UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number 1-9810
Owens & Minor, Inc.
(Exact name of Registrant as specified in its charter)
Virginia
54-1701843
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
4800 Cox Road, Glen Allen, Virginia
23060
(Address of principal executive offices)
(Zip Code)
Post Office Box 27626, Richmond, Virginia
23261-7626
(Mailing address of principal executive offices)
Registrant’s telephone number, including area code (804) 747-9794
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
x
No
o
The number of shares of Owens & Minor, Inc.’s common stock outstanding as of October 31, 2002, was 34,108,876 shares.
Owens & Minor, Inc. and Subsidiaries Index
Page
Part I.
Financial Information
Item 1.
Financial Statements
Consolidated Statements of Operations – Three Months and Nine Months Ended September 30, 2002 and 2001
3
Consolidated Balance Sheets – September 30, 2002 and December 31, 2001
4
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2002 and 2001
5
Notes to Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
23
Item 4.
Controls and Procedures
Part II.
Other Information
Legal Proceedings
24
Item 6.
Exhibits and Reports on Form 8-K
2
Part I. Financial Information Item 1. Financial Statements
Owens & Minor, Inc. and SubsidiariesConsolidated Statements of Operations
(in thousands, except per share data) (unaudited)
Three Months Ended September 30,
Nine Months Ended September 30,
2002
2001
Net sales
$
992,453
968,230
2,938,693
2,846,269
Cost of goods sold
887,326
865,162
2,627,118
2,543,597
Gross margin
105,127
103,068
311,575
302,672
Selling, general and administrative expenses
78,384
74,193
229,002
220,188
Depreciation and amortization
3,958
4,153
11,867
12,387
Amortization of goodwill
—
1,497
4,491
Interest expense, net
2,698
3,549
8,401
10,357
Discount on accounts receivable securitization
271
841
1,648
3,746
Impairment loss on investment
1,071
Distributions on mandatorily redeemable preferred securities
1,773
5,321
Restructuring credit
(185
)
(1,476
Total expenses
87,084
87,077
256,054
256,085
Income before income taxes and extraordinary item
18,043
15,991
55,521
46,587
Income tax provision
7,306
14,294
22,485
27,756
Income before extraordinary item
10,737
1,697
33,036
18,831
Extraordinary loss on early retirement of debt, net of income tax benefit
(7,068
Net income (loss)
(5,371
11,763
Per common share-basic:
0.32
0.05
0.98
0.57
Extraordinary loss on early retirement of debt
(0.21
(0.22
(0.16
0.35
Per common share-diluted:
0.29
0.89
0.54
(0.17
0.37
Cash dividends per common share
0.08
0.07
0.23
0.2025
See accompanying notes to consolidated financial statements.
Owens & Minor, Inc. and SubsidiariesConsolidated Balance Sheets
September 30, 2002
December 31, 2001
Assets
Current assets
Cash and cash equivalents
15,990
953
Accounts and notes receivable, net of allowances of $7,685 and $8,138
336,991
264,235
Merchandise inventories
350,877
389,504
Other current assets
20,355
24,760
Total current assets
724,213
679,452
Property and equipment, net of accumulated depreciation of $70,209 and $65,594
22,602
25,257
Goodwill
198,324
Other assets, net
54,507
50,820
Total assets
999,646
953,853
Liabilities and shareholders’ equity
Current liabilities
Accounts payable
292,264
286,656
Accrued payroll and related liabilities
9,665
12,669
Other accrued liabilities
68,784
68,349
Total current liabilities
370,713
367,674
Long-term debt
211,993
203,449
Other liabilities
20,570
14,487
Total liabilities
603,276
585,610
Company-obligated mandatorily redeemable preferred securities of subsidiary trust, holding solely convertible debentures of Owens & Minor, Inc.
132,000
Shareholders’ equity
Preferred stock, par value $100 per share; authorized - 10,000 shares Series A; Participating Cumulative Preferred Stock; none issued
Common stock, par value $2 per share; authorized - 200,000 shares; issued and outstanding – 34,113 shares and 33,885 shares
68,226
67,770
Paid-in capital
29,913
27,181
Retained earnings
168,048
142,854
Accumulated other comprehensive loss
(1,817
(1,562
Total shareholders’ equity
264,370
236,243
Total liabilities and shareholders’ equity
Owens & Minor, Inc. and SubsidiariesConsolidated Statements of Cash Flows
(in thousands) (unaudited)
Operating activities
Adjustments to reconcile income before extraordinary item to cash provided by (used for) operating activities:
16,878
Provision for LIFO reserve
3,940
2,750
Provision for losses on accounts and notes receivable
1,908
1,263
Changes in operating assets and liabilities:
Net decrease in receivables sold
(70,000
(26,000
Accounts and notes receivable, excluding sales of receivables
(4,664
(22,227
34,687
(82,292
10,608
36,171
Net change in other current assets and current liabilities
2,021
11,277
6,253
948
Other, net
3,025
3,842
Cash provided by (used for) operating activities
32,496
(38,964
Investing activities
Additions to property and equipment
(3,525
(8,893
Additions to computer software
(3,734
(3,641
(870
Cash used for investing activities
(7,253
(13,404
Financing activities
Net proceeds from issuance of long-term debt
194,591
Payments to retire long-term debt
(158,594
Addition to debt
11,839
Cash dividends paid
(7,842
(6,810
Proceeds from exercise of stock options
1,949
7,944
Increase (decrease) in drafts payable
(5,000
3,650
687
Cash provided by (used for) financing activities
(10,206
52,620
Net increase in cash and cash equivalents
15,037
252
Cash and cash equivalents at beginning of period
626
Cash and cash equivalents at end of period
878
Owens & Minor, Inc. and SubsidiariesNotes to Consolidated Financial Statements (unaudited)
1.
Accounting Policies
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (which are comprised only of normal recurring accruals and the use of estimates) necessary to present fairly the consolidated financial position of Owens & Minor, Inc. and its wholly-owned subsidiaries (O&M or the company) as of September 30, 2002 and the consolidated results of operations for the three and nine-month periods and cash flows for the nine-month periods ended September 30, 2002 and 2001.
2.
Interim Results of Operations
The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.
3.
Reclassifications
Certain prior period amounts have been reclassified in order to conform to the current period presentation for allowances and provisions for losses on accounts and notes receivable.
4.
Interim Gross Margin Reporting
During interim periods, the company estimates certain components of gross margin. To improve the accuracy of these estimates, the company takes physical inventory counts at selected distribution centers. Management will continue a program of interim physical inventories at selected distribution centers to the extent it deems appropriate to ensure the accuracy of interim reporting and to minimize year-end adjustments.
5.
On January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 142, Goodwill and Other Intangible Assets. The provisions of SFAS 142 state that goodwill should not be amortized but should be tested for impairment upon adoption of the standard, and at least annually, at the reporting unit level. As a result, the company no longer records goodwill amortization expense.
The provisions of SFAS 142 also require the company to evaluate its existing intangible assets and goodwill acquired in purchase business combinations, and to make any necessary reclassifications in order to conform with the new classification criteria in SFAS 141 for recognition separate from goodwill. At implementation, the company had no separately identifiable intangible assets from purchase business combinations that are recorded either separately or within goodwill.
The following table presents the company’s income before extraordinary item and net income (loss) for the three and nine-month periods ended September 30, 2002 and 2001, adjusted to exclude goodwill amortization expense and related tax benefits:
(in thousands, except per share data)
Goodwill amortization expense, net of tax benefit
1,335
4,005
Adjusted income before extraordinary item
3,032
22,836
Adjusted net income (loss)
(4,036
15,768
Per common share – basic:
0.09
0.69
(0.12
0.47
Per common share – diluted:
0.65
6.
Acquisition
In 1999, the company acquired certain net assets of Medix, Inc. (Medix), a distributor of medical and surgical supplies. The acquisition was accounted for by the purchase method. In connection with the acquisition, management adopted a plan for integration of the businesses that included closure of some Medix facilities and consolidation of certain administrative functions. An accrual was established to provide for certain costs of this plan. The following table sets forth the activity in the accrual since December 31, 2001:
(in thousands)
Balance at December 31, 2001
Charges
Balance at September 30, 2002
Losses under lease commitments
737
309
428
Other
65
8
57
Total
802
317
485
The integration of the Medix business was completed in 2001. However, the company continues to make payments under lease commitments and other obligations.
7.
Restructuring Reserve
As a result of the cancellation of a significant customer contract in 1998, the company recorded a restructuring charge to downsize operations. In the second quarter of 2002, the company re-evaluated its estimate of the remaining costs to be incurred in connection with the restructuring plan and reduced the reserve by approximately $0.2 million to reflect the reutilization of warehouse space that had previously been vacated under the plan. The following table sets forth the activity in the restructuring reserve since December 31, 2001:
7
Adjustments
921
106
185
630
Asset write-offs
849
230
619
1,770
336
1,249
8.
Revolving Credit Facility
Effective April 30, 2002, the company replaced its revolving credit facility with a new agreement expiring in April 2005. The credit limit of the new facility is $150.0 million, and the interest rate is based on, at the company’s discretion, LIBOR, the Federal Funds Rate or the Prime Rate. Under the new facility, the company is charged a commitment fee of between 0.30% and 0.40% on the unused portion of the facility, and a utilization fee of 0.25% if borrowings exceed $75.0 million. The terms of the new agreement limit the amount of indebtedness that the company may incur, require the company to maintain certain levels of net worth, current ratio, leverage ratio and fixed charge coverage ratio, and restrict the ability of the company to materially alter the character of the business through consolidation, merger, or purchase or sale of assets. The refinancing resulted in a write-off of deferred financing costs of $0.2 million, which was included in interest expense for the quarter ended June 30, 2002.
9.
Off Balance Sheet Receivables Financing Facility
Effective April 30, 2002, the company replaced its off balance sheet receivables financing facility (Receivables Financing Facility) with a new agreement expiring in April 2005. Under the terms of the new facility, O&M Funding is entitled to sell, without recourse, up to $225.0 million of its trade receivables to a group of unrelated third party purchasers at a cost of funds based on either commercial paper rates, the Prime Rate, or LIBOR. The terms of the new agreement require the company to maintain certain levels of net worth, current ratio, leverage ratio and fixed charge coverage ratio, and restrict the company’s ability to materially alter the character of the business through consolidation, merger, or purchase or sale of assets. The company incurred fees related to the origination of the agreement of $0.7 million, which were included in discount on accounts receivable securitization for the quarter ended June 30, 2002.
At September 30, 2002, there were no outstanding sales under the Receivables Financing Facility. At December 31, 2001, net accounts receivable of $70.0 million had been sold under the previous agreement and, as a result, were excluded from the consolidated balance sheet.
10.
Comprehensive Income
The company’s comprehensive income for the three and nine-month periods ended September 30, 2002 and 2001 is shown in the table below.
Other comprehensive income (loss), net of tax:
Change in unrealized gain (loss) on investment
(46
(19
(255
(14
Reclassification of unrealized loss to net income
642
Comprehensive income (loss)
10,691
(4,748
32,781
12,391
11.
Income per Common Share Before Extraordinary Item
The following sets forth the computation of income per basic and diluted common share before extraordinary item:
Numerator:
Numerator for income per basic common share before extraordinary item –income before extraordinary item
Distributions on convertible mandatorily redeemable preferred securities, net of income taxes
1,064
3,193
3,023
Numerator for income per diluted common share before extraordinary item – income before extraordinary item after assumed conversions
11,801
36,229
21,854
Denominator:
Denominator for income per basic common share before extraordinary item – weighted average shares
33,835
33,560
33,783
33,280
Effect of dilutive securities:
Conversion of mandatorily redeemable preferred securities
6,400
Stock options and restricted stock
432
636
585
628
Denominator for income per diluted common share before extraordinary item – adjusted weighted average shares and assumed conversions
40,667
34,196
40,768
40,308
Income per basic common share before extraordinary item
Income per diluted common share before extraordinary item
12.
Recently Adopted Accounting Pronouncement
On January 1, 2002, the company adopted the provisions of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The provisions of SFAS 144 modify the accounting treatment for impairments of long-lived assets and discontinued operations. The adoption of this standard did not have a material effect on the company’s results of operations or financial condition.
13.
Commitments and Contingencies
Effective August 1, 2002, the company entered into a new commitment through July 31, 2009 to outsource its information technology operations, which includes the management, start-up and operation of its mainframe computer and distributed services processing, as well as application support, development and enhancement services. The commitment is cancelable for convenience after August 1, 2005 with 180 days notice and payment of a termination fee. The termination fee is based upon certain costs that would be incurred by the vendor as a direct result of the early termination of the agreement. The maximum termination fee payable is $9.1 million after the third contract year. The termination fee declines each year to $2.3 million at the end of the sixth contract year.
9
As of September 30, 2002, assuming no contract terminations, the fixed and determinable portion of the obligations under this agreement are $7.4 million for the remainder of 2002, $29.7 million per year from 2003 through 2006, and $76.6 million in the aggregate for the remaining periods under the contract, totaling $202.8 million.
These obligations can vary annually up to a certain level for changes in the Consumer Price Index or for a significant increase in the company’s base business. Additionally, the service fees under this contract can vary to the extent additional services are provided by the vendor which are not covered by the negotiated base fees, or as a result of reduction in services provided by the vendor that were included in these base fees.
As a result of this new agreement, the company gave notice of cancellation to its previous vendor for mainframe computer services. The company is obligated under this previous contract to pay for termination fees and mainframe computer services through February 2003. As of September 30, 2002, the company is obligated to pay $0.2 million in 2002 and $2.8 million in 2003 for termination fees. The total termination fees of $3.0 million were accrued as an increase to SG&A expense in the third quarter of 2002. At September 30, 2002, the company is also obligated to pay $2.5 million for mainframe computer services in 2002 and $1.2 million in 2003, totaling $3.7 million.
10
14.
Condensed Consolidating Financial Information
The following tables present condensed consolidating financial information for: Owens & Minor, Inc.; on a combined basis, the guarantors of Owens & Minor, Inc.’s Notes; and the non-guarantor subsidiaries of the Notes. Separate financial statements of the guarantor subsidiaries are not presented because the guarantors are jointly, severally and unconditionally liable under the guarantees and the company believes the condensed consolidating financial information is more meaningful in understanding the financial position, results of operations and cash flows of the guarantor subsidiaries.
For the three months ended September 30, 2002
Guarantor Subsidiaries
Non-guarantor Subsidiaries
Eliminations
Consolidated
Statements of Operations
78,036
348
3,804
(1,106
Intercompany interest expense, net
(7,964
11,117
(3,153
268
(4,160
92,008
(764
Income before income taxes
4,160
13,119
764
1,767
5,064
475
Net income
2,393
8,055
289
For the three months ended September 30, 2001
73,961
232
4,544
(995
(5,824
10,478
(4,654
837
(209
89,098
(1,812
209
13,970
1,812
564
12,933
797
Income (loss) before extraordinary item
(355
1,037
1,015
(7,423
11
For the nine months ended September 30, 2002
227,004
1,995
11,317
(2,916
(21,192
30,772
(9,580
Intercompany dividend income
(44,999
44,999
1,638
(54,871
266,552
(626
54,871
45,023
4,194
17,714
577
50,677
27,309
49
For the nine months ended September 30, 2001
219,615
573
13,498
(3,141
(10,049
25,016
(14,967
(126,386
126,386
3,736
(121,866
256,902
(5,337
121,866
45,770
5,337
Income tax provision (benefit)
(1,517
26,911
2,362
123,383
18,859
2,975
116,315
12
Balance Sheets
15,941
48
1
Accounts and notes receivable, net
2,890
334,101
Intercompany advances, net
155,855
145,194
(301,049
171,796
519,364
33,053
Property and equipment, net
Intercompany investments
387,497
36,202
136,083
(559,782
20,978
33,260
269
580,271
809,752
169,405
2,666
66,825
(707
368,754
Intercompany long-term debt
263,890
(399,973
(755
21,353
(28
349,987
653,997
(735
Common stock
5,583
(5,583
138,225
16,001
(154,226
132,114
19,378
16,556
Accumulated other comprehensive income (loss)
31
(1,848
230,284
155,755
38,140
(159,809
13
507
445
173,802
58,161
(231,963
24,743
174,326
472,853
32,273
342,497
15,001
(493,581
13,708
36,110
1,002
530,531
747,545
169,358
7,238
61,800
(689
361,125
143,890
(279,973
15,270
346,015
520,285
(717
40,879
(46,462
151,145
(167,146
89,279
37,084
16,491
286
184,516
227,260
38,075
(213,608
14
Statements of Cash Flows
Adjustments to reconcile net income to cash provided by (used for) operating activities:
665
1,243
(3,555
(1,109
(4,555
6,590
1,571
722
732
47,693
98,901
(69,099
Investments in intercompany debt
(120,000
120,000
Decrease in intercompany investment
75,000
(75,000
(45,000
45,000
Proceeds from issuance of intercompany debt
Change in intercompany advances
17,947
(87,046
69,099
Intercompany dividends paid
Decrease in drafts payable
12,741
(92,045
(1
Net increase (decrease) in cash and cash equivalents
15,434
(397
15
Adjustments to reconcile income before extraordinary item to cash provided by operating activities:
1,620
(357
22,604
(44,831
6,802
4,439
36
2,621
1,221
133,877
21,722
(68,177
(143,890
17,504
(17,504
105
(975
(12,429
Additions (reductions) to other debt
12,500
(661
(57,622
(11,530
69,152
Increase in drafts payable
(7,991
(8,541
(500
752
118
870
16
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following management discussion and analysis describes material changes in the financial condition of Owens & Minor, Inc. and its wholly owned subsidiaries (the company) since December 31, 2001. Trends of a material nature are discussed to the extent known and considered relevant. This discussion should be read in conjunction with the consolidated financial statements, related notes thereto and management’s discussion and analysis of financial condition and results of operations included in the company’s Annual Report on Form 10-K for the year ended December 31, 2001.
Results of Operations Third quarter and first nine months of 2002 compared with 2001Overview. In the third quarter of 2002, the company earned net income of $10.7 million, or $0.29 per diluted common share, compared with a loss of $5.4 million, or $0.16 per diluted common share in the third quarter of 2001. For the first nine months of 2002, the company earned net income of $33.0 million, or $0.89 per diluted common share, compared to $11.8 million, or $0.37 per diluted common share, in the first nine months of 2001.
Excluding unusual items and goodwill amortization, net income increased by 11% from $11.3 million in the third quarter of 2001 to $12.5 million in 2002 and net income per diluted common share increased by 10% to $0.33 from $0.30 in the third quarter of 2001. For the first nine months of 2002, net income increased by 15% to $34.7 million from $30.2 million in 2001 and net income per diluted common share increased by 12% to $0.93 from $0.83, excluding unusual items and goodwill amortization. These increases are primarily attributable to success in controlling operating expenses while maintaining gross margins, as well as reductions in financing costs.
Unusual items. In the third quarter of 2002, the company incurred a $3.0 million charge, or $1.8 million net of tax, due to the cancellation of a mainframe computer services contract that was replaced by a new information technology agreement with Perot Systems Corporation. In the third quarter of 2001, unusual items consisted of a $1.1 million impairment loss on an investment in marketable equity securities, a $7.2 million additional tax provision related principally to disallowed interest deductions for corporate-owned life insurance for the years 1995 through 1998, and a $7.1 million after-tax extraordinary loss on the early retirement of debt. Net income for the first nine months of 2002 and 2001 also included reductions in a restructuring reserve of $0.1 million and $0.8 million, net of tax.
Goodwill amortization. On January 1, 2002, the company adopted the provisions of SFAS 142, under which the company no longer records goodwill amortization expense.
The following tables reconcile net income as reported under generally accepted accounting principles to income excluding goodwill amortization and unusual items for the three and nine-month periods ended September 30, 2002 and 2001:
As reported
Unusual items
As adjusted
Goodwill amortization
2,987
21,030
18,559
1,211
8,517
162
(7,168
7,288
1,776
12,513
8,239
11,271
7,068
15,307
2,802
58,323
(405
50,673
1,136
23,621
486
(7,817
20,425
1,666
34,702
7,412
30,248
14,480
Net sales. Net sales increased 2.5% to $992.5 million in the third quarter of 2002 from $968.2 million in the third quarter of 2001. Net sales increased 3.2% to $2.9 billion in the first nine months of 2002 from $2.8 billion in the comparable period of 2001. The increase in sales resulted from penetration of existing accounts as well as new business.
During the quarter and for the nine-month period, the company’s sales were impacted by losses of certain customers in late 2001 and early 2002, including those who chose other distributors in 2001 in connection with the new Novation contract. While new business awarded in early 2002 transitioned more slowly than expected, the new business, combined with penetration of existing accounts, more than offset the losses.
In addition, sales growth has been affected by a slight decrease in hospital-based surgeries within the acute-care hospital industry and by price deflation in some product categories. Management expects the rate of sales growth in 2002 to be lower than in recent years as a result of these factors.
Gross margin. Gross margin for the third quarter and the first nine months of 2002 was 10.6% of net sales, consistent with the same periods of 2001. Both customer margin and margin from supplier incentives have remained consistent.
Selling, general and administrative expenses. In July 2002, the company entered into a new, seven-year information technology agreement with Perot Systems Corporation, expanding an
18
existing outsourcing relationship. As a result of the new agreement, O&M recorded a liability for termination costs of $3.0 million in connection with the impending cancellation of its existing contract for mainframe computer services with another provider. This charge is included in selling, general and administrative (SG&A) expense for the third quarter of 2002. All subsequent comparisons of SG&A expense in this discussion exclude the effect of the cancellation costs.
In the third quarter of 2002, SG&A expenses increased by 1.6% from the third quarter of 2001 on 2.5% sales growth. SG&A expenses for the first nine months of 2002 increased by 2.6% from the first nine months of 2001 on 3.2% sales growth. As a percentage of net sales, SG&A expenses decreased to 7.6% in the third quarter of 2002 from 7.7% in the third quarter of 2001. The improvement is partly the result of continued control of information technology costs as well a decrease in distribution center personnel costs made possible by the completion of significant customer transitions that occurred in 2001. Additionally, SG&A continued to improve as a result of ongoing company-wide initiatives to improve productivity and control costs.
O&M expects to generate operating expense savings of approximately $30 million over the life of its new seven-year information technology agreement and plans to reinvest a significant portion of the savings to enhance the company’s technology leadership position in healthcare.
Interest expense, net, and discount on accounts receivable securitization (financing costs). Net financing costs totaled $3.0 million for the third quarter of 2002, compared with $4.4 million in the third quarter of 2001. Excluding collections of customer finance charges, financing costs for the third quarter were $4.0 million, a decrease of $1.3 million from the third quarter of 2001. The decrease in financing costs was primarily driven by lower outstanding financing and lower short-term interest rates.
The company expects to continue to manage its financing costs by managing working capital levels. Future financing costs will be affected primarily by changes in short-term interest rates, as well as by working capital requirements.
Restructuring credits. As a result of a cancellation of a significant customer contract in 1998, the company recorded a restructuring charge of $6.6 million, net of tax, to downsize operations. The company periodically re-evaluates its restructuring reserve, and since the actions under this plan have resulted in lower projected total costs than originally anticipated, the company recorded reductions in the reserve which increased net income by approximately $0.1 million in the second quarter of 2002 and $0.8 million in the second quarter of 2001, net of taxes. These reductions in the reserve resulted primarily from the reutilization of warehouse space that had previously been vacated under the restructuring plan.
Income taxes. The effective income tax rate was 40.5% for the third quarter and for the first nine months of 2002. The income tax provision for the third quarter of 2001 included a $7.2 million charge related principally to disallowed interest deductions for corporate-owned life insurance for the years 1995 through 1998. Excluding goodwill amortization, the $7.2 million charge and other unusual items mentioned previously, the effective income tax rate for the first nine months of 2001 was 40.3%.
Financial Condition, Liquidity and Capital ResourcesLiquidity. Combined outstanding debt and off balance sheet accounts receivable securitization decreased by $61.4 million to $212.0 million at September 30, 2002, from $273.4 million at December 31, 2001 as a result of favorable cash flow. Excluding sales of accounts receivable under the Receivables Financing
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Facility, $102.5 million of cash was provided by operating activities in the first nine months of 2002, compared with $13.0 million used for operating activities in the first nine months of 2001. This increase in operating cash flow was the result of inventory reductions made possible by the completion of customer transitions that began in 2001. For the third quarter of 2002, annualized inventory turns increased to 9.9 from 8.7 in the fourth quarter of 2001.
Effective April 30, 2002, the company replaced its revolving credit facility with a new agreement expiring in April 2005. The credit limit of the new facility is $150.0 million, and the interest rate is based on, at the company’s discretion, LIBOR, the Federal Funds Rate or the Prime Rate. Under the new facility, the company is charged a commitment fee of between 0.30% and 0.40% on the unused portion of the facility, and a utilization fee of 0.25% if borrowings exceed $75.0 million. The terms of the new agreement limit the amount of indebtedness that the company may incur, require the company to maintain certain levels of net worth, current ratio, leverage ratio and fixed charge coverage ratio, and restrict the ability of the company to materially alter the character of the business through consolidation, merger, or purchase or sale of assets.
Effective April 30, 2002, the company replaced its Receivables Financing Facility with a new agreement expiring in April 2005. Under the terms of the new facility, O&M Funding is entitled to sell, without recourse, up to $225.0 million of its trade receivables to a group of unrelated third party purchasers at a cost of funds based on either commercial paper rates, the Prime Rate, or LIBOR. The terms of the new agreement require the company to maintain certain levels of net worth, current ratio, leverage ratio and fixed charge coverage ratio, and restrict the company’s ability to materially alter the character of the business through consolidation, merger, or purchase or sale of assets.
The company expects that its available financing will be sufficient to fund its working capital needs and long-term strategic growth, although this cannot be assured. At September 30, 2002, the company had $148.6 million of unused credit under its revolving credit facility and the ability to sell $225.0 million of accounts receivable under its Receivables Financing Facility.
Capital Expenditures. Capital expenditures were $7.3 million in the first nine months of 2002, compared to $12.5 million in the first nine months of 2001. The decrease from 2001 to 2002 is primarily attributable to the company’s purchase of land for its future headquarters of $3.3 million in 2001. The company also relocated a larger number of warehouse facilities in 2001 than in 2002, resulting in higher expenditures for warehouse equipment and leasehold improvements. The company spent $5.5 million on computer hardware and software purchasing and development in the first nine months of 2002, compared to $5.7 million in the first nine months of 2001.
Critical Accounting PoliciesThe company’s consolidated financial statements and accompanying notes have been prepared in accordance with generally accepted accounting principles applied on a consistent basis. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The company continually evaluates the accounting policies and estimates it uses to prepare its financial statements. Management’s estimates are generally based on historical experience and various other assumptions that are judged to be reasonable in light of the relevant facts and circumstances. Because of the uncertainty inherent in such estimates, actual results may differ.
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Critical accounting policies are defined as those policies that relate to estimates that require a company to make assumptions about matters that are highly uncertain at the time the estimate is made and could have a material impact on the company’s results due to changes in the estimate or the use of different estimates that could reasonably have been used. The company believes its critical accounting policies and estimates include its allowance for doubtful accounts, inventory valuation and accounting for goodwill.
Allowances for losses on accounts and notes receivable. The company maintains valuation allowances based upon the expected collectibility of accounts and notes receivable. The allowances include specific amounts for accounts that are likely to be uncollectible, such as customer bankruptcies and disputed amounts, and general allowances for accounts that may become uncollectible. The general allowances are estimated based on many factors such as industry trends, current economic conditions, creditworthiness of customers, age of the receivables and changes in customer payment patterns. At September 30, 2002, the company had accounts and notes receivable of $337.0 million, net of allowances of $7.7 million. An unexpected bankruptcy or other adverse change in financial condition of a customer could result in increases in these allowances, which could have a material impact on net income. The company has not had a material adverse change in its estimate of collectibility in recent years. The company actively manages its accounts receivable to minimize credit risk and the company has no individual customers that account for more than 10% of the company’s accounts receivable.
Inventory valuation. In order to state inventories at the lower of LIFO cost or market, the company maintains an allowance for obsolete inventory based upon the expectation that some inventory will become obsolete and be sold for less than cost. The allowance is estimated based on factors such as age of the inventory and historical trends. At September 30, 2002, the company had inventory of $350.9 million, net of an allowance for obsolete inventory of $2.3 million. Changes in product specifications, customer product preferences or the loss of a customer could result in unanticipated obsolescence that may have a material impact on cost of goods sold, gross margin, and net income. The company has not had a material adverse change in its estimate for obsolete inventory in recent years. The company actively manages its inventory levels to minimize the risk of obsolescence and has achieved a higher level of inventory turnover than industry averages.
Goodwill. On January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 142, Goodwill and Other Intangible Assets. The provisions of SFAS 142 state that goodwill should not be amortized but should be tested for impairment upon adoption of the standard and, at least annually, at the reporting unit level. As a result, the company no longer records goodwill amortization expense.
The company performs an impairment test of its goodwill based on its reporting units as defined in SFAS 142 on an annual basis and on a more frequent basis in certain circumstances. In performing the impairment test, the company determines the fair value of its reporting units using valuation techniques which can include multiples of the units’ earnings before interest, taxes, depreciation and amortization (EBITDA), present value of expected cash flows and quoted market prices. The EBITDA multiples are based on an analysis of current market capitalizations and recent acquisition prices of similar companies. The fair value of each reporting unit is then compared to its carrying value to determine potential impairment. The company’s goodwill totaled $198.3 million at September 30, 2002.
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The impairment review required by SFAS 142 requires the extensive use of accounting judgment and financial estimates. The application of alternative assumptions, such as a change in discount rates or EBITDA multiples, or the testing for impairment at a different level of organization or on a different organization structure, could produce materially different results.
Recent Accounting PronouncementsIn September 2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations. The provisions of SFAS 143 address financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The company will be required to adopt the provisions of this standard beginning on January 1, 2003. Management believes that adoption of this standard will not have a material effect on the company’s results of operations or financial condition.
In May 2002, the FASB issued SFAS 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. The most significant provisions of SFAS 145 address the termination of extraordinary item treatment for gains and losses on early retirement of debt. The company will be required to adopt the provisions of this standard beginning on January 1, 2003. Upon adoption of the standard, the company will modify the presentation of its 2001 results with respect to its loss on early retirement of debt.
In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. The provisions of SFAS 146 modify the accounting for the costs of exit and disposal activities by requiring that liabilities for those activities be recognized when the liability is incurred. Previous accounting literature permitted recognition of some exit and disposal liabilities at the date of commitment to an exit plan. The provisions of this statement will be effective for exit or disposal activities initiated after December 31, 2002.
RisksThe company is subject to risks associated with changes in the medical industry, including continued efforts to control costs, which place pressure on operating margin, changes in the way medical and surgical services are delivered and changes in manufacturer preferences between the sale of product directly to hospital customers and the use of wholesale distribution. The loss of one of the company’s larger customers could have a significant effect on its business.
Forward-looking StatementsCertain statements in this discussion constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Although O&M believes its expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of its knowledge of its business and operations, all forward-looking statements involve risks and uncertainties and, as a result, actual results could differ materially from those projected, anticipated or implied by these statements. Such forward-looking statements involve known and unknown risks, including, but not limited to, general economic and business conditions; dependence on sales to certain customers; dependence on suppliers; changes in manufacturer preferences between direct sales and wholesale distribution; competition; changing trends in customer profiles; the ability of the company to meet customer demand for additional value added services; the ability to convert customers to CostTrack; the availability of supplier incentives; the ability to capitalize on buying opportunities; the ability of business partners to perform their contractual responsibilities; the ability to manage operating expenses; the ability of the company to manage financing costs and interest rate risk; the risk that a
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decline in business volume or profitability could result in an impairment of goodwill; the ability to timely or adequately respond to technological advances in the medical supply industry; the ability to successfully identify, manage or integrate possible future acquisitions; outcome of outstanding litigation; and changes in government regulations. As a result of these and other factors, no assurance can be given as to the company’s future results. The company is under no obligation to update or revise any forward-looking statements, whether as a result of new information, future results, or otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
O&M provides credit, in the normal course of business, to its customers. The company performs ongoing credit evaluations of its customers and maintains reserves for credit losses.
The company is exposed to market risk relating to changes in interest rates. To manage this risk, O&M uses interest rate swaps to modify the company’s balance of fixed and variable rate financing. The company is exposed to certain losses in the event of nonperformance by the counterparties to these swap agreements. However, O&M’s exposure is not significant and, since the counterparties are investment grade financial institutions, nonperformance is not anticipated.
The company is exposed to market risk from both changes in interest rates related to its interest rate swaps and changes in discount rates related to its Receivables Financing Facility. Interest expense and discount on accounts receivable securitization are subject to change as a result of movements in interest rates. As of September 30, 2002, O&M had $100 million of interest rate swaps on which the company pays a variable rate based on LIBOR and receives a fixed rate. A hypothetical increase in interest rates of 100 basis points would result in a potential reduction in future pre-tax earnings of approximately $1.0 million per year in connection with the swaps. The company had no outstanding financing under its Receivables Financing Facility at September 30, 2002, but does sell receivables under the facility from time to time. A hypothetical increase in interest rates of 100 basis points would result in a potential reduction in future pre-tax earnings of approximately $0.1 million per year for every $10 million of outstanding financing under the Receivables Financing Facility.
Item 4. Controls and Procedures
Within the 90 days prior to the filing date of this report, under the supervision and with the participation of the Company’s management (including its Chief Executive Officer and Chief Financial Officer), the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings. Since the date of the evaluation, there have been no significant changes in the Company’s internal controls or factors that could significantly affect them.
Part II. Other Information
Item 1. Legal Proceedings Certain legal proceedings pending against the company are described in the company’s Annual Report on Form 10-K for the year ended December 31, 2001. Through September 30, 2002, there have been no material developments in any legal proceedings reported in such Annual Report.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The company filed a Current Report on Form 8-K dated August 1, 2002, under Items 5 and 7, with respect to the press release issued by the company reporting a seven year information technology and services agreement with Perot Systems Corporation.
The company filed a Current Report on Form 8-K dated August 12, 2002, under Items 7 and 9, with respect to sworn statements under oath of the Chief Executive Officer and Chief Financial Officer pursuant to the U.S. Securities and Exchange Commission Order 4-460.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
OWENS & MINOR, INC.
(Registrant)
Date November 13, 2002
/s/ G. Gilmer Minor, III
G. Gilmer Minor, III Chairman and Chief Executive Officer
/s/ Jeffrey Kaczka
Jeffrey Kaczka Senior Vice President & Chief Financial Officer
/s/ Olwen B. Cape
Olwen B. Cape Vice President & Controller Chief Accounting Officer
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I, G. Gilmer Minor III, certify that:
I have reviewed this quarterly report on Form 10-Q of Owens & Minor Inc;
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ G. Gilmer Minor III
G. Gilmer Minor III Chief Executive Officer
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I, Jeffrey Kaczka, certify that:
Jeffrey Kaczka Chief Financial Officer
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Exhibit #
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