-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Jo7uPTWirRedAM8b3tIlQ18fsIOrcLbbCqfnM0Fw2Y9JNmtnffJr/4blqXtLr7IC Ml7p+G6hWV+hWqft02RnSA== 0000950134-03-002238.txt : 20030212 0000950134-03-002238.hdr.sgml : 20030212 20030212154430 ACCESSION NUMBER: 0000950134-03-002238 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030212 FILER: COMPANY DATA: COMPANY CONFORMED NAME: D & K HEALTHCARE RESOURCES INC CENTRAL INDEX KEY: 0000888914 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-DRUGS PROPRIETARIES & DRUGGISTS' SUNDRIES [5122] IRS NUMBER: 431465483 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-20348 FILM NUMBER: 03554496 BUSINESS ADDRESS: STREET 1: 8000 MARYLAND AVENUE STREET 2: SUITE 920 CITY: ST. LOUIS STATE: MO ZIP: 63105 BUSINESS PHONE: 3147273485 MAIL ADDRESS: STREET 1: 8000 MARYLAND AVENUE STREET 2: SUITE 920 CITY: ST. LOUIS STATE: MO ZIP: 63105 FORMER COMPANY: FORMER CONFORMED NAME: D & K WHOLESALE DRUG INC/DE/ DATE OF NAME CHANGE: 19930328 10-Q 1 c74629e10vq.txt FORM 10-Q Page 1 of 22 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2002 ----------------- 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) 8000 MARYLAND AVENUE, SUITE 920, 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 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 14,444,300 ---------------------------- -------------------- (class) (February 7, 2003)
Page 2 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Index
Page No. -------- Part I. Financial Information --------------------- Item 1. Financial Statements Condensed Consolidated Balance Sheets as of December 31, 2002 and June 30, 2002 3 Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended December 31, 2002 and December 31, 2001 4 Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2002 and December 31, 2001 5 Notes to Condensed Consolidated Financial Statements 6 - 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 - 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 17 Part II. Other Information ----------------- Item 4. Submission of Matters to a Vote of Security Holders 18 Item 6. Exhibits and Reports on Form 8-K 18
Page 3 of 22 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
ASSETS DECEMBER 31, JUNE 30, ------ 2002 2002 ------------ ---------- (Unaudited) Cash $ 9,558 $ 11,754 Receivables, net of allowance for doubtful accounts 26,533 31,217 Inventories 452,326 364,244 Other current assets 8,146 6,699 --------- --------- Total current assets 496,563 413,914 --------- --------- Net property and equipment 11,683 11,104 Other assets 6,815 5,024 Goodwill, net of accumulated amortization 44,105 51,131 Other intangible assets, net of accumulated amortization 1,891 1,965 --------- --------- Total assets $ 561,057 $ 483,138 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current maturities of long-term debt $ 1,870 $ 2,270 Accounts payable 216,578 215,777 Accrued expenses 12,526 13,231 --------- --------- Total current liabilities 230,974 231,278 --------- --------- Long-term liabilities 3,718 2,757 Revolving line of credit 158,589 80,445 Long-term debt, excluding current maturities 714 1,012 Deferred income taxes - 249 --------- --------- Total liabilities 393,995 315,741 --------- --------- Stockholders' equity: Common stock 151 151 Paid-in capital 124,705 124,089 Accumulated other comprehensive loss (1,300) (887) Retained earnings 50,442 49,590 Deferred compensation (513) - Less treasury stock (6,423) (5,546) --------- --------- Total stockholders' equity 167,062 167,397 --------- --------- Total liabilities and stockholders' equity $ 561,057 $ 483,138 ========= =========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. Page 4 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Net sales $ 530,843 $ 591,698 $ 1,064,809 $ 1,120,789 Cost of sales 509,621 567,203 1,022,534 1,074,436 ----------- ----------- ----------- ----------- Gross profit 21,222 24,495 42,275 46,353 Operating expenses 13,506 13,987 27,050 27,769 ----------- ----------- ----------- ----------- Income from operations 7,716 10,508 15,225 18,584 Other income (expense): Interest expense, net (2,899) (2,516) (5,412) (4,392) Other, net 17 (140) (37) (208) ----------- ----------- ----------- ----------- (2,882) (2,656) (5,449) (4,600) ----------- ----------- ----------- ----------- Income before income tax provision and minority interest 4,834 7,852 9,776 13,984 Income tax provision (1,958) (3,028) (3,910) (5,370) Minority interest (201) (182) (329) (385) ----------- ----------- ----------- ----------- Income before cumulative effect of accounting change 2,675 4,642 5,537 8,229 Cumulative effect of accounting change, net - - (4,249) - ----------- ----------- ----------- ----------- Net Income $ 2,675 $ 4,642 $ 1,288 $ 8,229 =========== =========== =========== =========== Earnings per share - basic Net income before cumulative effect of accounting change $ 0.18 $ 0.33 $ 0.38 $ 0.58 Cumulative effect of accounting change - - (0.29) - ----------- ----------- ----------- ----------- Net income $ 0.18 $ 0.33 $ 0.09 $ 0.58 Earnings per share - Diluted Net income before cumulative effect of accounting change $ 0.18 $ 0.31 $ 0.37 $ 0.56 Cumulative effect of accounting change - - (0.29) - ----------- ----------- ----------- ----------- Net income $ 0.18 $ 0.31 $ 0.08 $ 0.56 Basic Common Shares outstanding 14,470 14,258 14,512 14,100 Diluted common shares outstanding 14,583 14,730 14,717 14,580
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. Page 5 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, 2002 2001 ------------ ------------ Cash flows from operating activities: Net income $ 1,288 $ 8,229 Adjustments to reconcile net income to net cash flows from operating activities: Amortization of debt issuance costs 587 423 Depreciation and amortization 1,269 2,173 Gain from sale of assets - (173) Deferred income taxes (1,897) (236) Cumulative effect of change in accounting principle, net 4,249 - Changes in operating assets and liabilities, net of acquisitions: Decrease in receivables, net 4,684 11,663 Increase in inventories (88,082) (188,821) Increase in other current assets (2,000) (431) Increase in accounts payable 801 77,523 Increase in accrued expenses 2,070 930 Other, net 474 (1,994) ----------- ----------- Cash flows from operating activities (76,557) (90,714) Cash flows from investing activities: Cash from acquired company, net of cash paid - 329 Purchases of property and equipment (1,772) (1,825) ----------- ----------- Cash flows from investing activities (1,772) (1,496) Cash flows from financing activities: Borrowings under revolving line of credit 395,655 412,331 Repayments under revolving line of credit (317,511) (397,206) Proceeds from secondary stock offering - 76,888 Principal payments on long-term debt (698) (126) Proceeds from exercise of stock options - 899 Purchase of treasury stock (877) - Payment of dividends (436) (356) ----------- ----------- Cash flows from financing activities 76,133 92,430 (Decrease) increase in cash (2,196) 220 Cash, beginning of period 11,754 7,516 ----------- ----------- Cash, end of period $ 9,558 $ 7,736 =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ 4,527 $ 4,357 Income taxes 2,708 4,086 Non-cash transactions: Issuance of equity for PBI acquisition $ - $ 4,477
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. Page 6 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1. D&K Healthcare Resources, Inc. (the "Company") is a full-service, regional wholesale drug distributor, supplying customers from facilities in Missouri, Florida, Kentucky, Minnesota, and South Dakota. The Company distributes a broad range of pharmaceuticals and related products to its customers in more than 24 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 develops and markets sophisticated pharmacy systems software through two wholly owned subsidiaries, Tykon, Inc. and VC Services, Inc. (dba Viking Computer Services, Inc.). In addition, the Company owns a 70% equity interest in Pharmaceutical Buyers, Inc. ("PBI"), a leading alternate site group purchasing organization (see Note 6). The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and include all of the information and disclosures required by accounting principles generally accepted in the United States of America for interim reporting, which are less than those required for annual reporting. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair representation have been included. The results of operations for the three-month and six-month periods ended December 31, 2002, 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 2002 Annual Report to Stockholders. Note 2. 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" (see Note 8). Under step 1 of this approach, the fair value of the reporting unit as a whole is compared to the book value of the reporting unit (including goodwill) and, if a deficiency exists, impairment would need to be calculated. In step 2, the impairment is measured as the difference between the implied fair value of goodwill and its carrying amount. The implied fair value of goodwill is the difference between the fair value of the reporting unit as a whole less the fair value of the reporting unit's individual assets and liabilities, including any unrecognized intangible assets. Under this standard, goodwill and intangibles with indefinite lives are no longer amortized. A discounted cash flow model was used to determine the fair value of the Page 7 of 22 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. The effects of adopting the new standard on net income and earnings per share for the three-month and six-month periods ended December 31, 2002 and 2001 are: For the three-month period ended December 31: (in thousands, except per share amounts)
Net Income Basic EPS Diluted EPS ---------------------------------------------------------- 2002 2001 2002 2001 2002 2001 ---------------------------------------------------------- Net income $2,675 $4,642 $0.18 $0.33 $0.18 $0.31 Add: goodwill amortization -- 395 -- 0.03 -- 0.03 ---------------------------------------------------------- Income before cumulative effect of accounting change and goodwill amortization $2,675 $5,037 $0.18 $0.36 $0.18 $0.34
For the six-month period ended December 31: (in thousands, except per share amounts)
Net Income Basic EPS Diluted EPS ---------------------------------------------------------- 2002 2001 2002 2001 2002 2001 ---------------------------------------------------------- Net income $1,288 $8,229 $0.09 $0.58 $0.08 $0.56 Add: cumulative effect of accounting change, net 4,249 -- 0.29 -- 0.29 -- ---------------------------------------------------------- Income, before cumulative effect of accounting change 5,537 8,229 0.38 0.58 0.37 0.56 Add: goodwill amortization -- 790 -- 0.06 -- 0.06 ---------------------------------------------------------- Income before cumulative effect of accounting change and goodwill amortization $5,537 $9,019 $0.38 $0.64 $0.37 $0.62
Net income for the three-month period ended December 31, 2001 would have been $395,000, or $0.03 per share higher, if goodwill amortization had been discontinued effective July 1, 2001. Net income for the six-month period ended December 31, 2001 would have been $790,000, or $0.06 per share higher, if goodwill amortization had been discontinued effective July 1, 2001. Net income for the full fiscal year ended June 30, 2002 would have been $1,580,000, or $0.11 per diluted share, higher if goodwill amortization had been discontinued effective July 1, 2001. 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. Page 8 of 22 Changes to goodwill and intangible assets during the six-month period ended December 31, 2002, including the effects of adopting the new accounting standard are: (in thousands)
Intangible Goodwill Assets ------------------------------ Balance at June 30, 2002, net of accumulated amortization $51,131 $1,965 Write-off of goodwill recognized in cumulative effect adjustment (7,026) -- Amortization expense -- (74) ------------------------------ Balance at December 31, 2002, net of accumulated amortization $44,105 $1,891
Intangible assets totaled $1,891,000, net of accumulated amortization of $226,000, at December 31, 2002. Of this amount, $214,000 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 $150,000 each year between 2003 and 2018. Goodwill related to the wholesale drug distribution segment, net of amortization, was $32.3 and $39.3 million as of December 31, 2002 and June 30, 2002, respectively. Goodwill related to the Company's other segments, which are combined for reporting purposes, amounted to $11.8 million as of December 31, 2002 and June 30, 2002. Other intangible assets related to the wholesale drug distribution segment, net of amortization, were $0.2 as of December 31, 2002 and June 30, 2002, respectively. Other intangible assets related to the Company's other segments amounted to $1.7 million as of December 31, 2002 and June 30, 2002, respectively. Note 3. 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 11, 2002 to shareholders of record on March 29, 2002. All share and per share amounts included in the condensed consolidated financial statements have been adjusted to retroactively reflect this stock split. Page 9 of 22 Note 4. SFAS No. 128, "Earnings Per Share", requires dual presentation of basic and diluted earnings per share and requires a reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations. The reconciliation of the numerator and denominator of the basic and diluted earnings per share computations are as follows (in thousands, except for per share amounts):
Three-Months ended December 31, 2002 Three-Months ended December 31, 2001 ------------------------------------------- ---------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) (1) Amount (Numerator) (Denominator) (1) Amount ------------------------------------------- ---------------------------------------------- BASIC EARNINGS PER SHARE: Net income available to common stockholders $ 2,675 14,470 $0.18 $ 4,642 14,258 $0.33 EFFECT OF DILUTED SECURITIES: Options and warrants - 113 - 472 Convertible PBI securities (52) - (75) - ------------------------------ ------------------------------- DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions $ 2,623 14,583 $0.18 $4,567 14,730 $0.31 =============================== =============================== Six-Months ended December 31, 2002 Six-Months ended December 31, 2001 -------------------------------------------- --------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) (1) Amount (Numerator) (Denominator) (1) Amount -------------------------------------------- --------------------------------------------- BASIC EARNINGS PER SHARE: Net income available to common shareholders before cumulative effect of accounting change $ 5,537 14,512 $0.38 $ 8,229 14,100 $0.78 CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET (4,249) - (0.29) $0 - ------------------------------------------ ------------------------------ 1,288 14,512 0.09 EFFECT OF DILUTED SECURITIES: Options and warrants - 205 - 458 Convertible PBI securities (82) - (90) 22 ------------------------------ ------------------------------ DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions $ 1,206 14,717 $0.08 $8,139 14,580 $0.56 =============================== ==============================
(1) Outstanding shares computed on a weighted average basis Note 5. The Company's comprehensive income consists of net earnings and net change in value of cash flow hedge instruments as follows: (in thousands)
For the Three Months Ended For the Six Months Ended December 31, December 31, 2002 2001 2002 2001 ------------------------------- ------------------------------ Net income $ 2,675 $ 4,642 $ 1,288 $ 8,229 Change in value of cash flow hedge, net of tax 9 219 (413) (361) ------------------------------- ------------------------------ Total comprehensive income $ 2,684 $ 4,861 $ 875 $ 7,868 =============================== ==============================
Page 10 of 22 Note 6. On July 5, 2001, the Company completed a secondary offering of approximately 4.8 million shares of common stock. In connection with the secondary stock offering, the Company increased its ownership in PBI to 68% and an additional 2% was acquired in a subsequent transaction in August 2001. Prior to the completion of the offering, PBI was accounted for under the equity method. Since the completion of the offering, PBI has been consolidated. For the period prior to consolidation, certain other shareholders of PBI had the option to exchange their combined 20% ownership interests in PBI for a fixed number of shares of the Company's common stock or, at the Company's option cash, under the terms of the purchase agreement. The impact of the PBI convertible securities is included in the reconciliation of the basic and diluted earnings per share computation in Note 4 above. Note 7. In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk, such as standby letters of credit and other guarantees, which are not reflected in the accompanying balance sheets. At December 31, 2002, the Company was party to a standby letter of credit of $750,000 and was the guarantor of certain customer obligations totaling approximately $500,000. Management does not expect any material losses to result from these off-balance-sheet items. Note 8. Pursuant to Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," the Company has three identifiable business segments, only one of which, Wholesale drug distribution, meets the quantitative thresholds for separate disclosure prescribed in SFAS No. 131. The Company's interest in PBI is a second segment. Two wholly owned software subsidiaries, Tykon, Inc. and Viking Computer Services, Inc. constitute the third 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. These two additional segments are combined as Other in the table below. 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. Intersegment sales have been recorded at amounts approximating original cost. Page 11 of 22
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED (In thousands) DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2002 2001 2002 2001 ------------ ------------ ------------- ------------- Sales to unaffiliated customers - Wholesale drug distribution $ 528,076 $ 589,231 $ 1,059,733 $ 1,115,869 Other 2,767 2,467 5,076 4,920 ------------ ------------ ------------- ------------- Total $ 530,843 $ 591,698 $ 1,064,809 $ 1,120,789 Intersegment sales - Wholesale drug distribution $ - $ - $ - $ - Other - 284 - 603 Intersegment eliminations - (284) - (603) ------------ ------------ ------------- ------------- Total $ - $ - $ - $ - Net Sales - Wholesale drug distribution $ 528,076 $ 589,231 $ 1,059,733 $ 1,115,869 Other 2,767 2,751 5,076 5,523 Intersegment eliminations - (284) - (603) ------------ ------------ ------------- ------------- Total $ 530,843 $ 591,698 $ 1,064,809 $ 1,120,789 Gross Profit - Wholesale drug distribution $ 18,592 $ 22,140 $ 37,486 $ 41,631 Other 2,630 2,355 4,789 4,722 ------------ ------------ ------------- ------------- Total $ 21,222 $ 24,495 $ 42,275 $ 46,353 Pre-tax income Wholesale drug distribution $ 3,566 $ 6,638 $ 7,632 $ 11,634 Other 1,268 1,214 2,144 2,350 ------------ ------------ ------------- ------------- Total $ 4,834 $ 7,852 $ 9,776 $ 13,984
Except as otherwise disclosed, there has been no material change in total assets from the amount disclosed in the last annual report. There are no differences from the last annual report in the basis of segmentation or in the basis of measurement of segment profit or loss. Note 9. In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Asset Retirement Obligations." The new standard required entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002. Adoption of SFAS No. 143 did not impact our consolidated financial position. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets," which supersedes SFAS 121, "Accounting for Long-lived Assets and for Long-lived Assets to be Disposed Of," and Accounting Principles Page 12 of 22 Board Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS 144 establishes a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale. The adoption of this standard did not have a material impact on our consolidated financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement updates, clarifies and simplifies existing accounting pronouncements related to accounting for gains and losses from the extinguishments of debt and accounting for certain lease modifications. The adoption of this standard did not have a material impact on our consolidated financial statements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses the accounting for costs associated with disposal activities covered by SFAS No. 144 or with exit activities previously covered by EITF 94-3. This statement will be applied prospectively to any exit or disposal activities that we initiate after December 31, 2002. In October 2002, the FASB issued SFAS No.147, "Acquisitions of Certain Financial Institutions." This statement applies to all acquisitions of financial institutions except those between two or more mutual enterprises. This statement supersedes certain specialized accounting guidance included in previous statements and interpretations on the determination of goodwill in such transactions. We do not believe the adoption of this standard will have a material impact on our consolidated financial statements. In December 2002, the FASB issued SFAS No.148, "Accounting for Stock-Based Compensation -- Transition and Disclosure." This statement amends SFAS No. 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 employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We are required to adopt this standard for fiscal years beginning after December 15, 2002. The Company currently does not plan to change to the fair value method of accounting for stock-based employee compensation, but will comply with the disclosure requirements of this standard. Page 13 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The discussion below is concerned with material changes in financial condition and results of operations in the condensed consolidated balance sheets as of December 31, 2002 and June 30, 2002, and in the condensed consolidated statements of operations for the three-month and six-month periods ended December 31, 2002 and December 31, 2001, respectively. We recommend that this discussion be read in conjunction with the audited consolidated financial statements and accompanying notes included in our 2002 Annual Report to Stockholders. Certain statements in this document regarding future events, prospects, projections or financial performance are forward looking statements. Such forward looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and may also be identified by words such as "anticipates," "believes," "estimates," "expects," "intends" and similar expressions. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those described in or suggested by such forward looking statements. These risks and uncertainties include the competitive nature of the wholesale pharmaceutical distribution industry, with many competitors having substantially greater resources than the Company and the Company's customers and suppliers generally having the right to terminate or reduce their purchases or shipments on relatively short notice, changes in interest rates, the Company's ability to maintain or improve its operating margin with the industry's competitive pricing pressures, the changing business and regulatory environment, including possible changes in reimbursement for healthcare products and in manufacturers' pricing or distribution policies or practices, the availability of investment purchasing opportunities, the loss of one or more key suppliers for which alternative sources may not be available, and the ability to integrate recently acquired businesses. Readers are cautioned not to place undue reliance on these forward-looking statements that reflect the Company's views as of the date hereof. The Company undertakes no obligation to publicly update or revise any forward-looking statements. Results of Operations: Net Sales. Net sales decreased $60.9 million, or 10.3%, for the quarter ended December 31, 2002, compared to the corresponding period of the prior year. Sales growth in the independent and regional pharmacies was offset by a reduction in the national pharmacy chains. Independent and regional pharmacy sales increased $19 million over the second quarter of fiscal 2002 due to increased sales to existing customers. Sales to national pharmacy chains decreased $88 million primarily due to fewer attractively priced purchasing opportunities made available to us during the quarter. Page 14 of 22 Net sales decreased $56.0 million, or 5.0% for the six months ended December 31, 2002, compared to the corresponding period of the prior year. Sales growth in the independent and regional pharmacies was more than offset by a decrease in the national pharmacy chains. National pharmacy chain sales decreased $107 million during the first six months of fiscal 2003 due primarily to fewer attractively priced purchasing opportunities, particularly from our largest supplier in fiscal 2002. Sales to independent and regional pharmacies increased $43 million due to increased sales to existing customers and new accounts. Gross Profit. Gross profit decreased 13.4% to $21.2 million for the quarter ended December 31, 2002, compared to the corresponding period of the prior year. This decrease was primarily due to lower national pharmacy chain sales driven by fewer attractively priced purchasing opportunities. As a percentage of net sales, gross margin declined from 4.14% to 4.00% for the quarter ended December 31, 2002, compared to the corresponding period of the prior year. The decrease in gross margin percentage was primarily due to lower margins on national pharmacy chain sales. Gross profit decreased 8.8% to $42.3 million for the six months ended December 31, 2002, compared to the corresponding period of the prior year. As a percentage of net sales, gross margin decreased from 4.14% to 3.97% for the six months ended December 31, 2002, compared to the corresponding period of the prior year. The decrease in gross margin percentage was primarily due to lower margins on national pharmacy chain sales. Operating Expenses. Operating expenses decreased $0.5 million, or 3.4%, to $13.5 million for the quarter ended December 31, 2002, compared to the corresponding period of the prior year. For the six months ended December 31, 2002, operating expenses were $27.1 million, which was $0.7 million, or 2.6%, lower than the corresponding period of last year. The decrease in operating expenses for both the quarter and six-month period ended December 31, 2002, was the net result of several offsetting factors. With the adoption of SFAS 142, pre-tax goodwill amortization of approximately $0.5 million for the quarter, and $1.0 million for the six-month period, were eliminated. That savings combined with lower incentive based compensation was partially offset by higher property and casualty insurance premiums driven by general insurance market trends, and depreciation on the new Enterprise Resource Planning system which began in the fourth quarter of fiscal 2002. The ratio of operating expenses to net sales for the quarter was 2.54% compared to 2.36% for the same quarter last year. The ratio of operating expenses to net sales for the six-month period was 2.54% compared to 2.48% for the same period last year. The slightly higher ratios for the periods relate to the lower sales levels. Interest Expense, Net. Net interest expense increased $0.4 million or 15.2% for the quarter ended December 31, 2002, compared to the corresponding period of the prior year. As a percentage of net sales, net interest expense increased from 0.43% to 0.55% of net sales for the quarter ended December 31, 2002, compared to the corresponding Page 15 of 22 period of the prior year. The increase in net interest expense is primarily driven by higher average borrowings related to the higher average investment in inventories during the quarter compared to the same quarter of last year. Our weighted average interest rate declined approximately 90 basis points in the second quarter of fiscal 2003 compared to the same quarter of fiscal 2002, and the weighted average borrowings increased to approximately $255 million from $194 million. Net interest expense increased $1.0 million or 23.2% for the six months ended December 31, 2002, compared to the corresponding period of the prior year. As a percentage of net sales, net interest expense increased from 0.39% to 0.51% of net sales for the six-month period ended December 31, 2002, compared to the corresponding period of the prior year. The increase in net interest expense is primarily driven by higher average borrowings related to the higher average investment in inventories during this period compared to the same period of last year. Our weighted average interest rate declined approximately 102 basis points in the first half of fiscal 2003 compared to the same period of fiscal 2002, and the weighted average borrowings increased to approximately $228 million from $165 million. Provision for Income Taxes. Our effective tax rate in the second quarter was 40.5%, which brings the year-to-date rate to 40.0%, which is the rate currently expected to be applicable for the full fiscal year ending June 30, 2003. This compares to 38.5% for both the quarter and six-month periods last fiscal year. This modestly higher rate is due to the lower level of earnings relative to our permanent tax differences, compared to last year. Financial Condition: Liquidity and Capital Resources. Our working capital requirements are generally met through a combination of internally generated funds, borrowings under our revolving line of credit and our accounts receivable securitization facility, and trade credit from our suppliers. We utilize the following measures as key indicators of our liquidity and working capital management:
December 31, June 30, 2002 2002 ---- ---- Working capital (000's) $ 265,589 $ 182,636 Current ratio 2.15 to 1 1.79 to 1
Cash outflows from operating activities totaled $76.6 million for the six-month period ended December 31, 2002 compared to outflows of $90.7 million for the same period of the prior year. These results were driven by working capital increases during the respective quarters. Our first and second fiscal quarters generally produce operating Page 16 of 22 cash outflows as we establish inventory positions ahead of normal year-end price increases from the pharmaceutical manufacturers. We invested $1,772,000 in capital assets in the six-month period ended December 31, 2002, as compared to $1,825,000 in the corresponding period in the prior year. We believe that continuing investment in capital assets is necessary to achieve our goal of improving operational efficiency, thereby enhancing our productivity and profitability. Cash inflows from financing activities totaled $76.1 million for the six-month period ended December 31, 2002 as compared to cash inflows of $92.4 million for the corresponding period in the prior year. The current year cash inflows related to borrowings under our revolving credit facility to finance our inventory positions. In December 2002, we arranged an additional seasonal overline credit agreement that increased the revolving credit facility to $230 million. The increase in the revolving credit facility will be utilized during the third quarter to finance inventory purchases and repaid through the sale of inventory. This agreement expires March 31, 2003. At December 31, 2002, $106 million of the possible $200 million of the securitization facility was utilized and approximately $159 million of the possible $230 million of the revolving credit facility was utilized. Management believes that, together with internally generated funds, our available capital resources will be sufficient to meet foreseeable capital requirements. To allow for continued growth and greater flexibility, we are in negotiations to replace our existing borrowing facilities with a single secured credit facility that would be at least $500 million. The completion of this transaction, which would be subject to terms and conditions typical of such arrangements, is expected to occur prior to June 30, 2003. Recent Trends: During the first half of fiscal 2003, our internal revenue and margin objectives for the national pharmacy chain business were not achieved. The sales shortfall is principally the result of fewer attractively priced purchasing opportunities, particularly from our largest supplier in fiscal 2002. Our sales in the national pharmacy chain business have been variable from month to month historically, driven largely by opportunistic purchases from pharmaceutical companies for distribution primarily to national chains. Additionally, our growth in sales to the independent and regional pharmacy trade class has trended below internal expectations during the quarter. Sales to this trade class grew approximately 7%, year-over-year, in the second quarter of fiscal 2003 and 8% for the six months ended December 31, 2002. We believe our sales performance in this trade class reflects the continuing effects of the general economic slowdown, growing healthcare funding constraints on insurance providers and governmental bodies, the increased influence of generic drugs, fewer drug approvals, and the competitive nature of the industry. Accordingly, the outlook is for continued moderation in sales growth in this trade class. Page 17 of 22 Item 3. Quantitative and Qualitative Disclosures About Market Risk Our primary exposure to market risk consists of changes in interest rates on borrowings. An increase in interest rates would adversely affect the operating results and the cash flow available to fund operations and expansion. Based on the average variable borrowings, a change of 25 basis points in the average variable borrowing rate would result in a change of approximately $0.5 million in annual interest expense. The reductions in interest rates have had a positive impact on our short-term interest expense. We continually monitor this risk and review the potential benefits of entering into hedging transactions, such as interest rate collar agreements, to mitigate the exposure to interest rate fluctuations. Item 4. Controls and Procedures a) Evaluation of disclosure controls and procedures. Based on their evaluations as of a date within 90 days of the filing date of this report, our principal executive officer and our principal financial officer, with the participation of our full management team, have concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. b) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the date of their most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Page 18 of 22 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Part II. Other Information Item 4. Submission of Matters to a Vote of Security Holders (a) Registrant's 2002 Annual Meeting of Stockholders was held on November 13, 2002. (b) Proxies were solicited by Registrant's management pursuant to Regulation 14A under the Securities Exchange Act of 1934; there was no solicitation in opposition to management's nominees as listed in the proxy statement; and all director nominees were elected to the class indicated in the proxy statement pursuant to the vote of the Registrant's stockholders. (c) Matters voted upon at the Annual Meeting were as follows: a. Election of Harvey C. Jewett IV, Louis B. Susman, and Martin D. Wilson as class I directors for a term expiring in 2005. The results of the stockholder voting were as follows: Mr. Jewett, 12,061,435 for, and 749,401 withheld; Mr. Susman, 12,499,272 for, and 311,564 withheld; and Mr. Wilson, 12,031,642 for, and 779,194 withheld. b. Appointment of KPMG LLP as independent auditors for fiscal 2003. The result of the stockholder voting was as follows: 12,514,655 for, 288,383 against, and 7,798 withheld. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index on page 22. (b) Reports on Form 8-K a. On November 13, 2002, the registrant filed a Current Report on Form 8-K under Item 9 to furnish copies of the certifications required by Securities and Exchange Commission under Section 906 of the Sarbanes-Oxley Act of 2002, which accompanied the Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 filed by the registrant on November 13, 2002. Page 19 of 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. D & K HEALTHCARE RESOURCES, INC. Date: February 12, 2003 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 20 of 22 CERTIFICATIONS I, J. Hord Armstrong, III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of D&K Healthcare Resources, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of D&K Healthcare Resources, Inc. as of, and for, the periods presented in this quarterly report; 4. D&K Healthcare Resources, Inc.'s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for D&K Healthcare Resources, Inc. and we have: a) designed such disclosure controls and procedures to ensure that material information relating to D&K Healthcare Resources, Inc., including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of D&K Healthcare Resources, Inc.'s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. D&K Healthcare Resources, Inc.'s other certifying officer and I have disclosed, based on our most recent evaluation, to D&K Healthcare Resources, Inc.'s auditors and the audit committee of D&K Healthcare Resources, Inc.'s board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect D&K Healthcare Resources, Inc.'s ability to record, process, summarize and report financial data and have identified for D&K Healthcare Resources, Inc.'s auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in D&K Healthcare Resources, Inc.'s internal controls; and 6. D&K Healthcare Resources, Inc.'s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 12, 2003 /s/ J. Hord Armstrong, III ---------------------------------- Title: Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Page 21 of 22 I, Thomas S. Hilton, certify that: 1. I have reviewed this quarterly report on Form 10-Q of D&K Healthcare Resources, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of D&K Healthcare Resources, Inc. as of, and for, the periods presented in this quarterly report; 4. D&K Healthcare Resources, Inc.'s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for D&K Healthcare Resources, Inc. and we have: a) designed such disclosure controls and procedures to ensure that material information relating to D&K Healthcare Resources, Inc., including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of D&K Healthcare Resources, Inc.'s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. D&K Healthcare Resources, Inc.'s other certifying officer and I have disclosed, based on our most recent evaluation, to D&K Healthcare Resources, Inc.'s auditors and the audit committee of D&K Healthcare Resources, Inc.'s board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect D&K Healthcare Resources, Inc.'s ability to record, process, summarize and report financial data and have identified for D&K Healthcare Resources, Inc.'s auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in D&K Healthcare Resources, Inc.'s internal controls; and 6. D&K Healthcare Resources, Inc.'s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 12, 2003 /s/ Thomas S. Hilton ------------------------------- Title: Senior Vice President and Chief Financial Officer (Principal Financial Officer) Page 22 of 22 EXHIBIT INDEX Exhibit No. Description 3.1* Restated Certificate of Incorporation, filed as an exhibit to registrant's Registration Statement on Form S-1 (Reg. No. 33-48730). 3.2* Certificate of Amendment to the Restated Certificate of Incorporation of D&K Wholesale Drug, Inc. filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1998. 3.3* Certificate of Designations for Series B Junior Participating Preferred Stock of D&K Healthcare Resources, Inc. filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. 3.4* By-laws of the registrant, as currently in effect, filed as an exhibit to registrant's Registration Statement on Form S-1 (Reg. No. 33-48730). 3.5* Certificate of Amendment of Certificate of Incorporation of D&K Healthcare Resources, Inc., filed as an exhibit to registrants 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. * Incorporated by reference. -----END PRIVACY-ENHANCED MESSAGE-----