Item 1. Business - ------ --------
OVERVIEW
The Company is the leading publicly held regional wholesale distributor of pharmaceutical and related healthcare and beauty aid products in the United States. It serves retail and institutional customers in 24 states primarily in the Midwest and South. The Company also offers a variety of value-added services to its customers, particularly in the areas of cost containment and inventory management. The Company had net sales of $1.5 billion in fiscal 2000, of which 37% were to independent pharmacies, 34% were to retail chains, including national pharmacy chains and the pharmacy departments of supermarkets and mass merchandisers, and 29% were to healthcare institutions, including hospitals, alternate site care facilities, pharmacy benefit management companies and managed care organizations. The Company operates from highly efficient and cost effective distribution facilities in Cape Girardeau, Missouri; a new facility in Lexington, Kentucky; Minneapolis, Minnesota; Aberdeen, South Dakota; and a new distribution center in Davie, Florida.
On June 1, 1999, the Company acquired 100% of the outstanding stock of Jewett Drug Company, Inc., a pharmaceutical distribution company based in Aberdeen, South Dakota that provides comprehensive pharmaceutical distribution services to customers in the Upper Midwest and Great Plains region. The aggregate purchase price for this acquisition of $34.3 million consisted of $21.5 million in cash and $12.8 million (555,556 shares) of the Company's common stock.
Since its formation in 1987, the Company has expanded the scope and breadth of its business by consistently providing the highest levels of service to its customers and suppliers. The Company achieves such high levels of service by (i) providing its customers with a full continuum of products, value-added services and support, which enable its customers to compete more effectively; (ii) focusing on flexibility, which allows the Company to respond quickly to change and to customize systems to meet its customers' and suppliers' requirements; (iii) strategically locating the Company's distribution centers and satellite transfer depots throughout the Midwest and the South, which enables the Company to ship products to and service its customers promptly and efficiently; and (iv) attracting and motivating experienced and entrepreneurial management personnel, who continually seek to improve and expand the Company's business.
The management of the Company is focused on continuing its growth through means that stress: (i) aggressive growth of profitable sales to existing and new customers; (ii) use of practical cutting-edge technology leading to increased market share for customers and suppliers; and (iii) empowering its employees to share innovative ideas with customers and suppliers.
The Company believes that its regional-market focus and high level of customer service provide it with competitive advantages and position it to benefit from trends impacting the industry. Management believes that the increasing size of the wholesale pharmaceutical industry's larger national participants hampers the ability of these companies to deliver customized services to most of their customers. The Company has successfully differentiated itself from its national competitors through its ability to provide flexible and customized services to its targeted customer segments. The Company has demonstrated its ability to work with customers to eliminate inefficiency from the supply chain. In addition, healthcare providers' need for value-added services which help contain costs and effectively manage inventory has given the Company the opportunity to capitalize on its cost competitiveness and advanced systems. The location and quality of the Company's distribution facilities and satellite transfer depots in the Midwest and South allow the Company to service its customers' and suppliers' needs promptly and efficiently. The Company has capitalized on the increased demand for alternate care providers through its investment in Pharmaceutical Buyers, Inc. ("PBI") in fiscal 1996. PBI is one of the nation's leading alternate site group purchasing organizations, and the Company's investment in PBI provides it with access to a higher margin business segment and insight into alternate site distribution.
The wholesale pharmaceutical distribution industry has experienced rapid sales growth over the past 14 years, increasing from approximately $14.0 billion in sales in 1985 to more than $94.8 billion in 1999. The Company believes that there are several major trends currently affecting the industry, including: (i) continued consolidation of national and regional wholesale drug distribution companies; (ii) an increasing emphasis on value-added services that lower healthcare providers' administrative and other costs associated with medical supply management; (iii) the growing importance of an efficient
distribution model as customers become more cost conscious; (iv) a shift in the delivery of healthcare services from acute care settings to alternate sites, including physician offices and extended care facilities, (v) the aging population; (vi) the increase in research and development spending by pharmaceutical manufacturers; and (vii) an increase in direct-to-consumer advertising are all positively impacting pharmaceutical demand. In addition, there has been much discussion regarding federal legislative proposals that would offer outpatient prescription drug benefits to senior citizens under Medicare or other programs. It is impossible to determine the outcome of these proposals and what impact they would have on the wholesale drug industry.
PRODUCTS, SERVICES AND VALUE ADDED MARKETING SYSTEMS
The Company's product line consists of more than 25,000 SKUs (stock keeping units), including branded pharmaceuticals, multi-source generics, private label products, repackaged pharmaceutical products and over-the- counter health and beauty aids. The Company sells branded pharmaceuticals (approximately 87% of net sales in fiscal 2000), generic pharmaceuticals (approximately 7% of net sales in fiscal 2000) and over-the-counter health and beauty aids (approximately 6% of net sales in fiscal 2000). In addition, through its Tykon, Inc. subsidiary (acquired September 1998), the Company develops and markets a proprietary PC based order entry/order confirmation system to the drug distribution industry.
During fiscal 2000, the Company formed an alliance with CornerDrugstore.com, an internet service company that allows pharmacies to offer their customers online information and ordering capabilities, while keeping sales in their respective stores. A pharmacy that subscribes to CornerDrugstore.com can offer consumers a full menu of services over the internet, including electronic ordering of prescriptions and over-the-counter products, drug interaction checks, disease information, e-mail refill reminders and internet links to other local healthcare resources. The Company will supply the pharmacy with replacement inventory for purchases made through this service and can also offer the pharmacy the ability to offer a wider range of products to the consumer without having to keep a large stock on hand. The Company has also made a minor investment in CornerDrugstore.com.
The Company strives to offer services that enhance the operating efficiencies of its customers and assist them in competing effectively. Principal elements in the Company's service offerings to its customers include: (i) RESOURCE(SM), a proprietary PC based order entry/order confirmation system that completely automates all order creation, transmission and confirmation operations; (ii) PARTNERS(SM), a fully automated and customizable replenishment software system which helps pharmacies more efficiently coordinate product supply and demand; (iii) RESOURCE HQ(SM), a contract management and reporting software system designed for group purchasing and managed care organizations, and retail chains which automates functions relating to corporate and group contracts; and (iv) SCRIPTMASTER(R), a pharmacy management software system that provides prescription management functions, drug and allergy checks, instantaneous connections to hundreds of third party insurance plans, "just in time" inventory management, automated accounts receivable, quick pay program monitoring and central office functions.
The Company offers a broad range of merchandising and marketing services to its independent pharmacy customers under its MedPlus(R) identity program. Under this program, the Company plans and coordinates cooperative advertising programs and provides for the availability of various promotional products, including a single-source supply for generics at highly competitive prices from leading pharmaceutical manufacturers. The Company also offers 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, planogramming, 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.
CUSTOMERS AND MARKETS
The Company's diverse customer base consists of independent pharmacies, retail chains and healthcare institutions. Independent pharmacies generally are community-based pharmacies, which the Company believes benefit the most from the Company's sales and value added services. Retail chains, a fast growing segment of the market, include national pharmacy chains and the pharmacy departments of supermarkets and mass merchandisers. Healthcare institutions, which currently
comprise the largest segment of the market, consist of hospitals, nursing homes, clinics and other alternate site care facilities, home health agencies, HMOs and pharmacy benefit management companies.
The number of independent pharmacies has stabilized since the drop experienced in 1997. In addition, the Company has worked with entrepreneurs to open new independent community pharmacies. This could present additional opportunities as the Company is well positioned to respond to the needs of new pharmacies requiring a flexible, innovative trading partner.
The Company believes that diversifying its sales across the various market segments enables it to capture greater market share in the geographic areas it serves and better serve the faster growing segments of the healthcare markets. The following table sets forth the Company's sales mix by customer segment:
The Company's senior management is actively involved in identifying and developing opportunities to expand the Company's business with customers in each of these market segments, including the preparation of proposals which highlight customer benefits of the Company's cost competitiveness, advanced systems and value added services. During fiscal 1998, fiscal 1999 and fiscal 2000, the Company's 10 largest customers accounted for approximately 37.1%, 52.8% and 55.1%, respectively, of the Company's net sales. The Company's largest customer during fiscal 2000 was Tel-Drug which accounted for approximately 18% of the Company's net sales. The Company's largest customer during fiscal 1999 and 1998 was Anthem Prescription Management, Inc. which accounted for approximately 12% and 13% of the Company's net sales during those periods, respectively.
SALES AND MARKETING
The Company employs sales representatives and customer service representatives at each of its distribution centers. In addition to base salary, the Company's sales personnel receive incentive compensation based upon increases in the Company's market share and market penetration. D&K's corporate vice presidents of business development work closely with each business unit to develop sales goals. The Company's sales program includes regular training to improve customer service and to provide its sales and customer service representatives with the skills and resources necessary to increase business with existing customers and establish new customer relationships. The Company also maintains a telephone service department staffed with trained personnel who work with customers to answer questions and solve problems.
The Company's marketing efforts are focused on developing new primary relationships with its customers. The Company emphasizes frequent personal interaction of its sales force with customers so that the customer comes to rely on the Company's dependability, responsiveness, accuracy of order filling and breadth of product line. Retail customers also rely on the Company's sales force for consulting services on advertising, merchandising, stocking and inventory management.
The Company believes that its customer service department is a key element in its marketing program which differentiates it from its national competitors. The decentralized customer service staff emphasizes rapid response to customer inquiries and efficient order placement.
OPERATIONS
The Company is structured as an organization of locally managed drug wholesale distribution centers. Each distribution center has an executive, sales and operations staff with management compensation at each center determined by its operating results. These operations utilize the Company's corporate staff for procurement, marketing, financial, legal and executive management resources and corporate coordination of assets and working capital management. The Company's decentralized sales and distribution network, combined with its centralized procurement and corporate support staff structure, enable the Company to provide high levels of specialized customer service while minimizing administrative expenses and maximizing volume discounts for product purchases.
The Company's distribution centers maintain computer systems and sophisticated materials handling equipment for receiving, storing and distributing large quantities and varieties of products. The Company continuously seeks to improve its warehouse automation technologies to maximize operational efficiencies on a cost-effective basis. The Company developed state-of-the-art radio frequency (RF) and receiving procedures and barcoding and scanning technologies at one of its distribution centers which significantly improved accuracy, efficiency and productivity at that center. The Company subsequently exported this technology to its other distribution centers and has developed RF order verification, vendor returns and customer returns systems.
The Company receives virtually 100% of its orders electronically and, upon receipt of the customer's order at a distribution center, the Company's 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 market 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 the Company's distribution centers are available and shipped by the Company within 24 hours after the orders are placed by customers. Orders are delivered to customers by the Company's fleet of trucks and vans or by contract carriers.
PURCHASING AND INVENTORY CONTROL
The Company utilizes sophisticated inventory-control and purchasing software. The software perpetually tracks the Company's inventory, analyzes demand history and projects future demand. The Company's system is designed to enhance profit margins by eliminating the manual ordering process, allowing for automatic inventory replenishment and identifying inventory buying opportunities. The system also improves the Company's fill rate and enhances inventory management and control.
The Company purchases products from approximately 1,000 manufacturers for the wholesale purchase of pharmaceuticals and other products. The Company initiates purchase orders with manufacturers through its information systems. During fiscal 1999 and fiscal 2000, the Company's 10 largest suppliers accounted for approximately 47% and 52%, respectively, of the Company's purchases by dollar volume. Historically, the Company has not experienced difficulty in purchasing desired products from suppliers. The majority of contracts with suppliers are terminable by either party upon short notice and without penalty. The Company believes that its relationships with its suppliers are good.
MANAGEMENT INFORMATION SYSTEMS
Each of the Company's distribution centers operates as a distinct business with complete systems functionality: order processing, inventory management, accounts receivable, accounts payable, general ledger, master file maintenance, external and internal reporting. Historically, the Company has operated in a distributed data processing environment. Each distribution center maintained its own AS/400 system and I.S. staff to support that function. Over the past year, the Company has consolidated all systems into two major data centers: St. Louis and Cape Girardeau. St. Louis will operate the production environment while Cape Girardeau will function as a "hot site" backup to the production environment. Each of the divisions is connected to the central systems by a frame relay network. Each distribution center and the corporate offices will continue to house a local area network (LAN) and multiple PCs. A high-speed data network connects the Company's computer systems and information is transmitted between locations on a regular basis.
In March 2000, the Company selected the JD Edwards OneWorld product as its new Enterprise Resource Planning (ERP) package. The OneWorld 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. The new system will provide the Company with improved financial reporting systems and enhanced e-business capabilities. Implementation began in July 2000.
COMPETITION
The wholesale distribution of pharmaceuticals, health and beauty aids, and other healthcare products is highly competitive, with national and regional distributors competing primarily on the basis of service and price. Other competitive factors include delivery service, credit terms, breadth of product line, customer support, merchandising and marketing programs. The Company competes with large, national distributors such as McKesson HBOC, Inc., Bergen Brunswig Corporation, Cardinal Health, Inc., Bindley-Western Industries, Inc. and AmeriSource Health Corporation, as well as with local and regional wholesalers, manufacturers and generic pharmaceutical telemarketers and specialty distributors. The Company also competes with other wholesale distributors for purchases of products and financial support in the form of trade credit from manufacturers. Certain of the Company's competitors have significantly greater financial and marketing resources than the Company.
EMPLOYEES
As of August 31, 2000, the Company employed 354 persons, 313 of whom were full-time employees. Approximately 25 of the Company's employees at its 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 18 of the Company's employees at its 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 June 2000, the National Labor Relations Board certified the United Steelworkers of America as the collective bargaining representative for approximately 39 of the Company's employees at its Cape Girardeau, Missouri distribution center. The Company believes that its 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 generally having the right to terminate their contracts with the Company or reduce purchasing levels on relatively short notice without penalty, 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, the continued availability of investment buying 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, which 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 - ------ ----------
The Company conducts its business from a total of nine office, warehouse and satellite depot facilities. The Company's primary operating facilities include:
The Company also maintains warehouse and satellite depot facilities in Missouri, Tennessee, and Kentucky that enable it to efficiently distribute product on a timely basis.
The Company believes its facilities are adequate to support its present business plans.
Item 3.
Item 3. Legal Proceedings - ------ -----------------
No material legal proceedings are pending against the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders - ------- ---------------------------------------------------
The Company did not submit any matters to a vote of its security holders during the quarter ended June 30, 2000.
Item 4A. Executive Officers of the Registrant - ------- ------------------------------------
The name, age and position of each of the executive officers of the Company are set forth below.
J. Hord Armstrong, III, 59, has served as the Chairman of the Board, Chief Executive Officer and Treasurer and as a director of the Company since December 1987. Prior to joining the Company, 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 and as a member of the Board of Directors of Jones Pharma, Inc.
Martin D. Wilson, 39, has served as President and Chief Operating Officer of the Company since January 1996, as Secretary since August 1993 and as a director since 1997. Mr. Wilson previously served as Executive Vice President, Finance and Administration of the Company from May 1995 to January 1996, as Vice President, Finance and Administration of the Company from April 1991 to May 1995 and as Controller of the Company from March 1988 to April 1991. Prior to joining the Company, Mr. Wilson, a certified public accountant, was associated with KPMG Peat Marwick, a public accounting firm.
Thomas S. Hilton, 48, has served as Senior Vice President and Chief Financial Officer of the Company since January 1999. Between May 1980 and June 1998, Mr. Hilton was employed by the Peabody Group 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, 50, has served as Vice President, General Counsel and Secretary of the Company 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, 44, has served as 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 the 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.
James D. Largent, 62, has served as Vice President - Business Development of the Company since July 1999. Mr. Largent joined Delta Wholesale Drug, Inc. in March 1968, which was acquired by the Company in December 1987. Mr. Largent has served in a variety of management positions with the Company including Vice President and General Manager of the Cape Girardeau distribution center from May 1995 to July 1999.
Lewis E. Mead, 50, has served as Vice President - Business Development of the Company since July 1999. Mr. Mead previously served as Vice President and General Manager of the Lexington distribution center from February 1996 to July 1999. From May 1992 to February 1996, Mr. Mead served in various sales management positions with FoxMeyer Drug Company, which was a national wholesale drug distributor.
James A. Cordes, 52, has served as Vice President - Professional Trade Services of the Company since January 2000. Between January 1991 and December 1999, Mr. Cordes was Director of Professional Services for Schnuck Markets, Inc., a regional supermarket chain.
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 inside back cover of the registrant's 2000 Annual Report to Stockholders is incorporated herein by this reference.
Item 6.
Item 6. Selected Financial Data - ------ -----------------------
The information set forth under the caption "Financial Highlights" on page 1 of the registrant's 2000 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 "2000," "1999," and "1998" shall mean the Company's fiscal years ended June 30, 2000, June 30, 1999, and June 30, 1998, respectively. The Company has given retroactive effect to the change in accounting for determining the cost of its inventory from the last-in, first-out method to the first-in, first-out method. Accordingly, previously reported figures have been restated to account for this change. See Note 3 of "Notes to Consolidated Financial Statements."
FISCAL YEAR ENDED JUNE 30, 2000, COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
NET SALES. Net sales increased $642.7 million, or 78.8%, for the fiscal year ended June 30, 2000, compared with the fiscal year ended June 30, 1999. Sales were significantly impacted by the inclusion of the Company's acquisition of a drug wholesaler in June 1999. Institutional sales increased by $200.0 million, or 92.2% compared with fiscal 1999, due to sales to a prescription benefit management company that became a customer as a result of that acquisition. Chain store sales increased by $286.9 million, or 134.2%, from higher sales to existing and new chain store customers resulting from a focused marketing effort on this trade class. Independent pharmacy sales increased by $155.2 million, or 40.6% from higher sales to existing customers and new customers, including those obtained in the June 1999 acquisition. The remaining $0.6 million sales increase was primarily from software sales by Tykon, Inc. acquired in September 1998. The supply contracts with two customers (including the Company's largest customer), representing approximately 23% of fiscal 2000 sales, were terminated in the fourth quarter of fiscal 2000. As a result, the Company anticipates that institutional sales will decrease in fiscal 2001. In addition, during fiscal 2000, the Company made $46.8 million in "dock-to-dock" sales, which are not included in net sales
due to the Company's accounting policy of recording only the commission on such transactions as a reduction of cost of goods sold. There were $189.0 million of dock-to-dock sales in fiscal 1999. Dock-to-dock sales represent bulk sales of pharmaceuticals to self-warehousing retail chains for which the Company acts only as an intermediary in the order and subsequent delivery of products to the customers' warehouses. The commission on dock-to-dock sales is typically lower than the gross profit realized on sales of products from inventory.
GROSS PROFIT. Gross profit increased 35.8%, to $56.4 million in fiscal 2000 compared with fiscal 1999 driven primarily by higher sales. As a percentage of net sales, gross margin decreased from 5.09% to 3.87% in fiscal 2000 compared with fiscal 1999. The decrease in gross margin percentage was mainly due to a shift in customer mix as a result of the June 1999 acquisition partially offset by higher sales of more profitable generic pharmaceutical products and sales of inventory acquired through advantageous purchasing.
OPERATING EXPENSES. Total operating expenses increased $7.4 million, or 27.8%, to $34.1 million in fiscal 2000, compared with fiscal 1999. As a percentage of net sales, total operating expenses decreased from 3.27% to 2.34% in fiscal 2000 compared with fiscal 1999. The increase in operating expenses in fiscal 2000 resulted primarily from the Company's acquisition in June 1999. The decrease in operating expense percentage for the year is due mainly to the increase in sales that generated a lower expense to sales ratio.
NET INTEREST EXPENSE. Net interest expense increased $5.0 million, or 107.9%, in fiscal 2000, compared with fiscal 1999. As a percentage of net sales, net interest expense increased from 0.57% to 0.66% in fiscal 2000 compared with fiscal 1999. The increase in net interest expense was primarily the result of higher average outstanding borrowings in support of the Company's growth and by higher weighted average interest rates. Weighted average interest rates increased 105 basis points to 7.31% for the year primarily due to market conditions during fiscal 2000.
OTHER INCOME, NET. Other income, net increased from $431,000 to $736,000 in fiscal 2000 compared with fiscal 1999. The increase was primarily due to higher recorded earnings from the Company's equity interest in the net income of PBI during fiscal 2000, which totaled $634,000, compared with $332,000 in fiscal 1999.
INCOME TAX PROVISION. The Company's effective income tax rates of 38.8% in fiscal 2000 and 37.7% in fiscal 1999 differed from the statutory blended federal and state effective rates primarily due to the impact of the amortization of intangible assets that were not deductible for income tax purposes, partially offset by the Company's equity in the net income of PBI, a portion of which is excludable from taxable income.
FISCAL YEAR ENDED JUNE 30, 1999, COMPARED WITH THE FISCAL YEAR ENDED JUNE 30,
NET SALES. Net sales increased $202.9 million, or 33.1%, for the fiscal year ended June 30, 1999, compared with the fiscal year ended June 30, 1998. Institutional sales increased by $37.3 million, or 20.7% compared with fiscal 1998, due to increased sales to one prescription benefit management company (PBM) and sales to another PBM that became a customer as a result of the Company's acquisition of a drug wholesaler in June 1999. Chain store sales increased by $82.5 million, or 62.9%, from higher sales to existing and new chain store customers resulting from a focused marketing effort on this trade class. Independent pharmacy sales increased by $82.0 million, or 27.3% from higher sales to existing customers and new customers, including those obtained in the June 1999 acquisition. The remaining $1.1 million sales increase was primarily from software sales by Tykon, Inc. acquired in September 1998. In addition, during fiscal 1999, the Company made $189.0 million in "dock-to-dock" sales, which are not included in net sales due to the Company's accounting policy of recording only the commission on such transactions as a reduction of cost of goods sold. There were $62.1 million of dock-to-dock sales in fiscal 1998.
GROSS PROFIT. Gross profit increased 35.5%, to $41.5 million in fiscal 1999 compared with fiscal 1998 driven primarily by higher sales and partially by improved margins. As a percentage of net sales, gross margin increased from 5.01% to 5.09% in fiscal 1999 compared with fiscal 1998. The increase in gross margin percentage was mainly due to a shift in customer mix to higher margin business, higher sales of more profitable generic pharmaceutical products and sales of inventory acquired through advantageous purchasing. These benefits were partially offset by higher sales to large customers that typically generate lower margins.
OPERATING EXPENSES. Total operating expenses increased $5.8 million, or 27.8%, to $26.7 million in fiscal 1999, compared with fiscal 1998. As a percentage of net sales, total operating expenses decreased from 3.41% to 3.27% in fiscal 1999 compared with fiscal 1998. The increase in operating expenses in fiscal 1999 resulted primarily from incremental warehouse and distribution costs associated with increased sales activity and higher personnel costs related to additional managerial positions in several major functional areas of the Company. The decrease in operating expense percentage for the year is due mainly to the increase in chain store sales that typically generate a lower expense to sales ratio than other trade classes.
NET INTEREST EXPENSE. Net interest expense increased $0.8 million, or 21.8%, in fiscal 1999, compared with fiscal 1998. As a percentage of net sales, net interest expense decreased from 0.62% to 0.57% in fiscal 1999 compared with fiscal 1998. The increase in net interest expense was primarily the result of higher average outstanding borrowings in support of the Company's growth, partially offset by lower weighted average interest rates. Weighted average interest rates decreased 91 basis points to 6.26% for the year primarily due to the accounts receivable securitization facility finalized in August 1998.
OTHER INCOME, NET. Other income, net decreased from $530,000 to $431,000 in fiscal 1999 compared with fiscal 1998. The decrease was primarily due to lower recorded earnings from the Company's equity interest in the net income of PBI during fiscal 1999, which totaled $332,000, compared with $389,000 in fiscal 1998.
INCOME TAX PROVISION. The Company's effective income tax rates of 37.7% in fiscal 1999 and 39.3% in fiscal 1998 differed from the statutory blended federal and state effective rates primarily due to the impact of the amortization of intangible assets that were not deductible for income tax purposes, partially offset by the Company's equity in the net income of PBI, a portion of which is excludable from taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital requirements are generally met through a combination of internally generated funds, borrowings under the revolving line of credit, the accounts receivable securitization facility, and trade credit from its suppliers. The Company uses the following ratios as key indicators of its liquidity and working capital management:
The $65.0 million increase in working capital at June 30, 2000 was due primarily to the increase in accounts receivable and inventory as a result of increased sales and the Company's on-going growth requiring additional investment in inventories.
The Company invested $3.3 million in capital assets in fiscal 2000 and $879,000 in fiscal 1999. This increase was due in part to the move to a new facility in Lexington, Kentucky and the initial payments associated with the new ERP system that the Company is implementing. The Company believes that continued investment in capital assets is necessary to achieve its goal of improving operating efficiency and information services capabilities, thereby improving its productivity and ratio of operating expenses to net sales.
As of June 30, 2000, the revolving line of credit had a maximum borrowing capacity of $120 million, expiring in August 2001. Prior to December 1999, the revolving line of credit had maximum borrowing capacity of $95.0 million. 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 the maximum borrowing capacity. In December 1999, an additional seasonal line of credit was added to this facility increasing the maximum borrowing capacity to $120 million during a seasonal period. Such seasonal period starts on or after October 1 but not later than December 1 of each year and continues until six months after the commencement of such seasonal period, which was extended through September 30, 2000 for the current fiscal year. Generally, advances bear interest at the London Interbank Offered Rate (LIBOR) plus 1.75% or at the prime rate (8.43% at June 30, 2000) plus .25% per annum payable monthly. On May 4, 2000, the Company fixed $20 million of its revolving line of credit at a nominal rate of 7.30%. At June 30, 2000 and June 30, 1999, the unused portion of the line of credit amounted to $22.0 million and $55.5 million, respectively. The agreement expires August 7, 2001, and, therefore, the related debt has been classified as long-term. The revolving line of credit is secured by eligible inventories. The Company is engaged in discussions to extend the life of the revolving credit arrangement by one year and expand the borrowing capacity to $130 million year-round.
In the first quarter of fiscal 1999, the Company entered into a $45 million accounts receivable purchase facility under an asset securitization structure (the "Securitization") with its primary lender. In the second quarter of fiscal 1999, the Securitization was increased to $60 million and to $75 million in the fourth fiscal quarter of 2000. The Securitization has an initial term of three years, with annual renewal options, and bears interest at the LIBOR rate (6.68% at June 30, 2000) plus program and liquidity fees of 0.71% paid monthly. Under the Securitization, accounts receivable are sold on a non-recourse basis to a bankruptcy-remote subsidiary of the Company as security for commercial paper issued by an affiliate of the lender. Based upon the structure of the arrangement, the subsidiary's assets and liabilities, consisting of accounts receivable and long-term debt, are not consolidated with those of the Company. Accordingly, the company's trade accounts receivable at June 30, 2000 and 1999 are net of $75.0 million and $35.0 million, respectively, which represent accounts receivable that were sold under the Securitization.
To hedge its floating rate exposure, the Company has an interest rate collar agreement, whereby the LIBOR on $10 million of the outstanding revolving line of credit balance shall not exceed 6.75%. If the LIBOR is less than 5.25%, then the LIBOR rate on $7.5 million of the outstanding revolving line of credit balance shall not be less than 5.25%. The Company has an additional interest rate collar agreement on $40 million of the outstanding revolving line of credit, whereby the LIBOR shall not exceed 6.85% nor be less than 4.93%. At June 30, 2000, the approximate value of these instruments was $115,000. Both of these agreements expire in August 2001.
The Company believes that funds available under the line of credit and the securitization facility, together with internally generated funds, will be sufficient to meet its capital requirements for the foreseeable future.
On June 1, 1999, the Company consummated the acquisition of 100% of the outstanding stock of Jewett Drug Co. ("Jewett"). Jewett is a pharmaceutical distribution company based in Aberdeen, South Dakota, which provides comprehensive pharmaceutical distribution services to customers in the Upper Midwest and Great Plains region. The aggregate purchase price for this acquisition of $34.3 million consisted of $21.5 million in cash and $12.8 million (555,556 shares) of the Company's common stock. Funds for the cash portion of the purchase price were provided by the Company's revolving loan facility. The acquisition was accounted for as a purchase. As such, Jewett results are included in consolidated operating results from the acquisition date. The acquisition resulted in goodwill of $30.9 million, which is being amortized over 25 years.
In September 1998, the Company acquired 100% of the stock of Tykon, Inc., a wholesale distribution software developer, for cash consideration of $2.0 million. During fiscal 1998, the Company made two acquisitions of pharmaceutical distribution companies for aggregate consideration of $2.6 million, including cash payments and the issuance of notes payable.
Shareholders' equity increased to $45.3 million at June 30, 1999 from $40.9 million at June 30, 1998, primarily due to net earnings of $8.2 million offset by the purchase of $4.6 million of treasury stock.
INFLATION
The Company's 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 the ability to take advantage of forward purchasing opportunities, the Company believes that its gross profits generally increase as a result of manufacturers' price increases in the products it distributes. 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 the Company 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.
YEAR 2000
The Company has not been adversely affected by any Year 2000 problems as of the filing date and does not anticipate any such problems in the future. As of June 30, 2000, the Company had cumulatively spent approximately $662,000 on its Year 2000 project primarily on remediation and testing the Company's software products and on contingency planning. No additional spending is anticipated
EFFECT OF NEW ACCOUNTING STANDARDS
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 2000. Accordingly,
the Company adopted the provisions of this statement on July 1, 2000, resulting in an increase in stockholders' equity of approximately $69,000.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - ------- ----------------------------------------------------------
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data - ------ -------------------------------------------
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, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for the three fiscal years then ended. 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, 2000 and 1999, and the results of their operations and their cash flows for the three fiscal years then ended, in conformity with accounting principles generally accepted in the United States.
As explained in Note 3 to the financial statements, the Company has given retroactive effect to the change in accounting for determining the cost of its inventory from the last-in, first-out method to the first-in, first-out method.
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 9, 2000
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 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 focuses primarily on a target market sector, which includes independent retail, institutional, franchise, chain store, and alternate site pharmacies in the Midwest and South.
In 2000 sales to one customer represented approximately 18% of total net sales. In 1999 and 1998, sales to a different customer represented approximately 12% and 13% of total net sales, respectively. The supply contracts with two customers (including the Company's 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 generally accepted accounting principles 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.
Restricted Cash
Restricted cash of $3.7 million and $0.7 million, respectively, at June 30, 2000 and June 30, 1999, represents cash receipts from customers that must be used to reduce borrowings under the revolving line of credit and are included in cash.
Revenue Recognition
Revenue is recognized when products are shipped or services are provided to customers. During 2000, 1999 and 1998, the Company had $46.8 million, $189.0 million, and $62.1 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.
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. See Note 3 for additional information regarding the change in accounting for determining the cost of inventory.
Property and Equipment
Property and equipment is stated at cost. 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.
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 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.
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 $7.6 million and $5.2 million at June 30, 2000 and June 30, 1999, respectively.
Treasury Stock
In May 1999, the board of directors authorized the repurchase of up to 300,000 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 300,000 shares authorized, 296,400 shares were purchased during this period.
Earnings per Share
Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128) requires a dual presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common
stock were exercised or converted into common stock. All share and per share amounts have been stated in accordance with the provisions of SFAS No. 128 (see Note 14).
Reclassifications
Certain reclassifications, including the restatement for inventory costing (see Note 3), have been made to the prior years' financial statements to conform to the current year presentation.
NOTE 2. ACQUISITIONS:
On June 1, 1999, the Company consummated the acquisition of 100% of the outstanding stock of Jewett Drug Co. ("Jewett"). Jewett is a pharmaceutical distribution company based in Aberdeen, South Dakota, that provides comprehensive pharmaceutical distribution services to customers in the Upper Midwest and Great Plains region. The aggregate purchase price for this acquisition of $34.3 million consisted of $21.5 million in cash and $12.8 million (555,556 shares) of the Company's common stock. Funds for the cash portion of the purchase price were provided by the Company's revolving loan facility. In connection with the transaction, the Company paid investment banking fees of $0.8 million to a firm that employs a member of the Company's Board of Directors.
Also, on June 1, 1999, the Company entered into an amendment to the Amended and Restated Loan and Security Agreement with Fleet Capital Corporation pursuant to which the Company's revolving loan facility was increased from $75 million to $95 million and Jewett became a party to, and permitted borrower under, that facility (See Note 8).
The acquisition was accounted for as a purchase. As such, Jewett results are included in consolidated operating results from the acquisition date. The acquisition resulted in goodwill of $30.9 million, which is being amortized over 25 years.
The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and Jewett for 1999 and 1998 as if the acquisition had occurred at July 1, 1998, and July 1, 1997, respectively, with pro forma adjustments to give effect to amortization of goodwill, interest expense on acquisition debt and certain other adjustments, together with related income tax effects. The unaudited pro forma information has been prepared for comparative purposes only and does not purport to be indicative of the results of operations had these transactions been completed as of the assumed dates or which may be obtained in the future (in thousands, except per share amounts).
In September 1998, the Company acquired 100% of the stock of Tykon, Inc., a wholesale distribution software developer, for cash consideration of $2.0 million. During fiscal 1998, the Company made two acquisitions of pharmaceutical distribution companies for aggregate consideration of $2.6 million, including cash payments and the issuance of notes payable.
During the year, the Company made certain additional investments in companies in healthcare-related industries. These investments are accounted for using the cost mehtod.
NOTE 3. INVENTORIES:
In the fourth quarter of the fiscal year ended June 30, 2000, the Company changed its method of determining the cost of inventories to the first-in, first-out (FIFO) method from the last-in, first-out (LIFO) method. The Company
believes FIFO is preferable in that it is more reflective of certain changes to how its business is currently managed and operated, and therefore, more fairly reflects the Company's results of operations and financial position.
The effect of the accounting change on previously reported earnings is shown below:
NOTE 4. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following (in thousands):
The Company leases certain properties under capital leases. Capital lease asset balances consist of buildings of $0.9 million as of June 30, 2000.
NOTE 5. INVESTMENT IN PBI:
In November 1995, the Company purchased approximately 50% of the capital stock of Pharmaceutical Buyers, Inc. ("PBI"), a Colorado-based group purchasing organization. Pursuant to the transaction, the Company acquired approximately 50% of the voting and non-voting common stock of PBI for $3.75 million in cash. The Company's investment in PBI is accounted for under the equity method.
The Company's equity in the net income of PBI totaled $634,000, $332,000, and $389,000, respectively, for 2000, 1999, and 1998, which is net of amortization of goodwill associated with its investment in PBI of $276,000 for each of these years. The PBI goodwill is being amortized using the straight-line method over a period of 25 years. During 2000, 1999, and 1998, the Company received cash dividends of $350,000 in each year 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, 1999 and unaudited information for the periods ended June 30, 2000 and 1999 included (in millions):
Summarized income statement information for PBI for its fiscal year ended December 31, 1999 and unaudited information for the six months ended June 30, 2000, 1999 and 1998 included (in millions):
Certain other shareholders of PBI have 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 have been determined to be dilutive in 2000 and 1999 and are included in the reconciliation of the basic and the diluted earnings per share computation (See Note 14).
NOTE 6. OTHER ASSETS:
Other assets include deferred debt issuance costs of $1.2 million and $.9 million, respectively, at June 30, 2000 and June 30, 1999 that are being amortized over the periods the related debt is outstanding. Accumulated amortization amounted to $0.7 million and $0.4 million at June 30, 2000 and June 30, 1999, respectively. Amortization of deferred debt issuance costs totaled $375,000 in 2000, $188,000 in 1999, and $59,000 in 1998, and is included in interest expense in the consolidated statements of operations.
NOTE 7. INTANGIBLE ASSETS:
Intangible assets consisted of the following (in thousands):
The excess of purchase price over the fair value of net assets acquired is being amortized using the straight-line method over periods of 10 to 40 years. Amortization of intangible assets totaled $1.8 million in 2000, $0.6 million in 1999, and $0.4 million in 1998.
NOTE 8. LONG-TERM DEBT:
Long-term debt consists of the following (in thousands):
As of June 30, 2000, the revolving line of credit had a maximum borrowing capacity of $120 million, expiring in August 2001. Prior to December 1999, the revolving line of credit had maximum borrowing capacity of $95.0 million. 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 the maximum borrowing capacity. In December 1999, an additional seasonal line of credit was added to this facility increasing the maximum borrowing capacity to $120 million during a seasonal period. Such seasonal period starts on or after October 1 but not later than December 1 of each year and continues until six months after the commencement of such seasonal period, which was extended through September 30, 2000 for the current fiscal year. Generally, advances bear interest at the London Interbank Offered Rate (LIBOR) (6.68% at June 30, 2000) plus 1.75% or at the prime rate (8.43% at June 30, 2000) plus .25% per annum payable monthly. On May 4, 2000, the Company fixed $20 million of its revolving line of credit at a nominal rate of 7.30%. The Company was required to pay annual facility fees of $398,250 and $201,000, respectively, in 2000 and 1999. At June 30, 2000 and June 30, 1999, the borrowing base formula amounted to $135.0 million and $106.8 million, respectively. At June 30, 2000 and June 30, 1999, the unused portion of the line of credit amounted to $22.0 million and $55.5 million, respectively. The agreement expires August 7, 2001, and, therefore, the related debt has been classified as long-term. The revolving line of credit is secured by eligible inventories.
In the first quarter of fiscal 1999, the Company entered into a $45 million accounts receivable purchase facility under an asset securitization structure (the "Securitization") with its primary lender. In the second quarter of fiscal 1999, the Securitization was increased to $60 million and to $75 million in the fourth fiscal quarter of 2000. The Securitization has an initial term of three years, with annual renewal options, and bears interest at the LIBOR rate plus program and liquidity fees of 0.71% paid monthly. The Company was required to pay an original structuring fee of $225,000 plus an additional $75,000 for the increase in the facility, both of which are being amortized over the remaining term of the arrangement. Under the Securitization, accounts receivable are sold on a non-recourse basis to a bankruptcy-remote subsidiary of the Company as security for commercial paper issued by an affiliate of the lender. Based upon the structure of the arrangement, the subsidiary's assets and liabilities, consisting of accounts receivable and long-term debt, are not consolidated with those of the Company. Accordingly, the company's trade accounts receivable at June 30, 2000 and 1999 are net of $75.0 million and $35.0 million, respectively, which represent accounts receivable that were sold under the Securitization.
The Company also has an interest rate collar agreement, whereby the LIBOR on $10 million of the outstanding revolving line of credit balance shall not exceed 6.75%. If the LIBOR is less than 5.25%, then the LIBOR rate on $7.5 million of the outstanding revolving line of credit balance shall not be less than 5.25%. The Company has an additional interest rate collar agreement on $40 million of the outstanding revolving line of credit, whereby the LIBOR shall not exceed 6.85% nor be less than 4.93%. At June 30, 2000, the approximate value of these instruments was $115,000. Both of these agreements expire in August 2001.
The Company is required under the terms of its debt agreements to comply with certain financial covenants, including those related to the maintenance of current ratio, tangible net worth and debt service and interest coverage ratios. The Company also is limited in its ability to make loans and investments, enter into leases, make capital expenditures or incur additional debt, among other things, without the consent of its lenders.
In June 2000, the Company entered into a $965,000 equipment financing arrangement with a 5-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, 2000, maturities of long-term debt, including capital lease obligations, were as follows (in thousands):
At June 30, 2000 and June 30, 1999, the fair value of long-term debt approximated its current carrying value.
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 $1.9 million, $0.9 million, and $0.9 million in 2000, 1999, and 1998, respectively. Minimum rental payments under these leases with initial or remaining terms of one year or more at June 30, 2000, are $8.7 million and payments during the succeeding five years are: 2001, $2.1 million; 2002, $2.0 million; 2003, $1.9 million; 2004, $1.3 million; 2005, $1.0 million; and thereafter $0.4 million.
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 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 200,000 shares of common stock were authorized under the Long-Term Incentive Plan. The Committee determines the price (generally no 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 850,000 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 350,000 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.
Changes in options outstanding under the Company's Long-Term Incentive Plan and the 1993 Plan are as follows:
Stock options exercisable at June 30, 2000, June 30, 1999, and June 30, 1998 were 249,198, 451,198, and 409,998, respectively, with a weighted average exercise price of $7.42, $10.12, and $6.43, respectively. At June 30, 2000, the exercisable options had exercise prices ranging from $3.38 to $24.38. The weighted average remaining contractual terms for all outstanding options was 5.44 years at June 30, 2000.
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. WARRANTS:
In June 1994, the Company entered into a letter agreement with an independent research firm to produce reports with respect to the Company's publicly traded equity securities. In 1998, the research firm exercised the warrants, resulting in the issuance of 70,000 shares of common stock of the Company, recorded as additional equity of $288,750.
NOTE 12. 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 34.1%, 34%, and 34% in 2000, 1999 and 1998, respectively, to income before income tax provision, as follows (in thousands):
At June 30, 2000 and June 30, 1999, 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):
In connection with the change in accounting for inventory from the LIFO method to the FIFO method (See Note 3), net deferred tax liabilities of $5.7 million represent the tax impact of this change. The use of pre-acquisition operating losses is subject to limitations imposed by the Internal Revenue Code and if not utilized by the Company, the net operating loss carryforwards will expire beginning in 2007.
NOTE 13. 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 25% of employees' contributions up to a maximum contribution based on 6% of eligible compensation through December 31, 1999. On January 1, 2000 the discretionary match was raised to 50% of employees' contributions up to a maximum contribution based on 6% of eligible compensation. Expenses related to the plan were $176,000 in 2000, $66,000 in 1999, and $45,000 in 1998. 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 2000. Jewett also participates in the Central States Pension, a multiemployer pension plan, on behalf of its union employees in accordance with the union agreement. The expenses relating to this plan during 2000 were approximately $17,000.
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 3 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 $213,000 in 2000, $245,000 in 1999, and $176,000 in 1998.
NOTE 14. EARNINGS PER SHARE:
The Company adopted SFAS 128 in 1998. All earnings and share amounts have been restated in accordance with SFAS 128.
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 15. EFFECT OF NEW ACCOUNTING STANDARDS:
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 2000. Accordingly, the Company adopted the provisions of this statement on July 1, 2000, resulting in an increase in stockholders' equity of approximately $69,000.
NOTE 16. BUSINESS SEGMENTS:
During the fourth quarter of fiscal 1999, the Company adopted SFAS No. 131. This statement 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 equity investment in PBI (see Note 5) 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. 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.
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, restated for the change in accounting for inventory valuation (see Note 3), for the last two years were as follows:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting - ------ ----------------------------------------------------------- and Financial Disclosure ------------------------
None.
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 2000 Annual Meeting of Stockholders (the "2000 Proxy Statement") is incorporated herein by this reference. The Company will file the 2000 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 2000 Proxy Statement 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 2000 Proxy Statement 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 2000 Proxy Statement is incorporated herein by this reference.
Item 14.
Item 14. 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 34
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
None.
(c) See Item 14(a)(3) above.
(d) See Item 14(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 21, 2000
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.