10-Q 1 c76946e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2003 -------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------- --------------- Commission File No. 0-20348 D & K HEALTHCARE RESOURCES, INC. (Exact name of registrant as specified in its charter) DELAWARE 43-1465483 (State or other jurisdiction of (I.R.S. Employer 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.01 par value 13,984,300 ---------------------------- ------------------------- (class) (May 7, 2003) Page 2 of 25 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Index
Page No. -------- Part I. Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets as of March 31, 2003 and June 30, 2002 3 Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended March 31, 2003 and March 31, 2002 4 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2003 and March 31, 2002 5 Notes to Condensed Consolidated Financial Statements 6 - 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 18 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Item 4. Controls and Procedures 19 Part II. Other Information Item 6. Exhibits and Reports on Form 8-K 20
Page 3 of 25 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
Assets MARCH 31, JUNE 30, 2003 2002 --------- -------- (UNAUDITED) Cash $ 8,172 $ 11,754 Receivables, net of allowance for doubtful accounts 145,426 31,217 Inventories 347,566 364,244 Other current assets 7,596 6,699 --------- -------- Total current assets 508,760 413,914 --------- -------- Net property and equipment 11,342 11,104 Other assets 12,654 5,024 Goodwill, net of accumulated amortization 44,105 51,131 Other intangible assets, net of accumulated amortization 1,851 1,965 --------- -------- Total assets $ 578,712 $483,138 ========= ======== Liabilities and Stockholders' Equity Current maturities of long-term debt $ 1,682 $ 2,270 Accounts payable 203,875 215,777 Accrued expenses 13,250 13,231 --------- -------- Total current liabilities 218,807 231,278 --------- -------- Long-term liabilities 3,519 2,757 Revolving line of credit 188,231 80,445 Long-term debt, excluding current maturities 651 1,012 Deferred Income taxes -- 249 --------- -------- Total liabilities 411,208 315,741 --------- -------- Stockholders' equity: Common stock 151 151 Paid-in capital 124,705 124,089 Accumulated other comprehensive loss (1,306) (887) Retained earnings 54,463 49,590 Deferred compensation (462) -- Less treasury stock (10,047) (5,546) --------- -------- Total stockholders' equity 167,504 167,397 --------- -------- Total liabilities and stockholders' equity $ 578,712 $483,138 ========= ========
See notes to condensed consolidated financial statements. Page 4 of 25 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, MARCH 31, MARCH 31, 2003 2002 2003 2002 --------- --------- --------- --------- Net sales $ 628,618 $ 695,241 $1,693,427 $1,816,030 Cost of sales 601,600 664,894 1,624,134 1,739,330 --------- --------- --------- ---------- Gross profit 27,018 30,347 69,293 76,700 Operating expenses 14,881 14,672 41,931 42,441 --------- --------- --------- ---------- Income from operations 12,137 15,675 27,362 34,259 Other income (expense): Interest expense, net (2,765) (2,847) (8,178) (7,239) Securitization termination costs (2,008) -- (2,008) -- Other, net 3 (528) (33) (737) --------- --------- --------- ---------- (4,770) (3,375) (10,219) (7,976) --------- --------- --------- ---------- Income before income tax provision and minority interest 7,367 12,300 17,143 26,283 Income tax provision (2,947) (4,770) (6,857) (10,140) Minority interest (185) (228) (514) (612) --------- --------- --------- ---------- Income before cumulative effect of accounting change 4,235 7,302 9,772 15,531 Cumulative effect of accounting change, net -- -- (4,249) -- --------- --------- --------- ---------- Net income $ 4,235 $ 7,302 $ 5,523 $ 15,531 ========= ========= ========= ========== Earnings per share - basic Net income before cumulative effect of accounting change, net $ 0.30 $ 0.51 $ 0.67 $ 1.09 Cumulative effect of accounting change -- -- (0.29) -- --------- --------- --------- ---------- Net income $ 0.30 $ 0.51 $ 0.38 $ 1.09 Earnings per share - diluted Net income before cumulative effect of accounting change, net $ 0.29 $ 0.49 $ 0.66 $ 1.05 Cumulative effect of accounting change -- -- (0.29) -- --------- --------- --------- ---------- Net income $ 0.29 $ 0.49 $ 0.37 $ 1.05 Basic common shares outstanding 14,334 14,366 14,453 14,199 Diluted common shares outstanding 14,459 14,775 14,632 14,655
See notes to condensed consolidated financial statements. Page 5 of 25 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED MARCH 31, MARCH 31, 2003 2002 --------- --------- Cash flows from operating activities: Net income $ 5,523 $ 15,531 Adjustments to reconcile net income to net cash flows from operating activities: Amortization of debt issuance costs 1,018 885 Depreciation and amortization 1,900 3,245 Loss from sale of assets -- 334 Deferred income taxes (5,051) (251) Cumulative effect of change in accounting principle, net 4,249 -- Changes in operating assets and liabilities, net of acquisitions: (Increase) decrease in receivables, net (34,209) 11,441 Decrease (increase) in inventories 16,678 (215,006) Decrease (increase) in other current assets 344 (677) (Decrease) increase in accounts payable (11,902) 80,698 Increase in accrued expenses 2,794 2,734 Other, net (4,260) (2,037) --------- --------- Cash flows from operating activities (22,916) (103,103) Cash flows from investing activities: Cash from acquired company, net of cash paid -- 520 Purchases of property and equipment (2,021) (2,637) --------- --------- Cash flows from investing activities (2,021) (2,117) Cash flows from financing activities: Borrowings under revolving line of credit 686,738 708,912 Repayments under revolving line of credit (578,952) (679,262) Repurchase of receivables under securitization agreement (80,000) -- Proceeds from secondary stock offering -- 76,862 Principal payments on long-term debt (949) (189) Proceeds from exercise of stock options -- 1,707 Purchase of treasury stock (4,501) -- Cash dividend paid by affiliates (330) (300) Payment of dividends (651) (536) --------- --------- Cash flows from financing activities 21,355 107,194 (Decrease) increase in cash (3,582) 1,974 Cash, beginning of period 11,754 7,516 --------- --------- Cash, end of period $ 8,172 $ 9,490 ========= ========= Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ 7,317 $ 6,897 Income taxes 5,864 5,967 Non-cash transactions: Issuance of equity for PBI acquisition $ -- $ 6,477
See notes to condensed consolidated financial statements. Page 6 of 25 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 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). 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 nine-month periods ended March 31, 2003, are not necessarily indicative of the results to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company's 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 25 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 nine-month periods ended March 31, 2003 and 2002 are: For the three-month period ended March 31: (in thousands, except per share amounts)
Net Income Basic EPS Diluted EPS --------------------- --------------------- --------------------- 2003 2002 2003 2002 2003 2002 -------- -------- -------- -------- -------- -------- Net income $ 4,235 $ 7,302 $ 0.30 $ 0.51 $ 0.29 $ 0.49 Add: goodwill amortization -- 395 -- 0.03 -- 0.03 -------- -------- -------- -------- -------- -------- Income before cumulative effect of accounting change and goodwill amortization $ 4,235 $ 7,647 $ 0.30 $ 0.54 $ 0.29 $ 0.52
For the nine-month period ended March 31: (in thousands, except per share amounts)
Net Income Basic EPS Diluted EPS --------------------- --------------------- --------------------- 2003 2002 2003 2002 2003 2002 -------- -------- -------- -------- -------- -------- Net income $ 5,523 $ 15,531 $ 0.38 $ 1.09 $ 0.37 $ 1.05 Add: cumulative effect of accounting change, net 4,249 -- 0.29 -- 0.29 -- -------- -------- -------- -------- -------- -------- Income, before cumulative effect of accounting change 9,772 15,531 0.67 1.09 0.66 1.05 Add: goodwill amortization -- 1,185 -- 0.08 -- 0.08 -------- -------- -------- -------- -------- -------- Income before cumulative effect of accounting change and goodwill amortization $ 9,772 $ 16,716 $ 0.67 $ 1.17 $ 0.66 $ 1.13
Net income for the three-month period ended March 31, 2002 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 nine-month period ended March 31, 2002 would have been $1,185,000, or $0.08 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 25 Changes to goodwill and intangible assets during the nine-month period ended March 31, 2003, 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 -- (114) -------- ---------- Balance at March 31, 2003, net of accumulated amortization $ 44,105 $ 1,851
Intangible assets totaled $1,851,000, net of accumulated amortization of $266,000, at March 31, 2003. 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 March 31, 2003 and June 30, 2002, respectively. Goodwill related to the PBI segment amounted to $10.4 million as of March 31, 2003 and June 30, 2002. Goodwill related to the Company's software segment amounted to $1.4 million as of March 31, 2003 and June 30, 2002. Other intangible assets related to the wholesale drug distribution segment, net of amortization, were $0.2 million as of March 31, 2003 and June 30, 2002, respectively. Other intangible assets related to the PBI segment amounted to $1.7 million as of March 31, 2003 and June 30, 2002, respectively. The Company's software segment has no intangible assets. 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 25 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 March 31, 2003 Three-Months ended March 31, 2002 ------------------------------------------- -------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator)(1) Amount (Numerator) (Denominator)(1) Amount ----------- ---------------- --------- ----------- ---------------- --------- BASIC EARNINGS PER SHARE: Net income available to common stockholders $ 4,235 14,334 $ 0.30 $ 7,302 14,366 $ 0.51 EFFECT OF DILUTED SECURITIES: Options and warrants -- 125 -- 409 Convertible PBI securities (47) -- (56) -- ----------- ---------------- ----------- ---------------- DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions $ 4,188 14,459 $ 0.29 $ 7,246 14,775 $ 0.49 =========== ================ =========== =================
Nine-Months ended March 31, 2003 Nine-Months ended March 31, 2002 ------------------------------------------- -------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator)(1) Amount (Numerator) (Denominator)(1) Amount ----------- ---------------- --------- ----------- ---------------- --------- BASIC EARNINGS PER SHARE: Net income available to common shareholders before cumulative effect of accounting change $ 9,772 14,453 $ 0.67 $ 15,531 14,199 $ 1.09 CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET (4,249) -- (0.29) -- -- ----------- ---------------- --------- ----------- ---------------- 5,523 14,453 0.38 15,531 14,199 1.09 EFFECT OF DILUTED SECURITIES: Options and warrants -- 179 -- 441 Convertible PBI securities (128) -- (146) 15 ----------- ---------------- ----------- ---------------- DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions $ 5,395 14,632 $ 0.37 $ 15,385 14,655 $ 1.05 =========== ================ =========== ================
(1) Outstanding shares computed on a weighted average basis Note 5. The Company's comprehensive income consists of net income and the net change in value of cash flow hedge instruments as follows: (in thousands)
For the Three Months Ended For the Nine Months Ended March 31, March 31, 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Net income $ 4,235 $ 7,302 $ 5,523 $ 15,531 Change in value of cash flow hedge, net of tax (6) 136 (419) (225) ---------- ---------- ---------- ---------- Total comprehensive income $ 4,229 $ 7,438 $ 5,104 $ 15,306 ========== ========== ========== ==========
Page 10 of 25 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. 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 March 31, 2003, the Company was party to a standby letter of credit of $750,000 and was the guarantor of certain customer obligations totaling approximately $500,000. Management does not expect any material losses to result from these off-balance-sheet items. Note 8. On March 31, 2003, the Company announced that it had entered into a new $600 million credit facility. The credit facility, an asset-based senior secured revolving credit facility, increased its available credit from $430 million to $600 million. The new single credit facility replaces a $230 million revolving bank line of credit and a $200 million accounts receivable securitization program. The interest rate on the new credit facility is based on the 30-day LIBOR rate. Borrowings under the new credit facility will be reported as long-term debt in the Company's financial statements. Accounts receivable at March 31, 2003 reflected an increase over previous periods as a result of eliminating the securitization program since the accounts receivable securitization program had been reported as off-balance sheet financing. Long-term debt includes borrowings related to the repurchase of $80 million of receivables that had been part of the securitization at the time the new credit agreement was established. To hedge a portion of its exposure to variability in cash flows related to interest payments under the revolving credit facility, on March 28, 2003, the Company entered into a three-year interest rate cap agreement at a cost of $0.4 million. The notional amount of the instrument is $50 million and it caps the 30-day LIBOR rate at 3.5% in the first year, 4.25% in the second year and 5% in the third year. The Company's analysis of this hedge under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," shows this to be an effective hedge. As such, any change in the intrinsic value of this instrument will be reported in accumulated other comprehensive loss. Any change in time value of this will be reflected on its income statement. Page 11 of 25 Note 9. 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; Wholesale drug distribution, the Company's interest in PBI , and Software. Two wholly owned software subsidiaries, Tykon, Inc. and Viking Computer Services, Inc., constitute the Software 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. 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.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED (in thousands) MARCH 31, MARCH 31, MARCH 31, MARCH 31, 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Sales to unaffiliated customers - Wholesale drug distribution $ 625,965 $ 692,458 $ 1,685,698 $ 1,808,333 PBI 1,979 2,184 5,682 5,946 Software 674 599 2,047 1,751 ----------- ----------- ----------- ----------- Total $ 628,618 $ 695,241 $ 1,693,427 $ 1,816,030 Intersegment sales - Wholesale drug distribution $ -- $ -- $ -- $ -- PBI -- -- -- -- Software -- 292 -- 901 Intersegment eliminations -- (292) -- (901) ----------- ----------- ----------- ----------- Total $ -- $ -- $ -- $ -- Net Sales - Wholesale drug distribution $ 625,965 $ 692,458 $ 1,685,698 $ 1,808,333 PBI 1,979 2,184 5,682 5,946 Software 674 891 2,047 2,652 Intersegment eliminations -- (292) -- (901) ----------- ----------- ----------- ----------- Total $ 628,618 $ 695,241 $ 1,693,427 $ 1,816,030 Gross Profit - Wholesale drug distribution $ 24,501 $ 27,363 $ 61,986 $ 68,391 PBI 1,979 2,184 5,682 5,946 Software 538 800 1,625 2,363 ----------- ----------- ----------- ----------- Total $ 27,018 $ 30,347 $ 69,293 $ 76,700 Pre-tax income Wholesale drug distribution $ 6,187 $ 10,804 $ 13,820 $ 22,310 PBI 1,001 1,255 2,741 3,336 Software 179 241 582 637 ----------- ----------- ----------- ----------- Total $ 7,367 $ 12,300 $ 17,143 $ 26,283
Page 12 of 25 Except as otherwise disclosed, there has been no material change in total assets from the amount disclosed in the last annual report. Since the last annual report, PBI now exceeds certain reporting criteria and accordingly has been shown separately. Prior period segment information has been reclassified accordingly. There are no other differences in the basis of segmentation or in the basis of measurement of segment profit or loss. Note 10. 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 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 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. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). The disclosure requirements of FIN 45 are effective for our fiscal 2003 consolidated financial statements and have been included in our quarterly financial statements beginning with the quarter ending December 31, 2002. Page 13 of 25 For applicable guarantees issued after January 1, 2003, FIN 45 requires that a guarantor recognize a liability for the fair value of the obligation undertaken in issuing the guarantee. We do not believe that the accounting requirements of FIN 45 will have a material effect on our financial condition or results of operations. In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued after 2002; however, disclosures are required currently if any variable interest entities are expected to be consolidated. We do not believe that any entities will be consolidated as a result of FIN 46. Page 14 of 25 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The discussion below is concerned with material changes in financial condition and results of operations in the condensed consolidated balance sheets as of March 31, 2003 and June 30, 2002, and in the condensed consolidated statements of operations for the three-month and nine-month periods ended March 31, 2003 and March 31, 2002, 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. We have renamed the national pharmacy chains trade class the 'national accounts' trade class. Given the changing composition of this class of trade we feel this new name is more reflective of the broader nature of the business. This is a name change only; we have not changed or restated the financial results in any way. Results of Operations: Net Sales. Net sales decreased $66.6 million, or 9.6%, to $628.6 million, for the quarter ended March 31, 2003, compared to the corresponding period of the prior year. Sales growth in the independent and regional pharmacies trade class was offset by a reduction in the national accounts trade class. Sales in the independent and regional Page 15 of 25 pharmacies trade class increased $9.9 million over the third quarter of fiscal 2002 due to increased sales to existing customers. Sales to national accounts decreased $82.0 million primarily due to fewer attractively priced purchasing opportunities made available to us during the quarter. Sales to other healthcare providers increased by $5.5 million as a result of new customers and increased sales to existing customers. Net sales decreased $122.6 million, or 6.8%, to $1.7 billion for the nine months ended March 31, 2003, compared to the corresponding period of the prior year. Sales growth in the independent and regional pharmacies trade class was more than offset by a decrease in the national accounts trade class. National accounts sales decreased $188.9 million during the first nine 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 $53.3 million due to increased sales to existing customers and new accounts. Sales to other healthcare providers increased by $13.0 million as a result of new customers and increased sales to existing customers. Gross Profit. Gross profit decreased 11.0% to $27.0 million for the quarter ended March 31, 2003, compared to the corresponding period of the prior year. This decrease was primarily due to lower national accounts sales driven by fewer attractively priced purchasing opportunities. As a percentage of net sales, gross margin declined from 4.36% to 4.30% for the quarter ended March 31, 2003, compared to the corresponding period of the prior year. The decrease in gross margin percentage was primarily due to lower margin sales in the national accounts trade class. Gross profit decreased 9.7% to $69.3 million for the nine months ended March 31, 2003, compared to the corresponding period of the prior year. As a percentage of net sales, gross margin decreased from 4.22% to 4.09% for the nine months ended March 31, 2003, compared to the corresponding period of the prior year. The decrease in gross margin percentage was primarily due to lower margin sales in the national accounts trade class. Operating Expenses. Operating expenses increased $0.2 million, or 1.4%, to $14.9 million for the quarter ended March 31, 2003, compared to the corresponding period of the prior year. For the nine months ended March 31, 2003, operating expenses were $41.9 million, which was $0.5 million, or 1.2%, lower than the corresponding period of last year. The change in operating expenses for both the quarter and nine-month period ended March 31, 2003, 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 $1.5 million for the nine-month period, were eliminated. For the quarter, that savings was more than offset by higher incentive based compensation, higher property and casualty insurance premiums driven by general insurance market trends, and increased depreciation on the new enterprise resource planning system which began in the fourth quarter of fiscal 2002. For the nine month period, the savings Page 16 of 25 associated with goodwill was combined with lower incentive based compensation and offset by higher property and casualty insurance premiums driven by general insurance market trends, and increased 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 2.37% compared to 2.11% for the same quarter last year. The ratio of operating expenses to net sales for the nine-month period was 2.48% compared to 2.34% 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 for the quarter ended March 31, 2003 was $2.8 million, or approximately the same as the corresponding period of the prior year. Interest expense was slightly lower as weighted average interest rates were slightly lower and weighted average borrowings were comparable to the same quarter of last year. Interest income was also slightly lower this quarter, which offset the lower interest expense. As a percentage of net sales, net interest expense increased from 0.41% to 0.45% of net sales for the quarter ended March 31, 2003, compared to the corresponding period of the prior year. For the nine months ended March 31, 2003, net interest expense increased $1.0 million or 14.2%, to $8.2 million, compared to the corresponding period of the prior year. As a percentage of net sales, net interest expense increased from 0.40% to 0.49% of net sales for the nine-month period ended March 31, 2003, 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. The weighted average interest rate declined approximately 60 basis points in the first nine months of fiscal 2003 compared to the same period of fiscal 2002, and the weighted average borrowings increased to approximately $234 million from $194 million. Securitization termination costs. In March 2003, we entered into a new credit agreement that resulted in the termination of the existing accounts receivable securitization agreement. As a result, we incurred a one-time charge of $2.0 million during the quarter. These costs were associated with terminating the existing accounts receivable securitization program. Further discussion of the impact of the termination of the securitization agreement is included below in the Liquidity and Capital Resources portion of this document. Provision for Income Taxes. Our effective tax rate in the third quarter and year-to-date was 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 the nine-month period 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. Page 17 of 25 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 trade credit from our suppliers. We utilize the following measures as key indicators of our liquidity and working capital management:
Pro Forma (a) March 31, June 30, June 30, 2003 2002 2002 --------- ------------- -------- Working capital $ 289,953 $ 302,636 $ 182,636 Current ratio 2.33 to 1 2.31 to 1 1.79 to 1
(a) Includes accounts receivable related to securitization agreement The increase in working capital and current ratio compared to June 30, 2002 relates to the termination of the accounts receivable securitization agreement and the related increase in accounts receivable shown on our balance sheet as reflected in the pro forma figures. See further discussion below relating to the termination of the securitization agreement. Cash outflows from operating activities totaled $22.9 million for the nine-month period ended March 31, 2003 compared to outflows of $103.1 million for the same period of the prior year. These results were driven by working capital increases during the respective periods. Our first and second fiscal quarters generally produce operating cash outflows as we establish inventory positions ahead of normal year-end price increases from the pharmaceutical manufacturers. These positions are generally liquidated in our third and fourth fiscal quarters producing cash inflows from operating activities. We invested $2,021,000 in capital assets in the nine-month period ended March 31, 2003, as compared to $2,637,000 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 $21.4 million for the nine-month period ended March 31, 2003 as compared to cash inflows of $107.2 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 was utilized during the third quarter to finance inventory purchases and repaid through the sale of inventory. This agreement expired March 31, 2003. On March 31, 2003, we announced that we had entered into a new $600 million credit facility. The credit facility, an asset-based senior secured revolving credit facility, increased our available credit from $430 million to $600 million. The new single credit Page 18 of 25 facility replaces a $230 million revolving bank line of credit and a $200 million accounts receivable securitization program. The interest rate on the new credit facility is based on the 30-day LIBOR rate. Borrowings under the new credit facility will be reported as revolving line of credit in the company's financial statements. Accounts receivable at March 31, 2003 reflected an increase over previous periods as a result of eliminating the securitization program since the accounts receivable securitization program had been reported as off-balance sheet financing. The revolving line of credit includes borrowings related to the repurchase of $80 million of receivables that had been part of the securitization at the time the new credit agreement was established. To hedge a portion of our exposure to variability in cash flows related to interest payments under the revolving credit facility, on March 28, 2003, we entered into a three-year interest rate cap agreement at a cost of $0.4 million. The notional amount of the instrument is $50 million and it caps the 30-day LIBOR rate at 3.5% in the first year, 4.25% in the second year and 5% in the third year. Our analysis of this hedge under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," shows this to be an effective hedge. As such, any change in intrinsic value of this instrument will be reported in accumulated other comprehensive. Any change in time value of this instrument will be reflected on our income statement. At March 31, 2003, $188.2 million of the possible $600 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. Recent Trends: During the first nine months of fiscal 2003, our internal revenue and margin objectives for the national accounts trade class 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 accounts business have been variable from month to month historically, driven largely by opportunistic purchases from pharmaceutical companies for distribution primarily to national pharmacy 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 3.6%, year-over-year, in the third quarter of fiscal 2003 and 6.6% for the nine months ended March 31, 2003. 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 19 of 25 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 $0.6 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 20 of 25 D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES Part II. Other Information Item 6. Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index on page 24. (b) Reports on Form 8-K a. On February 12, 2003, 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 December 31, 2002 filed by the registrant on February 12, 2003. b. On March 4, 2003, the registrant filed a Current Report on Form 8-K under Item 9 with a press release announcing that it expects to have a new credit facility of at least $500 million in place by April 30, 2003. c. On March 31, 2003, the registrant filed a Current Report on Form 8-K under Item 9 with a press release announcing that it entered into a new credit facility of $600 million. d. On April 28, 2003, the registrant filed a Current Report on Form 8-K under Item 9 with a press release announcing its financial results for the third quarter of fiscal 2003. The information in this report is furnished pursuant to Item 9,"Regulation FD Disclosure" and Item 12, "Disclosure of Results of Operations and Financial Condition." The information in this Form 8-K is being furnished under Item 9 and Item 12 and shall not be deemed to be "filed" for the purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act"), or otherwise subject to the liabilities of such section, nor shall such information be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing. Page 21 of 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. D & K HEALTHCARE RESOURCES, INC. Date: May 12, 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 22 of 25 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: May 12, 2003 /s/ J. Hord Armstrong, III --------------------------------------- Title: Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Page 23 of 25 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: May 12, 2003 /s/ Thomas S. Hilton ------------------------------- Title: Senior Vice President and Chief Financial Officer (Principal Financial Officer) Page 24 of 25 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. 99.1** Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated May 12, 2003.
* Incorporated by reference. ** Filed herewith.