UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2003
OR
For the transition period from to
Commission file number 1-9810
Owens & Minor, Inc.
(Exact name of Registrant as specified in its charter)
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 ¨
The number of shares of Owens & Minor, Inc.’s common stock outstanding as of October 31, 2003, was 38,963,644 shares.
Owens & Minor, Inc. and Subsidiaries
Index
Part I. Financial Information
Consolidated Statements of Income – Three Months and Nine Months Ended September 30, 2003 and 2002
Consolidated Balance Sheets – September 30, 2003 and December 31, 2002
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2003 and 2002
Notes to Consolidated Financial Statements
Part II. Other Information
2
Item 1. Financial Statements
Consolidated Statements of Income
(unaudited)
(in thousands, except per share data)
Net sales
Cost of goods sold
Gross margin
Selling, general and administrative expenses
Depreciation and amortization
Restructuring credit
Operating earnings
Interest expense, net
Discount on accounts receivable securitization
Distributions on mandatorily redeemable preferred securities
Income before income taxes
Income tax provision
Net income
Net income per common share-basic
Net income per common share-diluted
Cash dividends per common share
See accompanying notes to consolidated financial statements.
3
Consolidated Balance Sheets
Assets
Current assets
Cash and cash equivalents
Accounts and notes receivable, net of allowances of $7,872 and $6,849
Merchandise inventories
Other current assets
Total current assets
Property and equipment, net of accumulated depreciation of $74,734 and $70,528
Goodwill
Other assets, net
Total assets
Liabilities and shareholders’ equity
Current liabilities
Accounts payable
Accrued payroll and related liabilities
Other accrued liabilities
Total current liabilities
Long-term debt
Company-obligated mandatorily redeemable preferred securities of subsidiary trust, holding solely convertible debentures of Owens & Minor, Inc.
Other liabilities
Total liabilities
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 – 38,949 shares and 34,113 shares
Paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
4
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
(in thousands)
Operating activities
Adjustments to reconcile net income to cash provided by operating activities:
Provision for LIFO reserve
Provision for losses on accounts and notes receivable
Changes in operating assets and liabilities:
Accounts and notes receivable, excluding sales of receivables
Net decrease in receivables sold
Net change in other current assets and current liabilities
Other, net
Cash provided by operating activities
Investing activities
Additions to property and equipment
Additions to computer software
Cash used for investing activities
Financing activities
Payments to repurchase mandatorily redeemable preferred securities
Payments to repurchase common stock
Net payments on revolving credit facility
Cash dividends paid
Proceeds from exercise of stock options
Decrease in drafts payable
Cash used for financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
5
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, 2003, and the consolidated results of operations for the three and nine month periods and cash flows for the nine month periods ended September 30, 2003 and 2002, in conformity with generally accepted accounting principles.
The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.
Certain prior period amounts have been reclassified in order to conform to the current period presentation.
The company uses the intrinsic value method as defined by Accounting Principles Board Opinion No. 25 to account for stock-based compensation. This method requires compensation expense to be recognized for the excess of the quoted market price of the stock at the grant date or the measurement date over the amount an employee must pay to acquire the stock. The following table presents the effect on net income and earnings per share had the company used the fair value method, as defined in Statement of Financial Accounting Standards No. (SFAS) 123, Accounting for Stock-Based Compensation, to account for stock-based compensation:
Add: stock-based employee compensation expense included in reported net income, net of tax
Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of tax
Pro forma net income
Per common share - basic:
Net income, as reported
Per common share - diluted:
6
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. In the third quarter of 2003, the company reduced the accrual by $76 thousand as a result of favorable subleasing activity in a closed Medix facility. The adjustment was recorded as a reduction in goodwill, as it reduced the purchase price of the Medix acquisition. The following table sets forth the activity in the accrual since December 31, 2002:
Losses under lease commitments
Other
Total
The integration of the Medix business was completed in 2001. However, the company continues to make payments under certain obligations.
As a result of the cancellation of a significant customer contract in 1998, the company recorded a restructuring charge to downsize operations. In the first quarter of 2003, the company reduced the accrual by $53 thousand due to the reutilization of space that had been vacated under the plan. The following table sets forth the activity in the restructuring reserve since December 31, 2002:
Balance at
December 31,2002
September 30,2003
Asset write-offs
During the third quarter of 2003, the company initiated and completed the redemption of all of the $2.6875 Term Convertible Securities, Series A (Securities) issued by Owens & Minor Trust I, a business trust owned by the company. Securities with a liquidation amount of $104.4 million were converted into 5.1 million shares of Owens & Minor common stock. The remaining Securities, with a liquidation amount of $27 thousand, were redeemed at a redemption price of 102.0156 percent of the liquidation amount.
The company’s comprehensive income for the three and nine months ended September 30, 2003 and 2002 is shown in the table below:
Three Months Ended
Other comprehensive income (loss) – change in unrealized gain on investment, net of tax
Comprehensive income
7
The following sets forth the computation of net income per basic and diluted common share:
Numerator:
Numerator for net income per basic common share – net income
Distributions on convertible mandatorily redeemable preferred securities, net of income taxes
Numerator for net income per diluted common share – net income attributable to common stock after assumed conversions
Denominator:
Denominator for net income per basic common share – weighted average shares
Effect of dilutive securities:
Conversion of mandatorily redeemable preferred securities
Stock options and restricted stock
Denominator for net income per diluted common share – adjusted weighted average shares and assumed conversions
Net income per basic common share
Net income per diluted common share
On January 1, 2003, the company adopted the provisions of 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. Adoption of this standard did not have a material effect on the company’s financial condition or results of operations.
On January 1, 2003, the company adopted the provisions of 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. As a result, effective January 1, 2003, the company presents gains and losses on early retirement of debt within income from continuing operations. Adoption of this standard did not affect the company’s financial condition or results of operations.
On January 1, 2003, the company adopted the provisions of 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 are effective for exit or disposal activities initiated after December 31, 2002.
8
On July 1, 2003, the company adopted the provisions of SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies the financial accounting and reporting requirements, originally established in SFAS 133, for derivative instruments and hedging activities. SFAS 149 provides greater clarification of the characteristics of a derivative instrument so that contracts with similar characteristics will be accounted for consistently. This statement is effective for contracts entered into or modified after June 30, 2003, as well as for hedging relationships designated after June 30, 2003. The adoption of this statement did not affect the company’s financial position or results of operations.
On July 1, 2003, the company adopted the provisions of SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The provisions of SFAS 150 modify the accounting for certain financial instruments with characteristics of both liabilities and equity by requiring that they be classified as liabilities. As a result, effective July 1, 2003, the company began presenting the distributions on its mandatorily redeemable preferred securities as interest expense on the company’s consolidated statements of income. Although adoption of the standard changed financial statement presentation, it did not affect the company’s financial condition or results of operations.
In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an Interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation were applicable to guarantees issued or modified after December 31, 2002. The application of this Interpretation affected some disclosures, but did not have a material effect on the company’s financial condition or results of operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created or obtained after January 31, 2003. For variable interests in a variable interest entity created before February 1, 2003, the Interpretation is applicable as of December 31, 2003. The application of this Interpretation did not have a material effect on the company’s financial condition or results of operations. Management does not expect the portions of this Interpretation that are not yet applicable to have a material effect on the company’s financial condition or results of operations.
The following tables present condensed consolidating financial information for: Owens & Minor, Inc.; on a combined basis, the guarantors of Owens & Minor, Inc.’s 8.5% Senior Subordinated 10-year notes (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.
9
Condensed Consolidating Financial Information
For the three months ended September 30, 2003
Statements of Operations
Net income (loss)
For the three months ended September 30, 2002
10
For the nine months ended September 30, 2003
For the nine months ended September 30, 2002
Intercompany dividend income
11
September 30, 2003
Balance Sheets
Accounts and notes receivable, net
Intercompany advances, net
Property and equipment, net
Intercompany investments
Intercompany long-term debt
Common stock
Accumulated other comprehensive income (loss)
12
December 31, 2002
13
Statements of Cash Flows
Accounts and notes receivable
Decrease in intercompany investment
Proceeds from investment in intercompany debt
Cash provided by (used for) investing activities
Change in intercompany advances
Payments on intercompany debt
Cash provided by (used for) financing activities
14
Adjustments to reconcile net income to cash provided by (used for) operating activities:
Cash provided by (used for) operating activities
Investments in intercompany debt
Proceeds from issuance of intercompany debt
Intercompany dividends paid
Net increase (decrease) in cash and cash equivalents
15
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis describes material changes in the financial condition of Owens & Minor, Inc. and its wholly-owned subsidiaries (O&M or the company) since December 31, 2002. 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 2002 Annual Report on Form 10-K for the year ended December 31, 2002.
Results of Operations
Third quarter and first nine months of 2003 compared with 2002
Overview. In the third quarter of 2003, the company earned net income of $12.8 million, or $0.34 per diluted common share, compared with $10.7 million, or $0.29 per diluted common share in the third quarter of 2002. For the first nine months of 2003, the company earned net income of $39.3 million compared to $33.0 million in the first nine months of 2002. The increase in net income resulted from increased sales, reduced financing costs, improved productivity in field operations and a lower effective tax rate, partially offset by increased spending on strategic initiatives. Results for the third quarter of 2003 were adversely affected by abnormally high employee healthcare costs and results for the third quarter of 2002 included a $3.0 million charge resulting from the cancellation of a mainframe computer services contract.
In late 2002, the company launched new strategic initiatives, which include the OMSolutionsSM and third-party logistics services, and Owens & Minor University, the company’s new in-house training program. Throughout the first nine months of 2003, the company continued the implementation of these initiatives by hiring staff and marketing new services to customers. Productivity improvements achieved in the core distribution business partially offset costs associated with the implementation of these initiatives. The company expects to continue to invest in these initiatives.
Net sales. Net sales increased 7% to $1.06 billion in the third quarter of 2003 from $992.5 million in the third quarter of 2002. Net sales increased 7% to $3.1 billion in the first nine months of 2003 from $2.9 billion in the comparable period of 2002. This increase in sales resulted primarily from additional sales volume with existing accounts.
Gross margin. Gross margin for the third quarter of 2003 was 10.5% of net sales, down slightly from 10.6% of net sales in the third quarter of 2002. Gross margin was 10.6% of net sales for the first nine months of 2003, consistent with the first nine months of 2002. The company continues to experience competitive pricing pressures but is working to offset them by offering value-added programs to customers such as PANDAC, CostTrackSM, and a variety of services through OMSolutionsSM.
Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses for the third quarter of 2003 were 7.8% of net sales, down from 7.9% in the third quarter of 2002. SG&A expenses for the first nine months of 2003 were 7.8% of net sales, consistent with the first nine months of 2002. SG&A expenses for the third quarter of 2003 included an increase in employee healthcare costs of $1.9 million over the third quarter of 2002. This increase was greater than expected due to a high number of large claims under the company’s self-insured plan. Expenses for the third quarter of 2002 included $3.0 million in termination costs related to the cancellation of the company’s contract for mainframe computer services. SG&A expenses for the third quarter and first nine months of 2003 were also affected by increased spending on strategic initiatives, partially offset by productivity improvements in the company’s core distribution services.
16
Financing costs. Financing costs, which include interest expense, net of finance charge collections, discount on accounts receivable securitization, and distributions on mandatorily redeemable preferred securities, totaled $3.4 million for the third quarter of 2003, compared with $4.7 million for the third quarter of 2002. Financing costs for the first nine months of 2003 were $11.4 million, compared with $15.4 million for the first nine months of 2002. These decreases were primarily the result of an overall decrease in the company’s outstanding financing, which included the repurchase of $27.6 million in mandatorily redeemable preferred securities in the fourth quarter of 2002 and first quarter of 2003, and the conversion of $104.4 million of mandatorily redeemable preferred securities in the third quarter of 2003.
The conversion of mandatorily redeemable preferred securities will reduce future financing costs by an annual rate of $5.6 million, compared to periods prior to the conversion. However, this conversion will not have an effect on net income per diluted common share.
The company expects to continue to manage its financing costs by managing working capital levels. In addition to the effect of the conversion of mandatorily redeemable preferred securities mentioned above, future financing costs will be affected primarily by changes in short-term interest rates and working capital requirements.
Income taxes. The effective tax rate was 39.2% for the third quarter of 2003, compared to 39.6% for the full year of 2002. This rate decrease resulted primarily from lower nondeductible expenses.
Financial Condition, Liquidity and Capital Resources
Liquidity. From December 31, 2002 to September 30, 2003, the company reduced its debt from $240.2 million to $211.3 million. In the first quarter of 2003, the company spent $20.4 million to repurchase 415,449 shares of its $2.6875 Term Convertible Securities, Series A (Securities) and $10.9 million to repurchase 661,500 shares of common stock under a repurchase plan initiated in late 2002. These repurchases, as well as the reduction of debt, were funded primarily by operating cash flows. As of September 30, 2003, the company had repurchased $27.6 million of Securities and $10.9 million of common stock, for a total of $38.5 million of the $50 million authorized under the repurchase plan, which expires December 31, 2003.
In the third quarter of 2003, the company initiated and completed the redemption of its outstanding Securities, resulting in the conversion of $104.4 million of Securities into approximately 5.1 million shares of common stock. The remaining Securities, representing a liquidation value of $27 thousand, were redeemed by the company.
In the first nine months of 2003, $128.4 million of cash was provided by operating activities, compared with $32.5 million in the first nine months of 2002. Cash flows in the first nine months of 2003 were positively affected by improved collections of accounts receivable. In the first nine months of 2002, the company reduced its sales of accounts receivable under the Receivables Financing Facility, resulting in a $70 million decrease in operating cash flow. The company uses the facility as a source of short-term financing, selling receivables as needed to provide cash for operations.
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, 2003, the company had $146.0 million of unused credit under its revolving credit facility and $225.0 million of unused financing under its Receivables Financing Facility.
17
Capital Expenditures. Capital expenditures were $12.3 million for the first nine months of 2003, up from $7.3 million for the first nine months of 2002. This increase included $4.3 million of additional spending on computer software, as the company focused on upgrading its information systems. The company expects capital expenditures for 2003 to continue to run at a higher rate than in 2002 as it continues to invest in its information systems.
Risks
The company is subject to risks associated with changes in the healthcare 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 or more of the company’s contracts with major customers or group purchasing organizations could have a significant effect on the company’s business.
Forward-looking Statements
Certain 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; the ability of the company to implement its strategic initiatives; 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 CostTrackSM; 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 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; the costs associated with and outcome of outstanding and any future litigation, including product and professional liability claims; 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
The company believes there has been no material change in its exposure to market risk from that discussed in Item 7A in the company’s Annual Report on Form 10-K for the year ended December 31, 2002.
18
Item 4. Controls and Procedures
The company conducted an evaluation, with the participation of the company’s management (including its Chief Executive Officer and Chief Financial Officer) of the effectiveness of its disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. 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. There has been no change in the company’s internal control over financial reporting during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
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, 2002. Through September 30, 2003, there have been no material developments in any legal proceedings reported in such Annual Report.
Item 6. Exhibits and Reports on Form 8-K
The company filed a Current Report on Form 8-K dated July 17, 2003, under Items 7 and 9, announcing its earnings for the second quarter ended June 30, 2003.
The company filed a Current Report on Form 8-K dated August 5, 2003, under Items 5 and 7, announcing the call for redemption of all of the outstanding $2.6875 Term Convertible Securities, Series A issued by Owens & Minor Trust I.
The company filed a Current Report on Form 8-K dated September 8, 2003, under Items 5 and 7, announcing the conversion of 2,086,771 of its $2.6875 Term Convertible Securities, Series A into approximately 5.1 million shares of Owens & Minor common stock on September 4, 2003.
19
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.
(Registrant)
Date November 13, 2003
/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
20
Exhibits Filed with SEC
21