows :
Three Months ended September 30, 2004 Three Months ended September 30, 2003
---------------------------------------- ----------------------------------------
Income Shares Per-share Income Shares Per-share
(in thousands, except for per share amounts) (Numerator) (Denominator)(1) Amount (Numerator) (Denominator)(1) Amount
----------- ---------------- --------- ----------- ---------------- ---------
Basic Earnings per Share:
Net income (loss) available to common
stockholders $(1,941) 14,058 $ (0.14) $ 1,467 13,956 $ 0.11
Effect of Diluted Securities:
Options -- -- -- 238
Convertible securities (66) -- (63) --
------- ------ ------- ------
Diluted Earnings per Share:
Net income (loss) available to common
stockholders plus assumed conversions $(2,007) 14,058 $ (0.14) $ 1,404 14,194 $ 0.10
======= ====== ======= ======= ====== =======
(1) Outstanding shares computed on a weighted average basis
Page 9 of 17
As of September 30, 2004 and 2003, stock options to purchase 1.5 million
and 0.9 million shares respectively were not dilutive and therefore not included
in the diluted earnings per share calculation.
NOTE 6. COMPREHENSIVE INCOME
The Company's comprehensive income consists of net income and the net
change in value of cash flow hedge instruments as follows: (in thousands)
Three Months Ended
September 30,
----------------------
2004 2003
------- -------
Net income (loss) $(1,941) $ 1,467
Change in value of cash flow hedge, net of tax (86) 192
------- -------
Total comprehensive income (loss) $(2,027) $ 1,659
======= =======
NOTE 7. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk, such as standby letters of credit and
other guarantees, which are not reflected in the accompanying balance sheets. At
September 30, 2004, the Company was party to standby letters of credit of
approximately $15.8 million and was the guarantor of certain customer
obligations totaling approximately $0.3 million. 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 June 2006. At September 30, 2004,
the remaining purchase commitment is approximately $25 million.
On February 5, 2004, an individual named Gary Dutton filed a complaint in
the United States District Court for the Eastern District of Missouri ("Court")
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. On April 30, 2004, United Food &
Commercial Workers Union, Local 655, AFL-CIO, Food Employees Joint Pension Plan
("Local 655") filed a motion to become lead plaintiff. On October 5, 2004, the
Court granted Local 655's motion appointing them lead plaintiff. The Company
believes that the existing complaint describes types of transactions in which
the Company has not engaged, contains a number of inaccurate statements, and
does not state any valid cause of action, and further, that the Company will
have substantial meritorious defenses to the complaint. The Defendants intend to
vigorously defend the claims.
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 8. LONG-TERM DEBT
The Company has a $600 million asset-based senior secured revolving credit
facility. Under the credit facility, the total amount of loans and letters of
credit outstanding at any time cannot exceed the lesser of an amount based on
percentages of eligible receivables and inventories (the borrowing base formula)
and $600 million. Total credit available at September 30, 2004 was approximately
$463 million of which approximately $128 million was unused.
Page 10 of 17
The interest rate on the credit facility is based on the 30-day London Interbank
Offering Rate (LIBOR) plus a factor based on certain financial criteria. The
interest rate was 4.34% at September 30, 2004. The facility expires in March
2007 and contains no subjective acceleration provision, and therefore, the
related debt has been classified as long-term in the Company's financial
statements.
The Company is required under the terms of the credit facility 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 is also 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. In August 2004, the Company amended
the credit facility modifying the loan covenants to make them less restrictive.
The Company is in compliance with its debt covenants as of September 30, 2004.
At this time, the Company projects that it will be in compliance with the debt
covenants for the next 12 months.
NOTE 9. BUSINESS SEGMENTS
Pursuant to SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the Company has three identifiable business segments:
wholesale drug distribution, the Company's interest in PBI, and Software/Other.
Two wholly owned software subsidiaries, Tykon, Inc. and Viking Computer
Services, and 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 distribution of Parata robotic
dispensing systems.
Though the wholesale drug distribution segment operates from several
different facilities, the nature of its products and services, the types of
customers and the methods used to distribute its products are similar and thus
they have been aggregated for presentation purposes. The Company operates
principally in the United States.
For The Three Months Ended
--------------------------------------
(in thousands) September 30, 2004 September 30, 2003
------------------ ------------------
Net Sales -
Wholesale drug distribution $ 722,925 $ 475,677
PBI 2,118 2,319
Software/Other 633 552
--------- ---------
Total $ 725,676 $ 478,548
Gross Profit -
Wholesale drug distribution $ 20,472 $ 15,363
PBI(1) 2,118 2,319
Software/Other 473 406
--------- ---------
Total $ 23,063 $ 18,088
Pre-tax earnings (loss) -
Wholesale drug distribution $ (3,892) $ 1,497
PBI 1,054 1,232
Software/Other (41) 60
--------- ---------
Total $ (2,879) $ 2,789
(1) Cost of operations recorded by PBI of $1.0 million in each period have
been classified as operating expenses in the Company's Condensed
Consolidated Statements of Operations.
The increase in total assets from the Company's 2004 Annual Report relates
primarily to increased inventory levels and the acquisition of the remaining
portion of PBI. There are no other differences in the basis of segmentation or
in the basis of measurement of segment profit or loss.
Page 11 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The discussion below is concerned with material changes in financial
condition and results of operations in the condensed consolidated balance sheets
as of September 30, 2004 and June 30, 2004, and in the condensed consolidated
statements of operations for the three-month periods ended September 30, 2004
and September 30, 2003, respectively. We recommend that this discussion be read
in conjunction with the audited consolidated financial statements and
accompanying notes included in our 2004 Annual Report to Stockholders.
FORWARD LOOKING STATEMENTS
Certain statements in this document regarding future events, prospects,
projections or financial performance are forward looking statements. Such
forward looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and may be identified by
words such as "anticipates," "believes," "estimates," "expects," "intends" and
similar expressions. Such forward-looking statements are inherently subject to
risks and uncertainties. The Company's actual results could differ materially
from those currently anticipated due to a number of factors, including without
limitation, the changing business and regulatory environment of the healthcare
industry in which the Company operates, including manufacturers' pricing or
distribution policies or practices, the competitive nature of the wholesale
pharmaceutical distribution industry with many competitors having substantially
greater resources than D & K Healthcare, the Company's ability to maintain or
improve its operating margins with the industry's competitive pricing pressures,
the Company's customers and suppliers generally having the right to terminate or
reduce their purchases or shipments on relatively short notice, changes in the
Company's prime vendor status with cooperative purchasing groups, the
availability of investment purchasing opportunities, the loss of one or more key
suppliers for which alternative sources may not be available, changes in private
and governmental reimbursement or in the delivery systems for healthcare
products, changes in interest rates, ability to complete and integrate
acquisitions successfully, and other factors set forth in reports and other
documents filed by D & K Healthcare with the Securities and Exchange Commission
from time to time. The reader should not place undue reliance on forward-looking
statements, which speak only as of the date they are made. D & K Healthcare
undertakes no obligation to publicly update or revise any forward-looking
statements.
RECENT TRENDS AND EVENTS
Sales in the national accounts trade class fell below expectations in the
first quarter of fiscal 2005, as fewer than anticipated product price increases
enacted by pharmaceutical manufacturers resulted in lower activity in this trade
class. Changes in manufacturers' inventory management practices resulting in
reduced availability of product 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 quarter of fiscal 2005. However, during this period sales
trends in this trade class show continued growth that 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 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
Page 12 of 17
classes of trade rely on us as their primary pharmaceutical and over-the-counter
products supplier. 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. 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 future results
more difficult to project. We believe that 2005 earnings results will likely be
`back-end' loaded, similar to 2004.
RESULTS OF OPERATIONS
NET SALES Net sales increased $247.1 million to $725.7 million, or 51.6%,
for the three months ended September 30, 2004, compared to the corresponding
period of the prior year. Sales to independent and regional pharmacies increased
$334.0 million to $654.0 million, or 104.4%, approximately 64% of which relates
to sales from the Walsh subsidiary. The majority of the remaining increase
relates to new business. National accounts sales decreased $89.8 million to
$38.1 million, or 70.2%, compared to the prior year period primarily due to
fewer product price increases enacted by pharmaceutical manufacturers and
changes in pharmaceutical manufacturers' inventory management practices that
reduced the availability of attractively priced purchase opportunities. We
provide our national accounts customers bulk pharmaceuticals that we purchase,
if available, on favorable terms from the manufacturers. If we are unable to
obtain bulk inventory on favorable terms, our sales in this area will continue
to decline.
GROSS PROFIT Gross profit increased $5.0 million to $23.1 million, or
27.5%, for the three months ended September 30, 2004, compared to the
corresponding period of the prior year. As a percentage of net sales, gross
margin decreased from 3.78% to 3.18% for the quarter ended September 30, 2004,
compared to the corresponding period of the prior year. Walsh gross margin was
consistent with the rest of our wholesale drug distribution segment. The
increase in gross profit was due to the addition of Walsh and additional sales
related to new business and same store growth offset by lower national accounts
sales and continued pricing pressure on new and existing business. The reduction
in gross margin percentage was primarily due to fewer price increases during the
quarter.
OPERATING EXPENSES Operating expenses (including depreciation and
amortization) increased $8.6 million to $21.8 million, or 65.4%, for the three
months ended September 30, 2004 compared to the corresponding period of the
prior year. The ratio of operating expenses to net sales was 3.01%, a 25 basis
point increase from the comparable period of the prior year. The increase in
operating expenses resulted primarily from the inclusion of Walsh-related
operating expenses during the quarter.
INTEREST EXPENSE, NET Net interest expense increased $1.9 million to $4.1
million, or 90.5%, for the three months ended September 30, 2004, compared to
the corresponding period of the prior year. As a percentage of net sales, net
interest expense increased to 0.56% from 0.45%, compared to the corresponding
period of the prior year. The increase in net interest expense was primarily the
result of higher inventory levels supporting sales growth and higher average
borrowing levels driven by financing the purchase of Walsh.
INCOME TAX PROVISION Our effective income tax rate was 39.0% for the three
months ended September 30, 2004, the same as 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.
PBI Net sales at PBI were $2.1 million for the three months ended
September 30, 2004, down $0.2 million from the corresponding period of the prior
year. The decrease relates to a lower volume of purchases by PBI members. Gross
profit generated by PBI as a percentage of our total gross profit decreased from
12.8% to 9.2% as a result of our higher overall gross profit. PBI recorded
pre-tax earnings of $1.1 million for the three months ended September 30, 2004,
down $0.2 million from the corresponding period of the prior year. This was the
result of the lower net sales for the period.
Page 13 of 17
LIQUIDITY AND CAPITAL RESOURCES
We generally meet our working capital requirements through a combination
of internally generated funds, borrowings under the revolving line of credit and
trade credit from our suppliers.
We use the following ratios as key indicators of our liquidity and working
capital management:
SEPTEMBER 30, JUNE 30,
2004 2004
------------ ---------
Working capital (1) (000s) $ 381,481 $ 382,900
Current ratio 2.14 to 1 2.52 to 1
(1) Working capital is total current assets less total current liabilities on
our balance sheet. The current ratio is calculated by dividing total
current assets by total current liabilities.
Our wholesale drug segment requires a substantial investment in working
capital that is susceptible to large variations during the year as a result of
inventory purchase patterns and seasonal demands. Inventory purchase activity is
a function of sales activity, new customer build-up requirements and the desired
level of investment inventory. Working capital and current ratio at September
30, 2004 are approximately the same as June 30, 2003 levels. At September 30,
2004, our inventory levels increased due to the start of normal seasonal
inventory requirements and as the result of decreased sales in our national
accounts trade class. The increase in inventory levels was offset by a
corresponding increase in accounts payable associated with the inventory.
On March 31, 2003, we entered into a new $600 million credit facility.
Under the credit facility, the total amount of loans and letters of credit
outstanding at any time cannot exceed the lesser of an amount based on
percentages of eligible receivables and inventories (the borrowing base formula)
and $600 million. Total credit available at September 30, 2004 was approximately
$463 million of which approximately $128 million was unused. The PBI acquisition
and the increase in inventory levels account for the increase in outstanding
long-term debt as the credit facility was used as the source of funds. The
interest rate on the credit facility is based on the 30-day London Interbank
Offering Rate (LIBOR) plus a factor based on certain financial criteria. The
interest rate was 4.34% at September 30, 2004.
Under the terms of the credit facility, we are required to comply with
certain financial covenants, including those related to a fixed charge coverage
ratio and tangible net worth. We are required to reduce borrowings by cash
received. We are also limited in our ability to make loans and investments,
enter into leases, or incur additional debt, among other things, without the
consent of our lenders. In August 2004, we amended the credit facility modifying
the loan covenants to make them less restrictive. We are in compliance with our
debt covenants as of September 30, 2004. At this time, we project that we will
be in compliance with the debt covenants for the next 12 months.
Net cash used in operating activities totaled $3.5 million for the three
months ended September 30, 2004 with net cash used in operating activities of
$39.6 million in the prior year. This decrease is primarily the result of an
increase in accounts payable levels due to timing of payments partially offset
by increases in inventory levels.
We invested $1.6 million in capital assets in the three months ended
September 30, 2004 compared with $0.3 million in the corresponding period of the
prior year. Current year and prior year additions relate primarily to the
expansion of our Cape Girardeau distribution center. We believe that continuing
investment in capital assets is necessary to achieve our goal of improving
operational efficiency, thereby enhancing our productivity and profitability.
Net cash inflows provided by financing activities totaled $13.4 million
for the three months ended September 30, 2004 with net cash provided by
financing activities of $38.1 million for last year. Borrowings under our
revolving line of credit related to the purchase of PBI and to support our
inventory levels produced this result.
Stockholders' equity decreased $2.0 million to $177.3 million at September
30, 2004 from $179.3 million at June 30, 2004, due to the net loss during the
period. We believe that funds available under the credit facility, together with
internally generated funds, will be sufficient to meet our capital requirements
for the foreseeable future.
Page 14 of 17
CRITICAL ACCOUNTING POLICIES
Refer to "Critical Accounting Policies" in our 2004 Annual Report on Form
10-K for information on accounting policies that we consider critical in
preparing our consolidated financial statements. These policies include
significant estimates made by management using information available at the time
the estimates are made. However, these estimates could change materially if
different information or assumptions were used.
NEW ACCOUNTING STANDARDS
Refer to Note 14 of Notes to Consolidated Financial Statements in our 2004
Annual Report on Form 10-K for a discussion of recently issued accounting
standards. Our adoption of these new accounting standards did not have a
material effect on our financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary exposure to market risk consists of changes in interest rates
on borrowings. An increase in interest rates would adversely affect our
operating results and the cash flow available to fund operations and expansion.
Based on estimated average variable borrowings during fiscal 2005, a change of
25 basis points in the average variable borrowing rate would result in a change
of approximately $0.9 million in annual interest expense. We continually monitor
this risk and review the potential benefits of entering into hedging
transactions, such as interest rate swap agreements, to mitigate the exposure to
interest rate fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
Based on an evaluation of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended) as of the end of the period covered by this
report, our Chief Executive Officer and our Chief Financial Officer have
concluded that such controls and procedures were effective as of the end of the
period covered by this report.
In connection with such evaluation, no change in the Company's internal
control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934, as amended) occurred during the
period covered by this report that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Page 15 of 17
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
PART ll. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On February 5, 2004, an individual named Gary Dutton filed a complaint in
the United States District Court for the Eastern District of Missouri ("Court")
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. On April 30, 2004, United Food &
Commercial Workers Union, Local 655, AFL-CIO, Food Employees Joint Pension Plan
("Local 655") filed a motion to become lead plaintiff. On October 5, 2004, the
Court granted Local 655's motion appointing them lead plaintiff. The Company
believes that the existing complaint describes types of transactions in which
the Company has not engaged, contains a number of inaccurate statements, and
does not state any valid cause of action, and further, that the Company will
have substantial meritorious defenses to the complaint. The Defendants intend to
vigorously defend the claims.
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
See Exhibit Index on page 17.
(b) Reports on Form 8-K
1. On August 10, 2004, the registrant filed a Current Report on
Form 8-K under Items 7 and 12 with a press release announcing
its financial results for the fiscal 2004 fourth quarter and
full year.
Page 16 of 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
D & K HEALTHCARE RESOURCES, INC.
Date: November 9, 2004 By: /s/ J. Hord Armstrong, III
--------------------------
J. Hord Armstrong, III
Chairman of the Board and
Chief Executive Officer
By: /s/ Thomas S. Hilton
---------------------
Thomas S. Hilton
Senior Vice President
Chief Financial Officer
(Principal Financial & Accounting Officer)
Page 17 of 17
EXHIBIT INDEX
Exhibit No. Description
2.1** Agreement and Plan of Merger dated as of October 21, 2003 between D
& K Healthcare Resources, Inc., Walsh HealthCare Solutions, Inc. and
D & K Acquisition Corp, filed as an exhibit to registrant's Current
Report on Form 8-K dated December 15, 2003.
3.1* Restated Certificate of Incorporation, filed as an exhibit to
registrant's Registration Statement on Form S-1 (Reg. No. 33-48730).
3.2* Certificate of Amendment to the Restated Certificate of
Incorporation of D & K Wholesale Drug, Inc filed as an exhibit to
the registrant's Annual Report on Form 10-K for the year ended June
30, 1998.
3.3* Certificate of Designations for Series B Junior Participating
Preferred Stock of D & K Healthcare Resources, Inc. filed as an
exhibit to the registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001.
3.4* By-laws of the registrant, as currently in effect, filed as an
exhibit to registrant's Registration Statement on Form S-1 (Reg. No.
33-48730).
3.5* Certificate of Amendment of Certificate of Incorporation of D & K
Healthcare Resources, Inc., filed as an exhibit to registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2002.
4.1* Form of certificate for Common Stock, filed as an exhibit to
registrant's Registration Statement on Form S-1 (Reg. No. 33-48730).
4.2* Form of Rights Agreement dated as of November 12, 1998 between
registrant and Harris Trust and Savings Bank as Rights Agent, which
includes as Exhibit B the form of Right Certificate, filed as an
exhibit to Form 8-K dated November 17, 1998.
10.1** Consent and Third Amendment to Sixth Amended and Restated Loan and
Security Agreement, dated August 30, 2004, by and among Fleet
Capital Corporation (individually and as Agent for Lenders),
registrant, Jewett Drug Co., Diversified Healthcare, LLC, Medical &
Vaccine Products, Inc., MYHCA, Inc., RxDirect, Inc., Walsh
Distribution, L.L.C., Walsh Healthcare Solutions, Inc., and Walsh
Heartland, L.L.C.
31.1** Section 302 Certification of Chief Executive Officer.
31.2** Section 302 Certification of Chief Financial Officer.
32** Section 906 Certification of Chief Executive Officer and Chief
Financial Officer.
* Incorporated by reference.
** Filed herewith.