UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2005
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 April 29, 2005, was 39,702,127 shares.
Owens & Minor, Inc. and Subsidiaries
Index
Part I.
Financial Information
Item 1.
Financial Statements
Consolidated Statements of Income – Three Months Ended March 31, 2005 and 2004
Consolidated Balance Sheets – March 31, 2005 and December 31, 2004
Consolidated Statements of Cash Flows – Three Months Ended March 31, 2005 and 2004
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II.
Other Information
Legal Proceedings
Item 5.
Item 6.
Exhibits
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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
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 allowances of $10,086 and $6,768
Merchandise inventories
Other current assets
Total current assets
Property and equipment, net of accumulated depreciation of $68,819 and $67,932
Goodwill, net
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 sharesSeries A; Participating Cumulative Preferred Stock; none issued
Common stock, par value $2 per share; authorized - 200,000 shares; issued and outstanding – 39,675 shares and 39,519 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 acquisitions
Cash used for investing activities
Financing activities
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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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 March 31, 2005 and the consolidated results of operations and cash flows for the three-month periods ended March 31, 2005 and 2004, 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.
Effective January 31, 2005, the company acquired Access Diabetic Supply, LLC (Access), a Florida-based direct-to-consumer distributor of diabetic supplies and products for certain other chronic disease categories. The company paid $57 million in cash, as well as transaction and due diligence costs of $0.9 million. The purchase price is subject to adjustment upon a final determination of the net working capital acquired. Access, with 2004 revenues of approximately $32 million, primarily markets blood glucose monitoring devices, test strips and other ancillary products used by diabetics for self-testing.
The acquisition has been accounted for as a purchase of a business and, accordingly, the operating results of Access have been included in the company’s consolidated financial statements from the date of acquisition. A preliminary allocation of the purchase price resulted in approximately $5 million of net tangible assets and $53 million of goodwill and intangible assets. The allocation of the purchase price is expected to be completed after the valuation of certain acquired assets is complete. Had the acquisition taken place on January 1, 2004, the consolidated revenue and net income of the company would not have materially differed from the amounts reported for the three months ended March 31, 2005 or 2004.
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:
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Three Months Ended
March 31,
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:
Beginning with the acquisition of Access Diabetic Supply, LLC on January 31, 2005, the company capitalizes the costs of direct-response advertising of its direct-to-consumer diabetic supplies for campaigns that meet the capitalization requirements of American Institute of Certified Public Accountants Statement of Position 93-7, Reporting on Advertising Costs. The company amortizes these costs over a four-year period on an accelerated basis. The company’s ability to realize the value of these assets is evaluated at each balance sheet date by comparing the carrying amounts of the assets to the remaining net cash flows expected to result from sales to customers obtained through the advertising. In the quarter ended March 31, 2005, the company capitalized $826 thousand of direct-response advertising costs and recorded amortization of $35 thousand. At March 31, 2005, deferred advertising costs of $791 thousand were included in other assets, net on the company’s consolidated balance sheet.
The components of net periodic pension cost of the company’s retirement plans for the three months ended March 31, 2005 and 2004 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 following sets forth the computation of basic and diluted net income per common share:
Numerator:
Numerator for basic and diluted net income per common share – net income
Denominator:
Denominator for basic net income per common share – weighted average shares
Effect of dilutive securities - stock options and restricted stock
Denominator for diluted net income per common share – adjusted weighted average shares
In September 2004, the company received a notice from the Internal Revenue Service (IRS) proposing to disallow, effective for the 2001 tax year and all subsequent years, certain reductions in the company’s tax-basis last-in, first-out (LIFO) inventory valuation. Since the proposed adjustment involves the timing of deductions, it primarily affects the company’s liability for interest. Management believes that its tax-basis method of LIFO inventory valuation is consistent with a ruling received by the company on this matter from the IRS and is appropriate under the tax law. The company filed an appeal with the IRS in December 2004 and plans to contest the proposed adjustment pursuant to all applicable administrative and legal procedures. If the company were unsuccessful, the adjustment would be effective for the 2001 tax year and all subsequent years, and the company would have to pay a deficiency of approximately $41.1 million in federal, state, and local taxes for tax years through 2004 on which deferred taxes have been provided, as well as interest calculated at statutory rates, of approximately $4.1 million as of March 31, 2005, net of any tax benefits, for which no reserve has been established. No penalties have been proposed. 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 only be reduced by the 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 cash flows and results of operations.
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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.
(in thousands)
For the three months ended
March 31, 2005
Statements of Operations
Operating earnings (loss)
Interest expense (income), net
March 31, 2004
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Condensed Consolidating Financial Information
Non-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, 2004
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For the three months ended March 31, 2005
Statements of Cash Flows
Adjustments to reconcile net income to cash provided by (used for) operating activities:
Cash provided by (used for) operating activities
Increase in intercompany investments
Net cash paid for acquisition of business
Change in intercompany advances
Cash provided by (used for) financing activities
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For the three months ended March 31, 2004
Net increase (decrease) in cash and cash equivalents
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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, 2004. 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 2004 Annual Report on Form 10-K for the year ended December 31, 2004.
Results of Operations
First quarter of 2005 compared with first quarter of 2004
Overview. In the first quarter of 2005, the company earned net income of $15.9 million, or $0.40 per diluted common share, compared with $14.6 million, or $0.37 per diluted common share, in the first quarter of 2004. Operating earnings were $29.6 million in the first quarter of 2005, compared to $27.4 million in the first quarter of 2004, an increase of 8%. The increase in operating earnings resulted from an 8% increase in revenue, while the company maintained a consistent operating margin of 2.5% of revenue. Net income per diluted common share increased 8% as a result of the increase in operating earnings, combined with slightly lower financing costs.
Acquisition. On January 31, 2005, the company acquired Access Diabetic Supply, LLC (Access), a Florida-based direct-to-consumer distributor of diabetic supplies and products for certain other chronic disease categories, for total consideration of approximately $57.9 million in cash. Access, which primarily markets blood glucose monitoring devices, test strips and other ancillary products used by diabetics for self-testing, operates as a separate business within Owens & Minor. The direct-to-consumer distribution business experiences significantly higher gross margins and selling, general and administrative (SG&A) expenses as a percent of revenue than the company’s core medical/surgical supply distribution business.
Revenue. Revenue increased 8% to $1.19 billion in the first quarter of 2005 from $1.11 billion in the first quarter of 2004. The increase primarily resulted from higher sales volume to existing customers. Access revenues accounted for approximately one-tenth of the increase.
Operating earnings. Operating earnings increased 8% to $29.6 million in the first quarter of 2005 from $27.4 million in 2004. As a percent of revenue, operating earnings remained consistent at 2.5%.
Gross margin for the first quarter of 2005 was 10.5% of revenue, up from 10.3% in the first quarter of 2004. The increase from the first quarter of 2004 resulted primarily from the addition of Access, whose gross margins are higher than the company’s core distribution business. Reduced alternate sourcing of products decreased gross margin by approximately 0.1% of revenue.
The core distribution business values inventory under the last-in, first-out (LIFO) method. Had inventory been valued under the first-in, first-out (FIFO) method, gross margin would have been higher by 0.4% and 0.2% of revenue in the first quarters of 2005 and 2004.
SG&A expenses were 7.9% of revenue in the first quarter of 2005, up from 7.6% of revenue in the first quarter of 2004. The increase resulted primarily from the acquisition of Access, as SG&A expenses in the core distribution business remained consistent as a percent of revenue.
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Financing costs. Financing costs, which include interest expense and discount on accounts receivable securitization, decreased to $3.3 million for the first quarter of 2005 from $3.4 million in the first quarter of 2004, as the company no longer incurs fees related to the receivables financing facility that it terminated in May 2004.
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 requirements.
Income taxes. The provision for income taxes was $10.3 million in the first quarter of 2005 compared with $9.4 million in the same period of 2004, representing an effective rate of 39.3% for the first quarter of 2005, compared with 38.0% for the full year of 2004. The lower rate in 2004 resulted from favorable adjustments to the company’s reserve for tax liabilities for years subject to audit.
Financial Condition, Liquidity and Capital Resources
Liquidity. The company’s liquidity remained strong in the first quarter of 2005, as its cash and cash equivalents increased $18.4 million to $74.2 million at the end of the quarter, and debt of $205.7 million, decreased $2.0 million from $207.7 million at December 31, 2004. In the first three months of 2005, the company generated $123.0 million of cash flow from operations, compared with $52.9 million in the first quarter of 2004. Cash flows in both quarters were positively affected by timing of payments for inventory purchases and improved collections of accounts receivable, while first quarter 2005 cash flows were also enhanced by inventory reductions. Accounts receivable days sales outstanding at March 31, 2005 were 24.4 days, improved from 26.5 days at December 31, 2004 and 26.1 days at March 31, 2004. Inventory turnover increased to 10.3 in the first quarter of 2005 from 10.2 in the first quarter of 2004.
In January 2005, the company purchased Access Diabetic Supply for total consideration of approximately $57.9 million using existing cash.
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 March 31, 2005, the company had $240.7 million of available credit under its revolving credit facility.
Capital Expenditures. Capital expenditures were $6.2 million in the first quarter of 2005, compared to $3.3 million in the first quarter of 2004. The increase was primarily due to increased spending on the construction of a new corporate headquarters. The company expects capital expenditures for the remainder of 2005 to include additional spending on the construction of the corporate headquarters as well as increased spending on information technology development.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS 151, Inventory Costs, which addresses how a business enterprise should account for abnormal amounts of idle facility expense, freight, handling costs and spoilage incurred in the production and acquisition of inventory. The provisions of SFAS 151 require that these costs be recognized as current period charges, rather than as inventory cost. The company will be required to adopt the provisions of this standard beginning on January 1, 2006. Management does not expect application of this standard to have a material effect on the company’s financial condition or results of operations.
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In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, which addresses the measurement of exchanges of nonmonetary assets. The provisions of SFAS 153 require that all exchanges of nonmonetary assets that have commercial substance be recorded at fair value. The company will be required to adopt the provisions of this standard beginning on January 1, 2006. Management does not expect application of this standard to have a material effect on the company’s financial condition or results of operations.
In December 2004, the FASB issued SFAS 123R, Share-Based Payment, a revision of SFAS 123, Accounting for Stock-Based Compensation.SFAS 123R also supersedes Accounting Principles Board Opinion No. (APB) 25, Accounting for Stock Issued to Employees, and amends SFAS 95, Statement of Cash Flows. SFAS 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the income statement based on their fair values, while SFAS 123 as originally issued provided the option of recognizing share-based payments based on their fair values or based on their intrinsic values with pro forma disclosure of the effect of recognizing the payments based on their fair values.
As a result of Final Rule Release No. 33-8568 of the United States Securities and Exchange Commission, the company will be required to adopt the provisions of this standard beginning on January 1, 2006, instead of July 1, 2005, as previously disclosed. SFAS 123R permits public companies to adopt its requirements using one of two methods:
As permitted by SFAS 123, the company currently uses the intrinsic value method as defined by APB 25 to account for share-based payments. As a result, the adoption of SFAS 123R is expected to have a material effect on the company’s results of operations, although it will not affect the company’s overall financial position. As the amount of expense to be recognized in future periods will depend on the levels of future grants, the effect of adoption of SFAS 123R cannot be predicted with certainty. However, had the company adopted SFAS 123R in prior periods, the effect of adoption would have approximated the effect of using the fair value method, as defined in SFAS 123, to account for share-based payment as disclosed in Note 4 to the company’s consolidated financial statements under the caption “Stock-Based Compensation.” SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flows, rather than as operating cash flows as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The company cannot estimate what these amounts will be in the future, as they depend on a number of factors including the timing of employee exercises of stock options and the value of the company’s stock at the date of those exercises. However, had the company adopted SFAS 123R in prior periods, the amount of cash flows
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recognized for such excess tax deductions would have been $0.6 million and $0.9 million in the first quarters of 2005 and 2004.
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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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, 2004.
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. 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 controls over financial reporting during the quarter ended March 31, 2005, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
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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, 2004. Through March 31, 2005, there have been no material developments in any legal proceedings reported in such Annual Report.
Entry into Material Definitive Agreements
The company entered into a letter agreement dated March 1, 2005 (Extension Letter) extending through June 30, 2006 the term of the Authorized Distributor Agreement between Novation, LLC and the company effective July 1, 2001 (AD Agreement) and modifying certain other terms which are not material. The company distributes medical/surgical supplies to Novation members pursuant to the AD Agreement. The form of Extension Letter is filed as Exhibit 10.1 hereto.
In addition, each of Access Diabetic Supply, LLC (Access) and Owens & Minor Healthcare Supply, Inc., a wholly-owned subsidiary of the company that owns all the membership interests in Access, executed a Joinder Agreement dated March 17, 2005 with Bank of America, N.A. pursuant to which each such subsidiary became a “Guarantor” under the company’s Amended and Restated Credit Agreement dated as of May 4, 2004 as required by Section 7.11 of such credit agreement.
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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 May 5, 2005
/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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Exhibits Filed with SEC
Exhibit #
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