UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2004
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 ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
The number of shares of Owens & Minor, Inc.’s common stock outstanding as of October 31, 2004, was 39,425,348 shares.
Owens & Minor, Inc. and Subsidiaries
Index
Part I.
Financial Information
Part II.
Other Information
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Part I. Financial Information
Consolidated Statements of Income
(unaudited)
Revenue
Cost of revenue
Gross margin
Selling, general and administrative expenses
Depreciation and amortization
Other operating income and expense, net
Operating earnings
Interest expense, net
Discount on accounts receivable securitization
Distributions on mandatorily redeemable preferred securities
Other expense
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.
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Consolidated Balance Sheets
Assets
Current assets
Cash and cash equivalents
Accounts and notes receivable, net of allowance of $7,570 and $8,350
Merchandise inventories
Other current assets
Total current assets
Property and equipment, net of accumulated depreciation of $70,990 and $74,056
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
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 – 39,416 shares and 38,979 shares
Paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
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Consolidated Statements of Cash Flows
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
Net change in other current assets and liabilities
Other, net
Cash provided by operating activities
Investing activities
Additions to property and equipment
Additions to computer software
Net cash paid for acquisition of business
Proceeds from sale of land
Cash used for investing activities
Financing activities
Repurchase of mandatorily redeemable preferred securities
Repurchase of 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
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Notes to Consolidated Financial Statements
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, 2004 and the consolidated results of operations for the three and nine month periods and cash flows for the nine month periods ended September 30, 2004 and 2003, in conformity with U.S. 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 reclassifications have no effect on total revenue or net income as previously reported. The most significant reclassifications are as follows:
In March 2004, the company acquired certain net assets of 5nQ, a small, clinical inventory management solutions company. 5nQ developed an innovative software service, QSight™, for clinical healthcare inventory management solutions. This strategic acquisition enables O&M to enhance the OMSolutionsSM technology and service offerings to hospitals and suppliers.
The acquisition has been accounted for as a purchase of a business and, accordingly, the operating results of 5nQ have been included in the company’s consolidated financial statements since the date of acquisition. The company paid $2.5 million in cash for the purchase, and will also make additional payments to the previous owners, who are now employed by O&M, based on the amount of QSight™ subscription revenues through March 2007. The allocation of the purchase price included $1.5 million of computer software and $0.2 million of intangible assets, both included in “other assets, net” on the consolidated balance sheet, and $0.9 million of goodwill. Had the acquisition taken place on January 1, 2003, the consolidated revenue and net income of the company would not have materially differed from the amounts reported for the three months ended September 30, 2003 or the nine months ended September 30, 2004 and 2003.
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
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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:
In December 2003, the Financial Accounting Standards Board (FASB) revised Statement of Financial Accounting Standards No. (SFAS) 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits. The revised statement requires disclosures in addition to those in the original SFAS 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. Most of the additional disclosure requirements were effective for the company as of December 31, 2003, with the remaining requirements effective in 2004. The adoption of the revised statement did not affect the company’s financial condition or results of operations. The revised statement requires interim disclosures to be made about the components of net periodic pension cost of the company’s retirement plans. The components of net periodic pension cost of the company’s retirement plans for the three and nine months ended September 30, 2004 and 2003 are as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic pension cost
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The company’s comprehensive income for the three and nine months ended September 30, 2004 and 2003 is shown in the table below:
Other comprehensive income – change in unrealized gain on investment, net of tax
Comprehensive income
The following sets forth the computation of basic and diluted net income per common share:
Numerator:
Numerator for basic net income per common share – net income
Distributions on convertible mandatorily redeemable preferred securities, net of income taxes
Numerator for diluted net income per common share – net income attributable to common stock after assumed conversions
Denominator:
Denominator for basic net income per common share – weighted average shares
Effect of dilutive securities:
Conversion of mandatorily redeemable preferred securities
Stock options and restricted stock
Denominator for diluted net income per common share – adjusted weighted average shares and assumed conversions
Net income per common share – basic
Net income per common share – diluted
In September 2004, the company received a notice from the Internal Revenue Service (IRS) proposing to disallow, effective for the 2001 tax year, the reduction in the company’s last-in first-out (LIFO) inventory for certain manufacturer discounts earned by the company and instead require the inclusion of the discounts in income. Since the proposed disallowance involves the timing of deductions, it primarily affects the company’s liability for interest. Management believes that its treatment of the discounts is consistent with a ruling received by the company on this matter from the IRS and is appropriate under the tax law. Accordingly, the company plans to contest the proposed disallowance pursuant to all applicable administrative and legal procedures. If the company were unsuccessful, the deductions would be disallowed effective for the 2001 tax year, and the company would have to pay a deficiency of $32.3 million in taxes on which deferred taxes have been provided, as well as interest calculated at statutory rates, for which no reserve has been established. The payment of the deficiency and interest would adversely affect operating cash flow for the full amount of the payment, while the company’s net income and earnings per share would be reduced by the
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amount of any liability for interest, net of tax. The ultimate resolution of this matter may take several years and a determination adverse to the company could have a material effect on the company’s results of operations.
In December 2003, the FASB issued FASB Interpretation No. (FIN) 46R (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. The company was required to apply FIN 46R to interests in variable interest entities as of March 31, 2004. Application of this Interpretation did not affect 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 (the 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.
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Condensed Consolidating Financial Information
(in thousands)
For the three months ended
September 30, 2004
Statements of Operations
Operating earnings (loss)
Interest (income) expense, net
September 30, 2003
Income (loss) before income taxes
Income tax provision (benefit)
Net income (loss)
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For the nine months ended
Intercompany dividend income
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Owens &
Minor, Inc.
Guarantor
Subsidiaries
Balance Sheets
Accounts and notes receivable, net
Intercompany advances, net
Property and equipment, net
Intercompany investments
Intercompany long-term debt
Common stock
Retained earnings (deficit)
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December 31, 2003
Non-guarantor
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Statements of Cash Flows
Noncash intercompany dividend income
Change in intercompany advances
Cash provided by (used for) financing activities
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Decrease in intercompany investment
Proceeds from investment in intercompany debt
Cash provided by (used for) investing activities
Payments on intercompany debt
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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, 2003. 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 2003 Annual Report on Form 10-K for the year ended December 31, 2003.
Reclassifications
As a result of the growth of the OMSolutionsSM business and the increasing effect of customer finance charge income on interest expense in recent periods, the company made certain changes to the presentation of its income statement effective January 1, 2004, to provide more useful information to investors. These reclassifications have no effect on total revenue or net income as previously reported. The most significant reclassifications are as follows:
Financial information for all prior periods included in this report has been reclassified to conform to the current presentation.
Results of Operations
Third quarter and first nine months of 2004 compared with 2003
Overview. For the third quarter and first nine months of 2004, net income increased by 18% and 15% from the comparable periods of 2003. The increase in net income was driven by increased operating earnings, lower financing costs as a result of the repurchase and conversion of mandatorily redeemable preferred securities in 2003 and improved collections of accounts receivable, as well as a lower effective tax rate. Operating earnings increased by 8% from the third quarter of 2003 to the third quarter of 2004, while for the first nine months of the year, operating earnings increased by 4% over the prior year period. Operating earnings increased as a result of revenue growth as well as lower employee benefit costs, partially offset by lower gross margins and increased spending on strategic initiatives.
Revenue. For the third quarter and first nine months of 2004, revenue increased 7% over the comparable prior year periods. This revenue increase resulted from new core distribution business, including HealthTrust Purchasing Group, and increased sales to existing customers.
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Operating earnings. As a percentage of revenue, operating earnings were consistent with the prior year periods, at 2.4% for the third quarters of 2004 and 2003, and 2.5% for the first nine months of 2004 and 2003. The following table presents the components of operating earnings as a percent of revenue for the third quarter and first nine months of 2004 and 2003:
SG&A expense
Percentages may not foot due to rounding
The decrease in gross margin from 2003 to 2004 resulted primarily from reduced alternate sourcing of products and ongoing competitive pricing pressure.
Competitive pricing pressure has been a significant factor in recent years, and management expects this trend to continue. In addition, as suppliers continue to seek more restrictive agreements with distributors, the company has access to fewer special inventory buying opportunities than in the past. The company is working to counteract the effects of these trends by continuing to offer customers a wide range of value-added services, such as OMSolutionsSM, PANDAC® and other programs, as well as expanding the MediChoice® private label product line. The company also continues to work with suppliers on programs to enhance gross margin.
SG&A expenses were 7.4% of revenue for the third quarter and 7.5% for the first nine months of 2004, down from 7.6% in the comparable periods of 2003. The company benefited from decreases in employee benefit costs, particularly healthcare coverage, as the company experienced an unusual number of large claims under its self-insured plan in the first nine months of 2003. In addition, depreciation and amortization decreased from 2003 to 2004 by $0.2 million for the third quarter and $0.6 million for the first nine months as the company has migrated some of its information technology (IT) applications from its own hardware to equipment provided under the IT outsourcing agreement that the company entered into in 2002.
The company continued to invest in its strategic initiatives, such as OMSolutionsSM and Owens & Minor University, at a higher rate than in the prior year. The company expects to continue to invest in its strategic initiatives while also focusing on operational standardization in order to further improve productivity. Additionally, OMSolutionsSM expenses exceeded revenue for the third quarter and first nine months of 2004, and management no longer expects it to become accretive by the end of the year. However, the company remains focused on growing the OMSolutionsSMbusiness both internally and through acquisitions, and in October 2004, acquired the assets of HealthCare Logistics Services, a small, California-based, healthcare consulting firm. The company expects this acquisition to add strength to its OMSolutionsSM consulting and outsourcing efforts across the nation.
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Financing costs. Financing costs, which include interest expense, discount on accounts receivable securitization and distributions on mandatorily redeemable preferred securities, totaled $3.1 million and $9.6 million for the third quarter and first nine months of 2004, compared with $4.3 million and $14.6 million for the same periods of 2003. The decrease in financing costs from 2003 resulted primarily from reductions in outstanding financing, most significantly the repurchase of $20.8 million and conversion of $104.4 million of mandatorily redeemable preferred securities in 2003. Financing costs were also favorably affected by interest income from increased cash and cash equivalents resulting principally from improved collections of accounts receivable and timing of payments for inventory purchases.
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 working capital and capital expenditure requirements.
Income taxes. The provision for income taxes was $9.3 million and $27.9 million in the third quarter and first nine months of 2004 compared with $8.3 million and $25.3 million in the same periods of 2003. The effective tax rate was 38.0% and 38.2% for the third quarter and first nine months of 2004, compared to 38.9% for the full year of 2003. The tax provision for the third quarter and first nine months of 2004 includes an adjustment of the company’s reserve for tax liabilities for years subject to audit as the company was better able to estimate its ultimate liability for those years.
Financial Condition, Liquidity and Capital Resources
Liquidity. The company’s liquidity remained strong in the first nine months of 2004, as its cash and cash equivalents increased $86.0 million to $102.3 million at September 30, and long-term debt remained consistent at $208.3 million, down $1.2 million from December 31, 2003. In the first nine months of 2004, the company generated $128.5 million of cash flow from operations, compared with $128.4 million in the first nine months of 2003. Cash flows in both periods were positively affected by improved collections of accounts receivable and timing of payments for inventory purchases. Accounts receivable days sales outstanding at September 30, 2004 were 25.8 days, improved from 27.8 days at December 31, 2003 and 27.5 days at September 30, 2003. Inventory turnover decreased slightly to 9.6 in the third quarter of 2004 from 9.7 in the third quarter of 2003.
Effective May 4, 2004, the company amended its revolving credit facility, extending its expiration to May 2009. The credit limit of the amended facility increased from $150.0 million to $250.0 million, and the interest rate is based on, at the company’s discretion, LIBOR, the Federal Funds Rate or the Prime Rate, plus an adjustment based on the company’s leverage ratio. Under the new terms of the facility, the company is charged a commitment fee of between 0.15% and 0.35% on the unused portion of the facility. The terms of the agreement limit the amount of indebtedness that the company may incur, require the company to maintain certain levels of net worth, 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. As a result of the increased borrowing capacity under the amended revolving credit facility, the company terminated its off balance sheet accounts receivable financing facility.
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, 2004, the company had $243.5 million of unused credit under its revolving credit facility.
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Capital Expenditures. Capital expenditures were $11.8 million in the first nine months of 2004 compared with $12.3 million in the same period of 2003. The mix of expenditures changed from 2003 to 2004, with increased spending on design and construction of a new corporate headquarters and equipment and improvements related to the relocation of two of the company’s distribution centers, offset by reduced capital spending on information systems. The company expects capital expenditures for the remainder of 2004 to include continued spending on the construction of the corporate headquarters building. Capital expenditures for information systems are expected to continue to run at a lower rate than in 2003.
Risks
The company is subject to risks associated with changes in the healthcare industry, including competition and continued efforts to control costs, which place pressure on operating earnings, 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 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:
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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.
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, 2003.
The company carried out an evaluation, with the participation of the company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the company’s 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. In September 2004, as the result of human error, the company made a late Form 8-K filing under Item 5.04 relating to a notice sent to Section 16 insiders informing them of a prohibition on trading in company securities during an upcoming 401(k) blackout period. This special blackout period overlapped with the company’s standard trading blackout period between earnings releases, of which the Section 16 officers had already been notified and were in compliance. Based upon the company’s 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 controls over financial reporting during the quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
Part II. Other Information
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, 2003. Through September 30, 2004, there have been no material developments in any legal proceedings reported in such Annual Report.
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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 5, 2004
/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
Exhibits Filed with SEC