Item 1. Business
GENERAL
We are a wholesale distributor of pharmaceutical and related healthcare and beauty aid products. We serve independent pharmacies, regional pharmacy companies, national pharmacy chains and other healthcare providers. Our independent and regional pharmacy customers are located in 24 states primarily in the Midwest and South. Independent and regional pharmacies generally operate single or multi-site locations in one or more states. National pharmacy chains generally operate a large number of locations in multiple regions of the United States. Our independent and regional pharmacy business has grown from $646.1 million in net sales in fiscal 2000 to $1.095 billion in fiscal 2002. Our national pharmacy chain business has grown from $392.5 million in net sales in fiscal 2000 to $1.247 billion in fiscal 2002. We sell branded pharmaceuticals (approximately 92% of net sales in fiscal 2002), generic pharmaceuticals (approximately 6% of net sales in fiscal 2002) and over-the-counter health and beauty aids (approximately 2% of net sales in fiscal 2002). In addition to distributing products to independent, regional and national pharmacies, we also provide our products and services to other healthcare providers, including hospitals, alternate-site care providers and pharmacy benefit management companies.
On March 13, 2002, the Company declared a two-for-one stock split in the form of a stock dividend, which was effective on April 11, 2002. All share and per share amounts included in this report and in the consolidated financial statements have been adjusted to retroactively reflect this stock split.
On July 5, 2001, we completed a secondary stock offering of approximately 4.8 million shares of our common stock. The net proceeds from the offering were approximately $77 million, which were used to repay debt.
In July 2001, as part of the secondary stock offering, we increased our ownership percentage in Pharmaceutical Buyers, Inc. (PBI) to 68% and in August 2001, we increased our ownership percentage another 2%. These additions were accomplished with individuals exchanging PBI stock for shares of our common stock. This exchange was provided for in the agreement for the original transaction pursuant to which we acquired our initial 50% ownership interest. These transactions are more fully described in Note 2 to our consolidated financial statements.
On June 15, 2001, we acquired 100% of the outstanding stock of Diversified Healthcare, LLC, a pharmaceutical distribution company based in Owensboro, Kentucky that provides comprehensive pharmaceutical distribution services to customers in the Midwest region.
We believe that our size, decentralized operating structure and high level of customer service provide us with competitive advantages and position us to benefit from trends impacting our industry. Our management believes that the increasing size, scale and consolidation of the wholesale pharmaceutical industry's national participants and their strategy to be primary or major distributors to national pharmacy chains and other healthcare providers create opportunities for us to effectively compete with them based on our business focus and differentiated product offering.
INDUSTRY OVERVIEW
Wholesale pharmaceutical distributors serve pharmacies and other healthcare providers by providing access to a single source for pharmaceutical and healthcare products from hundreds of different manufacturers. In addition, wholesale pharmaceutical distributors lower customer inventory costs, provide efficient and timely product delivery and provide valuable inventory and purchasing information. Customers also benefit from value-added programs developed by wholesale pharmaceutical distributors to reduce costs and to increase operating efficiencies for the customer, including packaging, stockless inventory and pharmacy computer systems. One industry association analysis estimates that wholesale distributors save the healthcare delivery system more than $146 billion per year compared to purchasing directly from manufacturers.
Wholesale pharmaceutical distributors are an important distribution channel for pharmaceutical manufacturers, accounting for approximately 72.4% of the $174.4 billion of prescription drug sales to retailers and institutions during 2001. Wholesale pharmaceutical distribution industry sales increased from $2.4 billion in 1970 to more than $126.3
billion in 2001, and we expect them to continue to increase. The principal factors contributing to this historical and expected growth are the following:
- AGING OF POPULATION. The number of individuals over age 50 in the United States is projected to grow from 28% of the population presently to 32% in 2010 and 35% by 2015. This demographic group represents the largest percentage of new prescriptions filled and obtains more prescriptions per capita annually than any other age group.
- INCREASED DRUG UTILIZATION. In recent years, a number of factors have contributed to the increased utilization of drug-based therapies to prevent and to treat disease. These factors include increased research and development spending by pharmaceutical manufacturers leading to the introduction of new pharmaceuticals, the lower costs of drug-based therapy relative to surgery and increased direct to consumer advertising by manufacturers.
- IMPORTANCE OF THE WHOLESALE DISTRIBUTION CHANNEL. Over the past decade, as the cost and complexity of maintaining inventories and arranging for delivery of pharmaceutical products has risen, manufacturers of pharmaceuticals have significantly increased the distribution of their products through wholesalers. Drug wholesalers are generally able to offer their customers and suppliers more efficient distribution and inventory management than pharmaceutical manufacturers. As a result, from 1980 to 2001, the percentage of total pharmaceutical sales through wholesale distributors increased from approximately 57.0% to approximately 72.4%.
- RISING PHARMACEUTICAL COSTS. We believe that price increases for branded pharmaceutical products by manufacturers will continue to equal or exceed the overall increases in the Consumer Price Index. We believe that these increases will be due in large part to relatively inelastic demand for branded pharmaceuticals in the face of higher prices charged for patented drugs as manufacturers attempt to recoup costs associated with the development, clinical testing and FDA approval of new products. From 1990 to 2001, the average retail price of a prescription increased from $22.06 to $50.17.
CUSTOMERS AND PRODUCTS
Our customer base consists of independent pharmacies, regional pharmacy companies, national pharmacy chains and other healthcare providers. Independent pharmacies generally are community-based pharmacies, which we believe benefit the most from our customized sales, information systems and other value added services. Regional pharmacy companies generally focus on serving customers with multiple sites in one or more states. National pharmacy chains generally have stores located in more than one region in the United States and include the pharmacy departments of supermarkets and mass merchandisers. Other healthcare providers consist of hospitals, other alternate-site care providers (including nursing homes, clinics, home health services and managed care organizations), and pharmacy benefit management companies. We are committed to serving the unique needs of independent and regional pharmacies and have structured our business and operating model to be able to do this in an efficient and profitable manner.
NET SALES
- ------------- (1) For FY2002, includes sales from PBI, which is now consolidated.
During fiscal 2000, fiscal 2001 and fiscal 2002, our 10 largest customers accounted for approximately 55.1%, 49.4%, and 56.4%, respectively, of our net sales. Our largest customer during fiscal 2002 accounted for approximately 24% of our net sales. Our largest customer in fiscal 2001 and fiscal 2000, which was a different customer in each year, accounted for approximately 16% and 18% of our net sales during those periods, respectively. In the fourth quarter of fiscal 2000, our contracts with our two largest mail-order customers were terminated by the customers. In each case, we were given the opportunity to submit proposals to renew the contracts but elected not to do so at prices that would have been required to retain the business. Sales to these customers in fiscal 2000 represented approximately 18% and 5%, respectively, of our total net sales for that period. The loss of these customers has not had a material adverse effect on our sales. See Note 16 to our consolidated financial statements for additional information regarding the impact of the loss of these customers.
Independent and Regional Pharmacies
Consistent with our strategy since our inception, one of our primary objectives has been to focus on serving the specialized needs of independent and regional pharmacies while our larger national competitors have increasingly organized their businesses around serving the primary needs of the national pharmacy chain companies as well as their national contracts with group purchasing organizations and pharmacy benefit managers. We have organized ourselves to profitably and efficiently provide all of our services to our independent and regional pharmacy customers from five distribution centers located in four states, serving customers in 24 states primarily in the Midwest and South. Our sales to independent and regional pharmacies grew from $646.1 million in fiscal 2000 to $1.095 billion in fiscal 2002. Each of our distribution centers has the personnel and capabilities to autonomously provide customized distribution, information systems, inventory management and other services to our local independent pharmacy and regional pharmacy customers.
Our product offerings to independent and regional pharmacy companies consist of more than 25,000 SKUs, including branded pharmaceuticals, multi-source generics, private label products, repackaged pharmaceutical products and over-the-counter health and beauty aids. We deliver our products directly to the stores of our independent pharmacy customers and deliver both to retail stores and to the warehouses of our regional pharmacy customers depending on whether they have centralized inventory warehouses.
Our decentralized organization allows our distribution centers to form strong, attentive and responsive business relationships with our independent and regional pharmacy customers. Our specialized infrastructure and autonomous distribution centers enable us to serve our independent and regional pharmacy customers with a high level of customer service. We believe that we fulfill our customers' orders with a high degree of accuracy and that our customers value our flexibility and willingness to meet and accommodate their special requests and needs. We believe that the large national wholesale distributors, which are focused on and organized to serve primarily large national pharmacy chains and national contracts, do not have the operating model or flexibility to service independent and regional pharmacies as we do.
National Pharmacy Chains
By virtue of our strong independent and regional pharmacy business and our competitive position and strong relationships with pharmaceutical manufacturers and national pharmacy chain companies, we have built a business that serves as a secondary supplier for the high-volume branded pharmaceutical distribution needs of our manufacturers and national pharmacy chain customers. We provide our national pharmacy chain customers with 700 to 800 high-volume, branded bulk pharmaceuticals that we purchase from pharmaceutical manufacturers on favorable terms. Our net revenues from these sales have grown from $392.5 million in fiscal 2000 to $1.247 billion in fiscal 2002.
Our industry is subject to regulations that require organizations handling the distribution or sale of pharmaceuticals to be able to trace the detailed history of those specific products back to the manufacturer or an authorized distributor. In order to ensure that we provide our customers with products that have verifiable shipment histories, we purchase the vast majority of our pharmaceuticals directly from manufacturers with the balance coming directly from authorized distributors. As a result of our reputation and conservative business practices, we believe that we are a desirable business partner for pharmaceutical manufacturers and national pharmacy chains.
We utilize our longstanding manufacturer and national pharmacy chain customer relationships to provide services that benefit both our customers and our suppliers. Our management team has developed and maintains reputations and contacts that enable them to identify opportunities to purchase branded pharmaceuticals from manufacturers at attractive prices. In addition to the experience and expertise of our management team in this area, we also employ sophisticated information and inventory management systems to understand the demand for particular products in advance of buying them for distribution. We generally purchase only fast moving branded pharmaceuticals for supply to national pharmacy chains. As a result, we minimize our inventory risk exposure and have not experienced any material inventory expiration or obsolescence in this part of our business. We have, however, had situations in which we have sold pharmaceutical products to national pharmacy chains at prices lower than what we expected when we procured those products.
ADDITIONAL SERVICES
Consistent with our strategy to offer a high level of customer service to our pharmacy customers, we offer a number of proprietary information system, marketing, and other business management solutions to assist our customers in profitably operating and growing their businesses. Through our Tykon, Inc. subsidiary, we develop and market a proprietary order entry/order confirmation system to the drug distribution industry. We offer and fully support these services from our distribution centers. We make these services available to all of our customers, however our independent pharmacy customers have the most to gain from them and are consequently the heaviest users of these services. In providing our services and support to independent and regional pharmacy customers, we give them access to resources and tools normally associated with larger businesses. In so doing, we believe that we enable them to operate their businesses more efficiently and that we increase our value to them.
We strive to offer services that enhance the operating efficiencies of our customers and assist them in competing effectively. Principal elements of our service offering to our customers include:
- RESOURCE(SM) a proprietary PC based order entry/order confirmation system that completely automates all order creation, transmission and confirmation operations and PARTNERS(SM) a fully automated and customizable replenishment software system which helps pharmacies more efficiently coordinate product supply and demand. Through these proprietary order entry/order confirmation systems that completely automate all order creation, transmission and confirmation operations, our customers have the opportunity to improve their margins and significantly reduce their working capital needs through effective inventory management.
- SCRIPTMASTER(R) is our pharmacy dispensing management system, which includes computerized order entry, point-of-sale capabilities, inventory control, patient histories, drug interactions and pharmacy reimbursement. This service provides cost savings and enhanced efficiencies to pharmacy customers as well as valuable information on prescription history for manufacturers.
We offer a broad range of merchandising and marketing services to our independent pharmacy customers under our MedPlus(R) identity program. Under this program, we plan and coordinate cooperative advertising programs and provide for the availability of various promotional products, including a single-source supply for generics at highly competitive prices from leading pharmaceutical manufacturers. We also offer new product introduction programs, point-of-sale materials, calendars, blood pressure testing units, automatic new product distribution, rack jobbing, store fixturing and retail employee training programs. Other services offered to independent pharmacies under MedPlus(R) include: retail merchandising, inventory management systems, electronic order entry, shelf labels and price stickers, private label products, monthly feature promotions, home healthcare marketing programs, store layout assistance, business management reports, pharmacy computer systems and monthly catalogs.
OPERATIONS
We are an organization of locally managed drug wholesale distribution centers. Each distribution center has its own executive, sales and operations staff. Management compensation at each center is determined by that center's operating results. These operations utilize our corporate staff for procurement, marketing, financial, legal and executive management resources and corporate coordination of assets and working capital management. Our decentralized sales and distribution network, combined with our centralized procurement and corporate support staff structure, enable us to
provide high levels of specialized customer service while minimizing administrative expenses and maximizing volume discounts for product purchases.
Our distribution centers include computer systems and sophisticated materials handling equipment for receiving, storing and distributing large quantities and varieties of products. We continuously seek to improve our warehouse automation technologies to maximize operational efficiencies on a cost-effective basis. We receive virtually 100% of our orders electronically and, upon receipt of the customer's order at a distribution center, our warehouse-management system produces a "picking document" containing product selection, loading and truck routing information. The system also provides customized price information (geared to local markets as determined by the customer) or individual package price stickers to accompany each shipment to facilitate the customer's pricing of the items. Virtually all items ordered from our distribution centers are available and shipped by us less than 24 hours after customers place the orders. Orders are delivered to customers by our fleet of trucks and vans or by contract carriers.
SALES AND MARKETING
We employ sales representatives and customer service representatives at each of our distribution centers. Our sales representatives receive regular training to help them improve customer service and to provide them with the skills and resources necessary to increase business with existing customers and establish new customer relationships. We also maintain at each of our distribution centers a telephone service department staffed with trained representatives who answer customer questions and solve problems.
We focus our marketing efforts on developing and maintaining primary relationships with customers. We emphasize frequent personal interaction between our sales force and customers so that our customers learn to rely on our dependability, responsiveness, accuracy of order filling and breadth of product line. Our customers also rely on our sales force for assistance with advertising, merchandising, stocking and inventory management.
We believe that our distribution center-based customer service departments differentiate us from our national competitors; they are a key element in our marketing program. Our decentralized customer service staffs focus on developing relationships with our customers, responding quickly to customer inquiries and placing orders accurately and efficiently.
PURCHASING AND INVENTORY CONTROL
We utilize sophisticated inventory control and purchasing software to track our inventory, to analyze demand history and to project future demand. Our system is designed to enhance profit margins by eliminating the manual ordering process, allowing for automatic inventory replenishment and identifying inventory buying opportunities.
We purchase products from approximately 1,200 manufacturers. We initiate purchase orders with manufacturers through our information systems. During fiscal 2002 and fiscal 2001, our 10 largest suppliers accounted for approximately 71% and 66%, respectively, of our purchases by dollar volume. Our largest supplier accounted for approximately 22% (by dollar volume) of our purchases during fiscal 2002 and approximately 31% (by dollar volume) of our purchases during fiscal 2001. Another vendor accounted for approximately 11% (by dollar volume) of our purchases during fiscal 2002. As is common practice in our industry, the majority of our supply contracts are terminable by either party upon short notice and without penalty. We believe that our relationships with our suppliers are good.
MANAGEMENT INFORMATION SYSTEMS
Each of our distribution centers operates as a distinct business with complete system functionality including, order processing, inventory management, accounts receivable, accounts payable, general ledger, master file maintenance, and external and internal reporting. Historically, we have operated in a distributed data processing environment. Each distribution center maintained its own AS/400 system and Information Systems staff to support that function. Over the past year, we have consolidated certain systems into data centers located in St. Louis and Cape Girardeau. Each of the divisions is connected to the central systems in St. Louis and Cape Girardeau.
In March 2000, we selected JD Edwards OneWorld(TM) product as our new Enterprise Resource Planning software package. The OneWorld(TM) product is a complete system that integrates sales order management, inventory
management, transportation management, customer service, accounts payable, accounts receivable, general ledger and financial reporting. Once implementation is complete, all systems will be consolidated in St. Louis and Cape Girardeau. The new system will provide us with improved operations management and financial reporting systems. Implementation of this system began in July 2000 and is expected to be completed during fiscal 2003.
BUYING GROUP
In November 1995, we purchased 50% of Pharmaceutical Buyers, Inc. (PBI), a Colorado-based group purchasing organization. PBI is one of the largest pharmaceutical group purchasing organizations in the United States with over 2,000 member organizations. PBI's member organizations include long-term care facilities, home infusion providers, and medical equipment distributors. In connection with the secondary stock offering in July 2001, we increased our ownership in PBI to 68% and an additional 2% was acquired in a subsequent transaction in August 2001. The resulting required consolidation of PBI's operations positively impacted our financial statements by increasing our gross profit and gross margin percentage but has had no effect on our earnings per share. See Note 13 to our consolidated financial statements.
COMPETITION
The wholesale distribution of pharmaceuticals, health and beauty aids, and other healthcare products is highly competitive. National and regional distributors compete primarily on the basis of service and price. Other competitive factors include delivery service, credit terms, breadth of product line, customer support, merchandising and marketing programs. We compete with national and regional wholesale distributors, manufacturers and generic pharmaceutical telemarketers and specialty distributors and with other wholesale distributors for purchases of products and financial support in the form of trade credit from manufacturers. Certain of our competitors, including McKesson Corporation, AmeriSourceBergen Corporation and Cardinal Health, Inc., have significantly greater financial and marketing resources than we do.
EMPLOYEES
As of August 31, 2002, we employed 456 persons, 408 of whom were full-time employees. Approximately 25 employees at our Minneapolis, Minnesota distribution center are covered by a collective bargaining agreement with the Miscellaneous Drivers, Helpers and Warehousemen's Union, Local 638, which expires in March 2003. Approximately 11 employees at our Jewett Drug Co. subsidiary are covered by a collective bargaining agreement with the General Drivers and Helpers Union Local 749, affiliated with the International Brotherhood of Teamsters, which expires February 29, 2004. In November 2001, the National Labor Relations Board decertified the United Steelworkers of America as the collective bargaining representative for approximately 34 employees at our Cape Girardeau, Missouri distribution center. We believe that our employee relations are good.
FORWARD-LOOKING STATEMENTS
Certain statements in this document regarding future events, prospects, projections or financial performance are forward looking statements. Such forward looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and may 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 Company's ability to compete in a competitive 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.
Item 2.
Item 2. Properties
We conduct our business from a total of nine office, warehouse and satellite depot facilities. Our primary operating facilities include:
- ------------- (1) Leased. (2) Owned. (3) Leased. To be occupied during fiscal 2003.
We also maintain warehouse and satellite depot facilities in Missouri and Kentucky that enable us to efficiently distribute products on a timely basis. We believe our facilities are adequate to support our present business plans.
Item 3.
Item 3. Legal Proceedings
No material legal proceedings are pending against us.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of our security holders during the quarter ended June 30, 2002.
Item 4A. Executive Officers of the Registrant
The name, age and position of each of our executive officers are set forth below.
J. Hord Armstrong, III, 61, has served as our Chairman of the Board, Chief Executive Officer and Treasurer and as one of our directors since December 1987. Prior to joining us, Mr. Armstrong served as Vice President and Chief Financial Officer of Arch Mineral Corporation, a coal mining and sales corporation, from 1981 to 1987 and as its Treasurer from 1978 to 1981. Mr. Armstrong serves as a Trustee of the St. Louis College of Pharmacy.
Martin D. Wilson, 41, has served as our President and Chief Operating Officer since January 1996, as Secretary from August 1993 to April 1999 and as one of our directors since 1997. Mr. Wilson previously served as our Executive Vice President, Finance and Administration from May 1995 to January 1996, as our Vice President, Finance and Administration from April 1991 to May 1995 and as our Controller from March 1988 to April 1991. Prior to joining D&K, Mr. Wilson, was associated with KPMG Peat Marwick, a public accounting firm.
Thomas S. Hilton, 50, has served as our Senior Vice President and Chief Financial Officer since January 1999. Between May 1980 and June 1998, Mr. Hilton was employed by the Peabody Group, a coal mining and sales corporation, serving in a variety of management positions including Vice President and Treasurer from March 1993 to May 1995 and as Vice President and Chief Financial Officer from May 1995 to June 1998.
Leonard R. Benjamin, 52, has served as our Vice President, General Counsel and Secretary since April 1999. Between January 1999 and April 1999, Mr. Benjamin was Assistant General Counsel of Innovex Corporation, a provider of sales forces to the pharmaceutical industry. Between October 1998 and January 1999, Mr. Benjamin was counsel to KWS&P/SFA Inc., a software provider to the pharmaceutical industry. Between April 1994 and July 1998, Mr. Benjamin was employed by Walsh International Inc., a software provider to the pharmaceutical industry, initially as Associate General Counsel and then as Vice President, General Counsel and Secretary.
Brian G. Landry, 46, has served as our Vice President and Chief Information Officer since April 2000. Mr. Landry previously served as Vice President, I.S. product management from April 1999 to April 2000 and as Vice President and General Manager of our Minneapolis distribution center from November 1996 to April 1999. From October 1992 to October 1996, Mr. Landry was employed by Cardinal Health as a general manager of a distribution center.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information set forth under the caption "Price Range Per Common Share" on page 1 of the registrant's 2002 Annual Report to Stockholders is incorporated herein by this reference.
The following table contains certain information concerning shares of common stock of the Company subject to options issued under the Company's 1992 Long-term Incentive Plan (as amended), 1993 Stock Option Plan (as amended) and 2001 Long-term Incentive Plan. The Company's stockholders have approved the 1992 Long-term Incentive Plan and the 2001 Long-term Incentive Plan. The 1993 Stock Option Plan (the 1993 Plan) is for employees and certain other persons (other than directors or executive officers of the Company) who perform services for the Company. Under the 1993 Plan, the Company may grant options, which do not qualify as Incentive Stock Options, at a price not less than fair market value of the Company's common stock at the time of grant. The term of the options shall not exceed 10 years from the date of grant. There were 700,000 shares authorized under the 1993 Plan. The 1993 Plan did not require stockholder approval.
Item 6.
Item 6. Selected Financial Data
The information set forth under the caption "Financial Highlights" on page 1 of the registrant's 2002 Annual Report to Stockholders is incorporated herein by this reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
The table below sets forth certain statement of operations data for the last three fiscal years expressed as a percentage of net sales and in comparison with the prior fiscal year. Unless otherwise indicated, for purposes of this discussion, all references to "2002," "2001," and "2000" shall mean the Company's fiscal years ended June 30, 2002, June 30, 2001, and June 30, 2000, respectively.
FISCAL YEAR ENDED JUNE 30, 2002, COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
NET SALES Net sales increased $807.8 million to $2.454 billion, or 49.1%, for the fiscal year ended June 30, 2002, compared to the corresponding period of the prior year. Sales growth was primarily in the independent and regional pharmacy and national pharmacy chain groups. Sales to independent and regional pharmacies increased $346.7 million to $1.095 billion, or 46.3%, as a result of the net increase in sales to existing customers, the addition of DHI for a full year, and the addition of new customers. National pharmacy chain sales increased $450.0 million to $1.247 billion, or 56.5%, over fiscal 2001 as proceeds from our equity offering were primarily used to capitalize on opportunities in this trade class, while sales to healthcare providers increased $3.6 million to $101.7 million, or 3.6%. The increase in net sales related to the consolidation of PBI in fiscal 2002 was insignificant.
We made replenishment purchases and investment purchases, including both forward purchasing and special purchasing opportunities, with our largest supplier for fiscal 2002. We continue to make replenishment and forward purchases, but do not anticipate any special purchasing opportunities in the near future, with this supplier. If we are unable to identify and benefit from other purchasing opportunities, then there could be a negative impact on our revenues and earnings in future periods.
In addition, during fiscal 2002 we made $70.5 million in dock-to-dock sales, which are not included in net sales due to our accounting policy of recording only the commission on such transactions as a reduction to cost of sales in our consolidated statements of operations. Dock-to-dock sales represent bulk sales of pharmaceuticals to self-warehousing chain pharmacies for which we act only as an intermediary in the order and subsequent delivery of products to the customers' warehouses. The commission on dock-to-dock sales is typically lower than the gross profit realized on sales of products from inventory. Dock-to-dock sales were $85.1 million during fiscal 2001.
GROSS PROFIT Gross profit increased $34.0 million to $102.8 million, or 49.4%, for fiscal 2002, compared to the corresponding period of the prior year. As a percentage of net sales, gross margin increased from 4.18% to 4.19% for the fiscal year ended June 30, 2002, compared to the corresponding period of the prior year. The slight increase in gross margin percentage was due to the inclusion of PBI partially offset by competitive forces in the business and a slightly higher mix of national pharmacy chain business that normally has lower gross margins.
OPERATING EXPENSES Operating expenses (including depreciation and amortization) increased $14.6 million to $56.5 million, or 34.9%, for the fiscal year ended June 30, 2002 compared to the corresponding period of the prior year. The ratio of operating expenses to net sales for fiscal 2002 was 2.30%, a 9.4% decrease from the comparable period of the prior year. The increase in operating expenses resulted from the inclusion of DHI and PBI operating
expenses during the year, a shift in sales mix to accounts requiring a higher level of service, and higher depreciation expense related to portions of the new ERP system being implemented. The ratio of operating expense to net sales fell as a function of the increase in sales in national pharmacy business that has lower incremental operating costs.
INTEREST EXPENSE, NET Net interest expense decreased $2.2 million to $9.7 million, or 18.7%, for the fiscal year ended June 30, 2002, compared to the corresponding period of the prior year. As a percentage of net sales, net interest expense decreased to 0.40% from 0.72% for fiscal 2002, compared to the corresponding period of the prior year. The decrease in net interest expense was primarily the result of lower average borrowing rates.
INCOME TAX PROVISION Our effective income tax rate was 39.3% for the fiscal year ended June 30, 2002 compared to 39.2% for the corresponding period of the prior year. These rates were different from the statutory blended federal and state rates primarily because of the amortization of intangible assets that are not deductible for federal and state income tax purposes. Our effective rate is slightly higher than the corresponding period of last year due to the impact of the sales mix on the blended state income tax rate.
MINORITY INTEREST We began recording minority interest during fiscal 2002 as a result of our additional investment in PBI in July 2001. Prior to fiscal 2002, our investment was treated under the equity method and our portion of the earnings in PBI where recorded accordingly.
FISCAL YEAR ENDED JUNE 30, 2001, COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
NET SALES Net sales increased $187.9 million to $1.646 billion, or 12.9%, for the fiscal year ended June 30, 2001, compared to the corresponding period of the prior year. Sales growth was primarily in the independent and regional pharmacy and national pharmacy chain groups. Sales to independent and regional pharmacies increased $102.3 million to $748.4 million, or 15.8%, as a result of the net increase in sales to existing customers and the addition of new customers. National pharmacy chain sales increased $404.2 million to $796.6 million, or 103.0%, over fiscal 2000 due to infrastructure investments and a focused effort on this trade class, while sales to healthcare providers decreased $318.7 million to $98.1 million, or 76.5%, as a result of the loss of two mail order customers during the fourth quarter of fiscal 2000.
In addition, during fiscal 2001 we made $85.1 million in dock-to-dock sales, which are not included in net sales due to our accounting policy of recording only the commission on such transactions as a reduction to cost of sales in our consolidated statements of operations. Dock-to-dock sales represent bulk sales of pharmaceuticals to self-warehousing chain pharmacies for which we act only as an intermediary in the order and subsequent delivery of products to the customers' warehouses. The commission on dock-to-dock sales is typically lower than the gross profit realized on sales of products from inventory. Dock-to-dock sales were $46.8 million during fiscal 2000.
GROSS PROFIT Gross profit increased $12.4 million to $68.8 million, or 22.0%, for fiscal 2001, compared to the corresponding period of the prior year. As a percentage of net sales, gross margin increased from 3.87% to 4.18% for the fiscal year ended June 30, 2001, compared to the corresponding period of the prior year. The increase in gross margin percentage was due to the discontinuance of lower gross profit business from the mail order customers mentioned above.
OPERATING EXPENSES Operating expenses (including depreciation and amortization) increased $7.8 million to $41.9 million, or 22.7%, for the fiscal year ended June 30, 2001 compared to the corresponding period of the prior year. The ratio of operating expenses to net sales for fiscal 2001 was 2.54%, an 8.5% increase from the comparable period of the prior year. The increase in operating expenses and the ratio of operating expenses to net sales resulted primarily from a shift in sales mix to accounts requiring a higher level of service and related expense.
INTEREST EXPENSE, NET Net interest expense increased $2.3 million to $12.0 million, or 24.1%, for the fiscal year ended June 30, 2001, compared to the corresponding period of the prior year. As a percentage of net sales, net interest expense increased to 0.72% from 0.66% for fiscal 2001, compared to the corresponding period of the prior year. The increase in net interest expense was primarily the result of higher average borrowings related to our continued growth.
INCOME TAX PROVISION Our effective income tax rate was 39.2% for the fiscal year ended June 30, 2001 compared to 38.8% for the corresponding period of the prior year. These rates were different from the statutory blended federal and state rates primarily because of the amortization of intangible assets that are not deductible for federal and state
income tax purposes. Our effective rate is slightly higher than the corresponding period of last year due to the impact of the sales mix on the blended state income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital requirements are generally met through a combination of internally generated funds, borrowings under the revolving line of credit, the accounts receivable securitization program, and trade credit from our suppliers. On July 5, 2001, stockholders' equity was increased by approximately $77 million as the result of our secondary stock offering. See Note 1 of our consolidated financial statements.
We use the following ratios as key indicators of our liquidity and working capital management:
Working capital and current ratio at June 30, 2002 are higher than June 30, 2001 levels. Increases in inventory levels are related to seasonal sales patterns and growth that have been partially offset by accounts payable increases tied to timing of inventory receipts and related payments.
We invested $3.4 million in capital assets in fiscal 2002, as compared to $3.5 million in the corresponding period in the prior year. The fiscal 2002 and 2001 expenditures were primarily related to the implementation of our new Enterprise Resource Planning computer system, which is scheduled to be completed during fiscal 2003. This system integrates sales order management, inventory management, transportation management, customer service, accounts payable, accounts receivable, general ledger and financial reporting. We believe that continuing investment in capital assets is necessary to achieve our goal of improving operational efficiency, thereby enhancing our productivity and profitability.
Net cash inflows from financing activities totaled $61.3 million for the year ended June 30, 2002 as compared to net cash outflows of $3.5 million for the corresponding period in the prior year. During fiscal 2002, we received proceeds from our secondary stock offering that was partially offset by increased repayments under our revolving credit agreement. During the previous year, the capacity under our accounts receivable securitization program increased which made available funds for repayment of the revolving credit facility.
On June 12, 2001, our revolving line of credit was amended to increase the maximum borrowing capacity to $150 million and extend the term to August 2005. Under the loan agreement, the total amount of loans and letters of credit outstanding at any time may not exceed the lesser of an amount based on percentages of eligible inventories (the borrowing base formula), or our maximum borrowing capacity under this agreement but may not be less than $20 million. The advances currently bear interest at a base rate of the London Interbank Offering Rate (LIBOR) plus 1.75%, or at the prime rate plus 0.25% per annum payable monthly. Through an interest rate swap agreement, we effectively fixed the interest rate on $20 million of our revolving line of credit at a nominal rate of 6.19%. At June 30, 2002 and June 30, 2001, the borrowing base formula amounted to $241.4 million and $132.2 million, respectively. The unused portion of the line of credit amounted to $71.3 million at June 30, 2002 and $56.9 million at June 30, 2001. The agreement expires in August 2005, and, therefore, the related debt has been classified as long-term. The revolving line of credit is secured by eligible inventories. In July 2002, our revolving line of credit was amended to increase the maximum borrowing capacity to $200 million.
In the first quarter of fiscal 1999, we entered into an accounts receivable securitization program under an asset securitization structure with our primary lender. On June 8, 2001, this agreement was amended to increase the maximum amount of receivables eligible to be sold to $150 million and the term was extended to August 2005. At June 30, 2002, $120 million of this facility was utilized. Under the program, undivided interests in a pool of eligible trade receivables that have been contributed to the Seller are sold, without recourse, to a multi-seller, asset backed commercial paper conduit ("Conduit"). Purchases by the Conduit are financed with the sale of highly rated commercial paper. We use the proceeds from the sale of our accounts receivable to repay long-term debt, effectively reducing its overall borrowing costs. Funding costs under this program are 4.85% on the first $50 million with the rate on the excess amounts equal to the commercial paper rate. Certain program fees total an additional 0.75%. The portion of receivables not sold by the subsidiary remains an asset on the balance sheet ($31.7 million as of June 30, 2002). In
August 2002, this agreement was amended to increase the maximum amount of receivables eligible to be sold to $200 million.
Stockholders' equity increased to $167.4 million at June 30, 2002 from $57.5 million at June 30, 2001, due to the impact of the equity offering and net earnings during the period. We believe that funds available under the line of credit and the securitization facility, together with internally generated funds, will be sufficient to meet our capital requirements for the foreseeable future.
INFLATION
Our financial statements are prepared on the basis of historical costs and are not intended to reflect changes in the relative purchasing power of the dollar. Because of our ability to take advantage of forward purchasing opportunities, we believe that our gross profits generally increase as a result of manufacturers' price increases in the products we distribute. Gross profits may decline if the rate of price increases by manufacturers declines.
Generally, price increases are passed through to customers as they are received by us and therefore reduce the negative effect of inflation. Other non-inventory cost increases, such as payroll, supplies and services, have been partially offset during the past three years by increased volume and productivity.
RECENT TRENDS
During the first two months of the fiscal 2003 first quarter, the Company's internal revenue and margin objectives for its national chain business were not achieved. The sales shortfall is principally the result of fewer than expected purchasing and sales opportunities available during the period. The Company's sales in the national 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, the Company's growth in sales to the independent and regional pharmacy trade class has trended below internal expectations in the first two months of the quarter of fiscal 2003. The Company now expects this trade class to achieve growth of approximately 10%, year-over-year, in the first quarter. While below expectations, this performance should enable the Company to further expand its share of this trade class, despite the unusually strong growth it achieved in the year-ago first quarter. The Company believes its sales performance in the trade class reflects a recent softening in retail sales trends now being exhibited across the country. The Company also believes the retail sales trends reflect a greater than expected revenue impact from generic drugs' encroachment on branded pharmaceuticals, the impact of increasingly higher prescription co-payment costs as well as funding challenges across most state Medicaid systems.
CRITICAL ACCOUNTING POLICIES
The Company's more critical accounting policies include the accounts receivable securitization program, the valuation of long-lived assets, and the use of estimates (which inherently involve judgment and uncertainties) in valuing accounts receivable.
Accounts Receivable Securitization Program
The Company and its wholly-owned, bankruptcy-remote subsidiary ("Seller") has an accounts receivable securitization program. Under the program, undivided interests in a pool of eligible trade receivables that have been contributed to the Seller are sold, without recourse, to a multi-seller, asset backed commercial paper conduit ("Conduit"). Purchases by the Conduit are financed with the sale of highly rated commercial paper. The Company utilizes proceeds from the sale of its accounts receivable to repay long-term debt, effectively reducing its overall borrowing costs. Under the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," (as amended by SFAS No. 140) the securitization transactions have been recorded as sales, with those accounts receivable sold to the Conduit removed from the consolidated balance sheet. The Seller is a separate legal entity from the Company. The Seller's assets are available first and foremost to satisfy the claims of its creditors. Eligible receivables, as defined in the securitization agreement, consist of trade receivables from our subsidiaries, excluding non-pharmaceutical receivables, reduced for certain items, including past due balances and
concentration limits. Of the eligible pool of receivables contributed to the Seller, undivided interests in only a portion of the pool are sold to the Conduit. The portion of eligible receivables not sold to the Conduit remains an asset of the Seller. The Seller's interest in these receivables is subordinate to the Conduit's interest in the event of default under the securitization agreement.
Valuation of Goodwill and Intangible Assets
Goodwill and certain identifiable intangibles assets are reviewed when events or circumstances indicate that the net book value may not be recoverable. Under SFAS No. 142,"Goodwill and Other Intangible Assets", goodwill and intangible assets that have indefinite lives will no longer be amortized but will be tested for impairment annually or more frequently if circumstances indicate potential impairment. Other intangible assets will continue to be amortized over their estimated useful lives.
Accounts Receivable
We perform ongoing credit evaluations of our customers, including reviews of their current credit information, and adjust credit limits based upon payment history and the customer's current credit worthiness. We continuously monitor collections and payments from customers and maintain a provision for estimated credit losses based upon the Company's historical experience and any specific customer collection issues that have been identified. However, the ultimate collectibility of a receivable is dependent upon the financial condition of an individual customer, which could change rapidly and without advance warning.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS 141 is effective for all business combinations completed after June 30, 2001. See Note 2 of our consolidated financial statements.
The Financial Accounting Standards Board has issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new standard, we will no longer be required or permitted to amortize goodwill or other intangible assets with indefinite lives reflected on the balance sheet. We will, however, be required to evaluate these items reflected on the balance sheet to determine whether they are impaired under the guidelines of the standard. Other intangible assets with definite lives will continue to be amortized over their estimated useful lives. We adopted SFAS No. 142 as of July 1, 2002. As a result of this adoption, the Company will recognize an impairment loss of approximately $7.0 million ($4.2 million net of tax) during the first quarter of fiscal 2003. This will be 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. The earnings per share impact of goodwill amortization during fiscal 2002 was $0.08 per share.
The Financial Accounting Standards Board has issued SFAS No. 143, "Asset Retirement Obligations" in June 2001. SFAS 143 provides guidance on accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated retirement costs. We adopted this statement in fiscal 2002, and it did not affect 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 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. We are in the process of evaluating the adoption of this standard, but do not believe it will have a material impact on our consolidated financial statements.
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. We are in the process of evaluating the adoption of this standard, but do not believe it will have a material impact on our consolidated financial statements.
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.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary exposure to market risk consists of changes in interest rates on borrowings. An increase in interest rates would adversely affect the operating results and the cash flow available to fund operations and expansion. Based on the average variable borrowings, a change of 25 basis points in the average variable borrowing rate would result in a change of approximately $0.4 million in annual interest expense. We continually monitor this risk and review the potential benefits of entering into hedging transactions, such as interest rate swap agreements, to mitigate the exposure to interest rate fluctuations. Our hedging arrangements at June 30, 2002 are described in Note 8 to our audited consolidated financial statements.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT
The Board of Directors D&K Healthcare Resources, Inc.:
We have audited the accompanying consolidated financial statements of D&K Healthcare Resources, Inc. and subsidiaries as of June 30, 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. In connection with our audit of the consolidated financial statements, we also have audited the financial statement schedule. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audit. The consolidated financial statements and the financial statement schedule of D&K Healthcare Resources, Inc. and subsidiaries as of June 30, 2001, and for each of the years in the two-year period then ended, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements and financial statement schedule, before the restatement described in Note 1 to the consolidated financial statements, in their report dated August 7, 2001.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of D&K Healthcare Resources, Inc. and subsidiaries as of June 30, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed above, the consolidated financial statements of D&K Healthcare Resources, Inc. and subsidiaries as of June 30, 2001, and for each of the years in the two-year period then ended, were audited by other auditors who have ceased operations. As described in Note 1, the Company declared a two-for-one stock split in the form of a stock dividend during the year ending June 30, 2002, and the amounts in the consolidated financial statements as of June 30, 2001, and for each of the years in the two-year period then ended, relating to all share and per share amounts have been restated to retroactively reflect this stock split. We audited the adjustments that were applied to restate the share and per share amounts reflected in the June 30, 2001 and 2000 consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the June 30, 2001 and 2000 consolidated financial statements of D&K Healthcare Resources, Inc. and subsidiaries other than with respect to such adjustments and, accordingly, do not express an opinion or any other form of assurance on the June 30, 2001 and 2000 consolidated financial statements taken as a whole.
/s/ KPMG LLP
St. Louis, Missouri August 7, 2002
THIS IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP. ALL SHARE AND PER SHARE AMOUNTS INCLUDED IN THE CONSOLIDATED FINANCIAL STATEMENTS FOR FISCAL 2001 AND 2000 HAVE BEEN ADJUSTED TO RETROACTIVELY REFLECT A TWO-FOR-ONE STOCK SPLIT IN THE FORM OF A STOCK DIVIDEND THAT OCCURRED IN FISCAL 2002.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To D&K Healthcare Resources, Inc.:
We have audited the accompanying consolidated balance sheets of D&K Healthcare Resources, Inc. (a Delaware corporation) and subsidiaries as of June 30, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of D&K Healthcare Resources, Inc. and subsidiaries as of June 30, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
St. Louis, Missouri August 7, 2001
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
Preferred stock has no par value; 1 million shares are authorized. At June 30, 2002 and 2001, no shares were issued or outstanding.
Common stock has a par value of $.01 per share; 25 million shares are authorized; 15,146,602 and 9,416,062 shares were issued at June 30, 2002 and 2001, respectively. At June 30, 2002, 14,553,802 shares were outstanding and 592,800 shares were held in treasury. At June 30, 2001, 8,823,262 shares were outstanding and 592,800 shares were held in treasury.
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these statements.
D&K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The consolidated financial statements include the accounts of all divisions and wholly-owned and majority-owned subsidiaries of D&K Healthcare Resources, Inc. (the Company). All significant intercompany accounts and transactions are eliminated.
Fiscal Year
The Company's fiscal year end is June 30. References to years relate to fiscal years rather than calendar years unless otherwise stated.
Concentration of Credit Risk
The Company is a full-service, regional wholesale drug distributor. From facilities in Missouri, Kentucky, Minnesota, South Dakota and Florida, the Company distributes a broad range of pharmaceutical products, health and beauty aids and related products to its customers in more than 24 states. The Company is focused on serving the unique needs of independent and regional pharmacies and have structured its business and operating model to be able to do this in an efficient and profitable manner.
In 2002, sales to one customer represented approximately 24% of total net sales. In 2001, sales to one customer represented approximately 16% of total net sales. In 2000, sales to one customer represented approximately 18% of total net sales. The supply contracts with two customers (including the Company's then largest customer), representing approximately 23% of fiscal 2000 sales, were terminated in the fourth quarter of fiscal 2000.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition
Revenue is recognized when products are shipped or services are provided to customers. Shipping and handling costs associated with the shipment of goods are recorded as operating expenses in the consolidated statements of operations.
During 2002, 2001 and 2000, the Company had $70.5 million, $85.1 million, and $46.8 million, respectively, of "dock-to-dock" sales, which are excluded from net sales due to the Company's policy of recording only the commission on such transactions as a reduction against cost of goods sold in the consolidated statements of operations. Dock-to-dock sales represent large volume sales of pharmaceuticals to major self-warehousing retail chain pharmacies whereby the Company acts as an intermediary in the order and subsequent delivery of products to the customers' warehouses.
Restricted Cash
Restricted cash of $11.8 million and $7.5 million, respectively, at June 30, 2002 and June 30, 2001, represents cash receipts from customers that must be used to reduce borrowings under the revolving line of credit and are included in cash.
Inventories
Inventories consist of pharmaceutical drugs and related over-the-counter items, which are stated at the lower of cost or market. Cost is determined using the first-in, first-out method.
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are charged to operations primarily using the straight-line method over the shorter of the estimated useful lives of the various classes of assets, which vary from 2 to 30 years, or the lease term for leasehold improvements. For income tax purposes, accelerated depreciation methods are used. Repairs and maintenance costs are expensed as incurred.
Intangible Assets
Intangible assets are stated at cost less accumulated amortization. Amortization is determined using the straight-line method over the estimated useful lives of the related assets.
Long-Lived Assets
If facts and circumstances suggest that a long-lived asset, including intangible assets, may be impaired, the carrying value is reviewed. If this review indicates that the carrying value of the asset will not be recovered, as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value. See Note 16 regarding implementation of SFAS No. 142.
Interest Rate Risk Management
Effective July 1, 2001, the Company adopted Statement of Financial Accounting Standard No. 133, "Accounting for Derivatives and Hedging Activities", as amended by SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities." Under these standards, all derivative instruments are recorded at fair value on the balance sheet and all changes in fair value are recorded to earnings or to stockholders' equity through other comprehensive income. The adoption of these standards did not have a material impact on the Company's consolidated financial statements taken as a whole. The Company does not use derivative instruments for trading or speculative purposes.
Income Taxes
Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective basis for income tax purposes. Deferred tax assets and liabilities are measured and recorded using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
Book Overdrafts
Accounts payable includes book overdrafts (outstanding checks) of $17.1 million and $10.6 million at June 30, 2002 and June 30, 2001, respectively.
Stockholders' Equity
Treasury Stock. In May 1999, the board of directors authorized the repurchase of up to 600,000 shares of the Company's outstanding common stock. The shares were acquired in the open market during the twelve-month period from the date of authorization. Of the 600,000 shares authorized, 592,800 shares were purchased during the program.
Equity Offering. On July 5, 2001, the Company completed a secondary offering of approximately 4.8 million shares of common stock with net proceeds of approximately $77 million.
Authorization of additional shares of Common Stock. In January 2002, the Board of Directors amended the Certificate of Incorporation of the Company to increase the number of authorized shares of Common Stock to 25 million shares.
Stock Split. On March 13, 2002, the Company declared a two-for-one stock split in the form of a stock dividend and distributed on April 11, 2002 to shareholders of record on March 29, 2002. All share and per share amounts included in the consolidated financial statements have been adjusted to retroactively reflect this stock split.
Earnings per Share
Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128) requires a dual presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. All share and per share amounts have been stated in accordance with the provisions of SFAS No. 128 (see Note 13).
NOTE 2. ACQUISITIONS:
In July 2001, as part of the secondary stock offering, the Company increased its ownership percentage in Pharmaceutical Buyers, Inc. (PBI) to 68% and in August 2001, our ownership percentage increased another 2%. The aggregate purchase price was $6.9 million. The value of the 400,000 shares issued was based on the initial price of the secondary stock offering for the first increase and the closing price of the stock for the second increase. These additions were accomplished with individuals converting PBI stock to shares of our common stock. This arrangement was part of the original transaction when we acquired our initial 50% ownership interest. This transaction was accounted for under the purchase method of accounting. Goodwill recognized in this transaction amounted to $10.7 million, but is not deductible for tax purposes. Intangible assets other than goodwill recognized in this transaction amounted to $1.9 million that have a weighted-average useful life of approximately 15 years.
On June 15, 2001, the Company acquired 100% of the outstanding stock of Diversified Healthcare, LLC, a pharmaceutical distribution company based in Owensboro, Kentucky, that provides comprehensive pharmaceutical distribution services to customers in the Midwest region. This transaction was accounted for under the purchase method of accounting. The purchase price for this acquisition was approximately $9.0 million, consisting of $7.5 million in cash and a $1.5 million 2-year note. Approximately $1.1 million of goodwill was recorded as part of this transaction, which will be amortized over 25 years. Results of operations were not significantly impacted during fiscal year 2001 as a result of this transaction.
NOTE 3. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following (in thousands):
Total depreciation and amortization relating to property and equipment was $2.1 million in 2002, $1.6 million in 2001, and $1.2 million in 2000. The Company leases certain properties under capital leases. Capital lease asset balances
consist of buildings of $1.3 million and $1.8 million as of June 30, 2002 and 2001, respectively. Related accumulated amortization amounted to approximately $358,000 and $345,000 respectively.
NOTE 4. INVESTMENT IN PBI:
In November 1995, the Company purchased approximately 50% of the capital stock of Pharmaceutical Buyers, Inc. ("PBI"), a Colorado-based group purchasing organization. Pursuant to the transaction, the Company acquired approximately 50% of the voting and non-voting common stock of PBI for $3.75 million in cash. The Company's investment in PBI was accounted for under the equity method until July 2001 at which time an additional 18% ownership interest was acquired and consolidated PBI for financial reporting purposes. See Note 2 for further discussion of the additional ownership.
The Company's equity in the net income of PBI totaled $607,000 and $634,000, respectively, for 2001 and 2000, which is net of amortization of goodwill associated with its investment in PBI of $276,000 for each of these years. The PBI goodwill was amortized using the straight-line method over a period of 25 years. During 2001 and 2000, the Company received cash dividends of $450,000 and $350,000 from PBI, which were recorded as a reduction in the carrying amount of the investment.
Summarized balance sheet information for PBI for its fiscal year ended December 31, 2001 and information for the periods ended June 30, 2002 and 2001 included (in millions) (June 30, 2002 amounts were included in the consolidated results of the Company):
Summarized income statement information for PBI for its fiscal year ended December 31, 2001 and information for the six months ended June 30, 2002, 2001 and 2000 included (in millions) (June 30, 2002 amounts were included in the consolidated results of the Company):
In connection with its investment in PBI, the Company entered into an agreement pursuant to which MassMutual is entitled to exchange its capital stock of PBI with the Company at fair market value. The Company has the right, and it is their intention, to satisfy this exchange with cash. If the Company elects not to satisfy the exchange with cash, the Company could satisfy the exchange with shares of its common stock, in which case MassMutual would have certain registration rights.
Certain other shareholders of PBI had the option to exchange their combined 20% ownership interests in PBI for shares of the Company's common stock under the terms of the original purchase agreement. Those options were determined to be dilutive in 2001 and 2000 and are included in the reconciliation of the basic and the diluted earnings per share computation (See Note 13). See Note 2 regarding the conversion of these interests into the Company's stock during fiscal 2002.
NOTE 5. INTANGIBLE ASSETS:
Intangible assets consisted of the following (in thousands):
The goodwill is being amortized using the straight-line method over periods of 5 to 40 years. Amortization of goodwill totaled $2.2 million in 2002, $1.9 million in 2001, and $1.8 million in 2000. Other intangible assets, which primarily represent valued placed on supplier and customer relationships, are being amortized using the straight-line method over periods of 5 to 15 years with an approximate weighted-average amortization period of 13.5 years. Amortization of intangible assets totaled $0.1 million in 2002 and is estimated to remain approximately the same for the next five years. Other intangible assets not subject to amortization total $0.2 million. Goodwill related to the Wholesale drug distribution segment, net of amortization, was $38.3 and $39.3 million as of June 30, 2002 and 2001, respectively. Goodwill related to the Company's other segments, which are combined for reporting purposes, amounted to $12.8 million and $2.7 million as of June 30, 2002 and 2001, respectively. Other intangible assets related to the Wholesale drug distribution segment, net of amortization, were $0.2 as of June 30, 2002. Other intangible assets related to the Company's other segments amounted to $1.7 million as of June 30, 2002. The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" effective July 1, 2002. See Note 16 for further discussion on the impact of the adoption of this statement.
NOTE 6. LONG-TERM DEBT:
Long-term debt consists of the following (in thousands):
As of June 30, 2002, the revolving line of credit had a maximum borrowing capacity of $150 million, expiring in August 2005. Under the loan agreement, the total amount of loans and letters of credit outstanding at any time may not exceed the lesser of an amount based on percentages of eligible inventories (the borrowing base formula), or our maximum borrowing capacity under this agreement but may not be less than $20 million. The advances currently bear interest at a base rate of the London Interbank Offering Rate (LIBOR) plus 1.75%, or at the prime rate plus 0.25% per annum payable monthly. The Company was required to pay annual facility fees of $807,000 and $521,323, respectively, in 2002 and 2001. At June 30, 2002 and June 30, 2001, the borrowing base formula amounted to $241.4 million and $132.2 million, respectively. At June 30, 2002 and June 30, 2001, the unused portion of the line of credit amounted to $71.3 million and $56.9 million, respectively. The agreement expires August 7, 2005, and, therefore, the related debt has been classified as long-term. The revolving line of credit is secured by eligible inventories. In July 2002, this agreement was amended to increase the maximum borrowing capacity to $200 million.
The Company is required under the terms of its debt agreements to comply with certain financial covenants, including those related to interest coverage ratios and cash flow to fixed charges ratios. The Company also is limited in its ability
to make loans and investments, enter into leases, or incur additional debt, among other things, without the consent of its lenders. The Company is in compliance with its debt covenants as of June 30, 2002.
In June 2000, the Company entered into a $965,000 equipment financing arrangement with a five-year term ending July 2005. The arrangement provides for monthly payments bearing interest at LIBOR plus 1.95%. This arrangement is secured by the equipment purchased with the proceeds.
At June 30, 2002, maturities of long-term debt, including capital lease obligations, were as follows (in thousands):
At June 30, 2002 and June 30, 2001, the fair value of long-term debt approximated its current carrying value.
NOTE 7. ACCOUNTS RECEIVABLE SECURITIZATION:
During 1999, the Company and its wholly-owned, bankruptcy-remote subsidiary ("Seller") established an accounts receivable securitization program. Under the program, undivided interests in a pool of eligible trade receivables that have been sold on a non-recourse basis by the Company to the Seller are then sold to a multi-seller, asset backed commercial paper conduit ("Conduit"). Purchases by the Conduit are financed with the sale of highly rated commercial paper. The Company utilizes proceeds from the sale of its accounts receivable to repay long-term debt, effectively reducing its overall borrowing costs. Funding costs under this program are 4.85% on the first $50 million with the rate on the excess amounts equal to the commercial paper rate. Certain program fees total an additional 0.75%. At June 30, 2002, the securitization program had a maximum capacity of $150 million which expires in August 2005. The funding cost of the securitization program for fiscal year 2002 and 2001 was $4.2 million and $6.0 million, respectively. In August 2002, this program was amended to increase the maximum capacity to $200 million.
Under the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," (as amended by SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities") the securitization transactions have been recorded as sales, with those accounts receivable sold to the Conduit removed from the consolidated balance sheet. The amount of undivided interests in accounts receivable sold to the Conduit were $120.0 and $110.0 million at June 30, 2002 and 2001, respectively.
The Seller is a separate legal entity from the Company. The Seller's assets are available first and foremost to satisfy the claims of its creditors. Eligible receivables, as defined in the securitization agreement, consist of trade receivables from our subsidiaries, excluding non-pharmaceutical receivables, reduced for certain items, including past due balances and concentration limits. Of the eligible pool of receivables contributed to the Seller, undivided interests in only a portion of the pool are sold to the Conduit. The Seller's interest in these receivables is subordinate to the Conduit's interest in the event of default under the securitization agreement. The portion of eligible receivables not sold to the Conduit remains an asset of the Seller ($31.7 million as of June 30, 2002).
NOTE 8. DERIVATIVE INSTRUMENTS:
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which was amended by SFAS No. 138, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", which was required to be adopted in years beginning after June 15, 2000. Accordingly, the Company adopted the provisions of this standard on July 1, 2000, resulting in an increase in stockholders' equity of approximately $69,000. At June 30, 2001, the Company had recorded short-term liabilities of approximately $90,000 and long-term liabilities of approximately $640,000 relating to derivative instruments. At June 30, 2002, the Company had recorded long-term liabilities of approximately $1,461,000 related to the interest rate swap.
Through an interest rate swap agreement, the Company effectively fixed the interest rate on $20 million of our revolving line of credit at a nominal rate of 6.19%. This interest rate derivative instrument has been designated as a cash flow hedge. Such instruments are those that effectively convert variable interest payments on debt instruments into fixed payments. For qualifying hedges, SFAS No. 133 and No. 138 allow derivative gains and losses to offset related results on hedged items in the consolidated statements of operations. The Company formally documents, designates and assesses the effectiveness of transactions that receive hedge accounting. Changes in the fair value of interest rate agreements designated as hedging instruments of the variability of cash flows associated with floating-rate debt obligations are reported in accumulated other comprehensive loss. During fiscal 2002 and 2001, approximately $531,000 (net of $347,000 of tax) and $356,000 (net of $227,000 of tax), was recorded as other comprehensive loss, respectively. No gain or loss representing the ineffectiveness of the cash flow hedge was recognized in other expense, as this derivative instrument represents a perfect hedge.
NOTE 9. COMMITMENTS AND CONTINGENCIES:
The Company leases office and warehouse space and other equipment through noncancelable operating leases. Rental expense under operating leases was $2.9 million, $2.3 million, and $1.9 million in 2002, 2001, and 2000, respectively. Minimum rental payments under these leases with initial or remaining terms of one year or more at June 30, 2002, are $11.9 million and payments during the succeeding five years are: 2003, $3.6 million; 2004, $2.6 million; 2005, $2.2 million; 2006, $2.1 million; 2007, $1.2 million; and thereafter $0.2 million.
In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk, such as bank letters of credit and other guarantees, which are not reflected in the accompanying balance sheets. Such financial instruments are to be valued based on the amount of exposure under the instrument and the likelihood of performance being required. In the Company's past experience, virtually no claims have been made against these financial instruments. Management does not expect any material losses to result from these off-balance-sheet instruments and, therefore, is of the opinion that the fair value of these instruments is zero.
There are various pending claims and lawsuits arising out of the normal course of the Company's business. In the opinion of management, the ultimate outcome of these claims and lawsuits will not have a material adverse effect on the financial position or results of operations of the Company.
NOTE 10. STOCK OPTIONS:
In 1992, the Company adopted a Long-Term Incentive Plan that authorized the Stock Option and Compensation Committee of the Board of Directors (the Committee) to grant key employees and officers of the Company incentive or non-qualified stock options, stock appreciation rights, performance shares, restricted shares and performance units. Options to purchase up to 400,000 shares of common stock were authorized under the Long-Term Incentive Plan. The Committee determines the price (which may not be less than fair market value on the date of grant) and terms at which awards may be granted, along with the duration of the restriction periods and performance targets. In 1999, the Company's shareholders approved an Amended and Restated Long-Term Incentive Plan (Long-Term Incentive Plan) that increased the number of shares available for grant to 1,700,000 shares. Stock options granted under the Long-Term Incentive Plan are not exercisable earlier than six months from the date of grant (except in the case of death or disability of the employee holding the same), nor later than ten years from the date of grant.
In February 1993, the Board of Directors of the Company adopted the D&K Wholesale Drug, Inc. 1993 Stock Option Plan (the 1993 Plan) to grant key employees of the Company non-qualified stock options to purchase up to 700,000 shares of the Company's common stock. The 1993 Plan is administered by the Company's Board of Directors, which determines the price and terms at which awards may be granted. Stock options granted under the 1993 Plan are immediately exercisable from the date of grant and expire not later than ten years from the date of grant. The exercise price of all options granted pursuant to the 1993 Plan was equal to the fair market value of stock on the respective dates of grant.
In November 2001, the Board of Directors adopted, and the Company's shareholders approved, the 2001 Long Term Incentive Plan (the 2001 Plan). Under the 2001 Plan, the Committee may grant to directors, officers and key employees of the Company up to an aggregate of 1,000,000 incentive or non-qualified stock options, stock appreciation rights, performance shares, restricted shares and performance units. The Committee determines the price of stock options
which may not be less than the fair market value on the date of grant. Stock options granted under the 2001 Plan vest over a three year period from the date of grant, and may be exercised no later than five years from the date of grant.
The following tables summarize information about options at June 30, 2002:
Changes in options outstanding under the Company's stock option plans are as follows:
Stock options exercisable at June 30, 2002, June 30, 2001, and June 30, 2000 were 874,773, 857,396, and 498,396, respectively, with a weighted average exercise price of $11.95, $5.18, and $3.71, respectively. Shares available to be granted at June 30, 2002, June 30, 2001, and June 30, 2000 were 841,000, 212,138, and 564,938, respectively.
In accordance with the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company has elected to account for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation expense has been recognized in the consolidated financial statements for the stock option plans. If the Company had elected to recognize compensation expense based upon the fair value of the options granted at the grant date as prescribed by SFAS 123, pro forma net income and earnings per share would have been as follows (in thousands, except per share data):
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model using the following weighted-average assumptions:
NOTE 11. INCOME TAXES:
The components of the income tax provision were as follows (in thousands):
The actual income tax provision differs from the expected income tax provision, computed by applying the U.S. statutory Federal tax rates of 35.0%, 34.3%, and 34.1% in 2002, 2001 and 2000, respectively, to income before income tax provision, as follows (in thousands):
At June 30, 2002 and June 30, 2001, the tax effects of temporary differences that give rise to significant portions of the Company's deferred tax assets and liabilities are as follows (in thousands):
The use of pre-acquisition operating losses is subject to limitations imposed by the Internal Revenue Code or individual states and if not utilized by the Company, the net operating loss carryforwards will expire beginning in 2007. The Company believes that the net deferred tax assets are fully recoverable.
NOTE 12. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution 401(k) plan covering substantially all of its employees. Plan participants may contribute up to 20% of their annual compensation, subject to certain limitations. The Company contribution is discretionary and was equivalent to 50% of employees' contributions up to a maximum contribution based on 6% of eligible compensation. Expenses related to the plan were $260,000 in 2002, $234,000 in 2001, and $176,000 in 2000. Jewett Drug Company (Jewett) has a defined contribution 401(k)/profit sharing plan covering substantially all of its employees. Jewett made a discretionary contribution of $100,000 to this plan in 2002 and 2001. Jewett also participates in the Central States Pension, a multi-employer pension plan, on behalf of its union employees in accordance with the union agreement. The expenses relating to this plan during 2002 and 2001 were approximately $21,000 and 23,000, respectively.
The Company also has an executive retirement benefit plan, implemented in 1998, that provides supplemental pre-retirement life insurance plus supplemental retirement income to key executives. The life insurance benefit is calculated at three times the participant's annual salary. The retirement income benefit is provided through discretionary contributions to each participant's account, which vest 20% annually and are fully vested upon attaining age 65. Upon retirement, the accumulated account balance is paid to the participant over 15 years in quarterly benefit payments. The Company's expense related to the plan was $75,000 in 2002, $241,000 in 2001, and $213,000 in 2000. In July 2002, this plan was terminated with participants receiving their vested retirement income benefit balance in the plan. There was no income statement impact as a result of this termination. The life insurance benefit will continue for each participant.
NOTE 13. EARNINGS PER SHARE:
SFAS No. 128, "Earnings Per Share", requires dual presentation of basic and diluted earnings per share and requires reconciliation of the numerators and denominators of the basic and diluted earnings per share calculation. The reconciliation of the numerator and denominator of the basic and diluted earnings per common share computations are as follows (in thousands, except for shares and per share amounts):
NOTE 14. EFFECT OF NEW ACCOUNTING STANDARDS:
The Financial Accounting Standards Board has issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS 141 is effective for all business combinations completed after June 30, 2001. See Note 2 of our consolidated financial statements.
The Financial Accounting Standards Board has issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new standard, we will no longer be required or permitted to amortize goodwill or other intangible assets with indefinite lives reflected on the balance sheet. We will, however, be required to evaluate these items reflected on the balance sheet to determine whether they are impaired under the guidelines of the standard. Other intangible assets with definite lives will continue to be amortized over their estimated useful lives. We adopted SFAS No. 142 as of July 1, 2002. The impact of this adoption is explained in Note 16 of our consolidated financial statements.
The Financial Accounting Standards Board has issued SFAS No. 143, "Asset Retirement Obligations" in June 2001. SFAS 143 provides guidance on accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated retirement costs. We adopted this statement in fiscal 2002, and it did not affect 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 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. We are in the process of evaluating the adoption of this standard, but do not believe it will have a material impact on our consolidated financial statements.
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. We are in the process of evaluating the adoption of this standard, but do not believe it will have a material impact on our consolidated financial statements.
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.
NOTE 15. BUSINESS SEGMENTS:
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", establishes standards for the way public companies report information about operating segments that is consistent with that made available to management of the Company in allocating resources and assessing performance.
After application of the aggregation criteria, 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. This segment is described in Note 1. The Company's ownership of PBI (see Note 4) is a second segment. Two wholly-owned software subsidiaries; Viking Computer Services, Inc. and Tykon, 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 segments are combined as Other in the table that follows.
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. During fiscal 2002, approximately 92% of net sales were branded pharmaceuticals, 6% were generic pharmaceuticals, and 2% were various health and beauty products. The Company operates principally in the United States. Intersegment sales have been recorded at amounts approximating market. Interest and corporate expenses are allocated to wholly-owned subsidiaries only. Assets have been identified with the segment to which they relate.
(1) Amortization of PBI goodwill is netted against Equity in net income of PBI in the accompanying Consolidated Statements of Operations in 2001 and 2000. (2) Amounts represent assets at Corporate Headquarters consisting primarily of deferred tax assets, property and equipment and deferred debt costs.
NOTE 16. SUBSEQUENT EVENT:
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" effective July 1, 2002. As a result of this adoption, the Company will recognize an impairment loss of approximately $7.0 million ($4.2 million net of tax) during the first quarter of fiscal 2003. This will be 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. The earnings per share impact of goodwill amortization during fiscal 2002 was $0.08 per share.
NOTE 17. QUARTERLY RESULTS (UNAUDITED)
Quarterly results are determined in accordance with annual accounting policies. They include certain items based upon estimates for the entire year. Summarized quarterly results for the last two years were as follows:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Effective June 11, 2002, the Board of Directors of the Registrant, upon recommendation of its audit committee, dismissed Arthur Andersen LLP ("Andersen") as the Registrant's independent public accountants and engaged KPMG LLP ("KPMG") to serve as the principal accountant to audit the Registrant's financial statements for the fiscal year ending June 30, 2002. Andersen audited the Registrant's financial statements for fiscal years 1999, 2000 and 2001, and served as the Registrant's principal accountant since 1989.
In connection with its audit for fiscal years 2000 and 2001, and during the subsequent interim period preceding the engagement of KPMG, there were no disagreements with Andersen on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. Andersen's report on the financial statements for fiscal years 2000 and 2001 did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. During the last two fiscal years, and during the subsequent interim period preceding the engagement of KPMG, Andersen did not advise, and has not indicated to the Registrant that it had reason to advise, the Registrant of any reportable event, as defined in Item 304(a) of Regulation S-K of the Exchange Act. The Registrant requested that Andersen furnish it with a letter addressed to the Securities and Exchange Commission stating whether or not it agrees with the statements made in the Form 8-K filed on June 11, 2002. A copy of the letter from Andersen dated June 11, 2002, stating its agreement with the foregoing disclosures is filed as Exhibit 16.1 to the Form 8-K filed on June 11, 2002.
During the last two fiscal years, and during the subsequent interim period preceding the engagement of KPMG, the Registrant had not consulted KPMG regarding the application of accounting principles to a specified transaction, either contemplated or proposed, or the type of audit opinion that might be rendered on the Registrant's financial statements or any other matter that would be required to be reported.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information set forth under the captions "Election of Directors" in the registrant's Proxy Statement for its 2002 Annual Meeting of Stockholders (the "2002 Proxy Statement") is incorporated herein by this reference. The Company will file the 2002 Proxy Statement with the Commission pursuant to Regulation 14A within 120 days after the close of the fiscal year. Information regarding executive officers is set forth in Part I of this report.
Item 11.
Item 11. Executive Compensation
The information set forth under the captions "Directors' Fees" and "Compensation of Executive Officers" in the registrant's 2002 Proxy Statement to be filed with the SEC pursuant to Regulation 14A of the Exchange Act is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the captions "Voting Securities and Principal Holders Thereof" and "Security Ownership By Management" in the registrant's 2002 Proxy Statement to be filed with the SEC pursuant to Regulation 14A of the Exchange Act is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information set forth under the caption "Certain Transactions" in the registrant's 2002 Proxy Statement to be filed with the SEC pursuant to Regulation 14A of the Exchange Act is incorporated herein by this reference.
Item 14.
Item 14. Controls and Procedures
The registrant does not need to comply with the requirements of this item until their first quarter filing for fiscal 2003, which will be their first report for a period ending on or after August 29, 2002.
Item 15.
Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a)(1) Financial statements: See Item 8 above.
(2) The following financial statement schedule and auditors' report thereon are included in Part IV of this report: Page ---- Schedule II - Valuation and Qualifying Accounts 41
Schedules other than those listed above have been omitted because they are either not required or not applicable, or because the information is presented in the consolidated financial statements or the notes thereto.
(3) Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K
On June 11, 2002, the registrant filed a Current Report on Form 8-K under Item 4 that announced the change in auditors for the fiscal year ending June 30, 2002.
On June 27, 2002, the registrant filed a Current Report on Form 8-K under Item 4 that announced the change in auditors for its 401-k Profit Sharing Plan and Trust for the year ending December 31, 2001.
(c) See Item 15(a)(3) above.
(d) See Item 15(a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
D & K HEALTHCARE RESOURCES, INC. (Registrant)
By /s/ J. Hord Armstrong, III -------------------------- J. Hord Armstrong, III, Chairman of the Board, Chief Executive Officer and Treasurer Date: September 24, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CERTIFICATIONS
I, J. Hord Armstrong, III, certify that:
1. I have reviewed this annual report on Form 10-K of D&K Healthcare Resources, Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: September 24, 2002
/s/ J. Hord Armstrong, III -------------------------- J. Hord Armstrong, III Chairman & Chief Executive Officer
I, Thomas S. Hilton, certify that:
1. I have reviewed this annual report on Form 10-K of D&K Healthcare Resources, Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: September 24, 2002
/s/ Thomas S. Hilton -------------------- Thomas S. Hilton Senior Vice President & Chief Financial Officer
D & K HEALTHCARE RESOURCES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR FISCAL 2000, FISCAL 2001, AND FISCAL 2002
EXHIBIT INDEX
Exhibit No. Description
2.1* Stock Purchase and Redemption Agreement, dated as of November 30, 1995, by and among Pharmaceutical Buyers, Inc., J. David McCay, The J. David McCay Living Trust, Robert E. Korenblat and the registrant filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended March 28, 1997.
2.2* Stock Purchase Agreement dated June 1, 1999 by and between the registrant and Harvey C. Jewett, IV, filed as an exhibit to Form 8-K dated June 14, 1999.
3.1* Restated Certificate of Incorporation, filed as an exhibit to registrant's Registration Statement on Form S-1 (Reg. No. 33-48730).
3.2* Certificate of Amendment to the Restated Certificate of Incorporation of D&K Wholesale Drug, Inc filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1998.
3.3* Certificate of Designations for Series B Junior Participating Preferred Stock of D&K Healthcare Resources, Inc. filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001.
3.4* By-laws of the registrant, as currently in effect, filed as an exhibit to registrant's Registration Statement on Form S-1 (Reg. No. 33-48730).
3.5* Certificate of Amendment of Certificate of Incorporation of D&K Healthcare Resources, Inc., dated March 13, 2002, filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002
4.1* Form of certificate for Common Stock, filed as an exhibit to registrant's Registration Statement on Form S-1 (Reg. No. 33-48730).
4.2* Form of Rights Agreement dated as of November 12, 1998 between registrant and Harris Trust and Savings Bank as Rights Agent, which includes as Exhibit B the form of Right Certificate, filed as an exhibit to Form 8-K dated November 17, 1998.
10.1* D & K Healthcare Resources, Inc., Amended and Restated 1992 Long Term Incentive Plan, filed as Annex A to the registrant's 1999 Proxy Statement.
10.2* D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan and Trust, dated January 1, 1995, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended March 29, 1996.
10.2a* Amendment Number 1 to D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan and Trust, dated December 20, 1996, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.2b* Amendment Number 2 to D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan and Trust, dated September 17, 1997, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.2c* Resolution to D & K Wholesale Drug, Inc. 401(k) Profit Sharing Plan and Trust, dated March 27, 2000, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
EXHIBIT INDEX
Exhibit No. Description
10.3* Amended and Restated Lease Agreement, dated as of January 16, 1996, by and between Morhaert Development, L.L.C. and the registrant, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended March 29, 1996.
10.4* Purchase and Sale Agreement dated as of August 7, 1998 between registrant, certain of its subsidiaries and D&K Receivables Corporation, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1998.
10.5* Fifth Amended and Restated Loan and Security Agreement dated September 30, 2000, by and among Fleet Capital Corporation, the registrant, Jaron Inc., and Jewett Drug Co., filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000.
10.5a* First Amendment to Fifth Amended and Restated Loan and Security Agreement, dated as of March 7, 2001, by and among Fleet Capital Corporation, the registrant, Jaron, Inc, and Jewett Drug Co., filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001.
10.5b* Third Amendment to Fifth Amended and Restated Loan and Security Agreement, dated as of June 12,2001, by and among Fleet Capital Corporation, the registrant, Jaron, Inc., and Jewett Drug Co, filed as an exhibit to the registrant's Current Report on Form 8-K dated June 14, 2001.
10.5c** Ninth Amendment to Fifth Amended and Restated Loan and Security Agreement, dated July 9, 2002, by and among Fleet Capital Corporation, the registrant, Jaron, Inc., and Jewett Drug Co, Diversified Healthcare, LLC, and Medical and Vaccine Products, Inc.
10.6* Amended and Restated Receivables Purchase Agreement, dated June 8, 2001, by and among D&K Receivables Corporation, the registrant, Blue Keel Funding, LLC, Market Street Funding Corporation, PNC Bank, N.A. and Fleet National Bank, filed as an exhibit to the registrant's Current Report on Form 8-K dated June 14, 2001.
10.6a** Third Amendment to the Amended and Restated Receivables Purchase Agreement, dated August 9, 2002, by and among D&K Receivables Corporation, the registrant, Blue Keel Funding, LLC, Market Street Funding Corporation, Fifth Third Bank, Indiana, PNC Bank, N.A. , Fifth Third Bank, and Fleet National Bank.
10.7* Prime Vendor Agreement dated as of August 25, 1999, between Tennessee Pharmacy Purchasing Alliance and the registrant, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
10.7a* First Amendment to Prime Vendor Agreement dated effective as of April 1, 2001 between The Pharmacy Cooperative formerly known as Tennessee Pharmacy Purchasing Alliance and the registrant filed as an exhibit to the registrant's Registration Statement, Amendment No. 2 to Form S-3 dated June 27, 2001.
10.8* Lease Agreement, dated as of May 18, 1999, by and between BSRT Lexington Trust and the registrant, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
10.9* Lease Agreement, dated as of January 1, 1997, by and between Jewett Family Investments, LLC and Jewett Drug Co, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
EXHIBIT INDEX
Exhibit No. Description
10.10* First Amendment to Lease, dated as of June 1, 1999, by and between Jewett Family Investments, LLC and Jewett Drug Co, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
10.11* Lease Agreement dated as of July 1, 1997 by and between Jewett Family Investments, LLC and the registrant, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
10.12* First Amendment to Lease, dated as of June 1, 1999, by and between Jewett Family Investments, LLC and Jewett Drug Co, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 1999.
10.13* Employment agreement for J. Hord Armstrong, III dated September 15, 2000, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.14* Employment agreement for Martin D. Wilson dated August 28, 2000, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.15* Employment agreement for Thomas S. Hilton dated August 31, 2000, filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.16* D&K Healthcare Resources, Inc. Executive Retirement Benefit Plan, dated January 1, 1998. filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended June 30, 2000.
10.17* D & K Healthcare Resources, Inc. 2001 Long Term Incentive Plan, dated November, 2001, filed as an exhibit to the registrant's 2001 Proxy Statement.
10.18** Lease Agreement dated as of October 10, 2001 by and between Forsyth Centre Associates, L.L.C., and the registrant.
10.18a** Amendment to Lease Agreement dated February 26, 2002 by and between Forsyth Centre Associates, L.L.C., and the registrant.
10.19* Lease Agreement, dated February 7, 2001, by and between Industrial Property Fund III, L.P. and the registrant, filed as an exhibit to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001.
13** Registrant's 2002 Annual Report to Stockholders.
21** Subsidiaries of the registrant.
23.1** Consent of KPMG LLP.
23.2** Consent of Arthur Andersen LLP
* Incorporated by reference. ** Filed herewith. *** Incorporated by reference. Confidential portion omitted and filed separately with the Commission.