UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 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)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
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 Securities Exchange Act). Yes x No ¨
The number of shares of Owens & Minor, Inc.’s common stock outstanding as of August 1, 2005, was 39,879,564 shares.
Owens & Minor, Inc. and Subsidiaries
Index
2
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Income
(unaudited)
Three Months Ended
June 30,
Six Months Ended
(in thousands, except per share data)
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
2005
December 31,
2004
Assets
Current assets
Cash and cash equivalents
Accounts and notes receivable, net of allowances of $10,974 and $6,768
Merchandise inventories
Other current assets
Total current assets
Property and equipment, net of accumulated depreciation of $69,168 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 – 39,864 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
(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
Deferred direct-response advertising costs
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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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 June 30, 2005 and the consolidated results of operations for the three- and six-month periods and cash flows for the six-month periods ended June 30, 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. 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 company paid total consideration of approximately $57.9 million in cash. The purchase price is subject to adjustment upon a final determination of the net working capital acquired. A preliminary allocation of the purchase price resulted in approximately $5.6 million of net tangible assets, $37.7 million of goodwill and $14.7 million of intangible assets, which consist primarily of customer relationships. The allocation of the purchase price is expected to be finalized after the valuation of certain acquired assets is complete.
Effective April 4, 2005, Access acquired certain assets of Direct Diabetic Supplies, Inc., a Florida-based, direct-to-consumer distributor of diabetic supplies for $1.6 million in cash. A preliminary allocation of the purchase price included $0.7 million of goodwill and $0.9 million of intangible assets, primarily customer relationships. The allocation of the purchase price is expected to be finalized after the valuation of certain acquired assets is complete.
Effective April 8, 2005, O&M acquired certain assets of Cyrus Medical Systems, Inc., a software company that created and markets a tissue implant tracking system which will expand the technology product offerings of OMSolutionsSM, for $1.0 million in cash. The allocation of the purchase price included $0.9 million of computer software, included in “other assets, net” on the consolidated balance sheet, and $0.1 million of intangible assets.
All of these acquisitions have been accounted for as purchases of businesses, and the results of operations have been included in the company’s consolidated financial statements since their dates of acquisition. Had the acquisitions 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 and six months ended June 30, 2005 or 2004.
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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:
Beginning with the acquisition of Access on January 31, 2005, the company defers 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 periodically 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.
For the quarter ended June 30, 2005, the company deferred $1.6 million of direct response advertising costs and recorded amortization of $0.2 million. At June 30, 2005, deferred direct response advertising costs of $2.2 million, net of accumulated amortization of $0.2 million, were included in “other assets, net” on the consolidated balance sheet.
The following table presents the activity in goodwill for the six months ended June 30, 2005 and 2004:
Beginning balance
Additions due to acquisitions
Ending balance
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Intangible assets, included in other assets, net, at June 30, 2005 and December 31, 2004 are as follows:
Customer relationships
Other intangibles
Unamortized intangible pension asset
Total
Customer relationship intangibles are amortized on an accelerated basis over four years. Other intangibles are amortized on a straight line basis, generally for periods of between 4 and 15 years.
Amortization expense for intangible assets was $1.5 million and $0.03 million for the three months ended June 30, 2005 and 2004, and $1.5 million and $0.1 million for the six months ended June 30, 2005 and 2004.
Based on the current carrying value of intangible assets subject to amortization, estimated future amortization expense is as follows: Remainder of 2005 - $2.9 million, 2006 - $4.3 million, 2007 - $2.8 million, 2008 - $2.6 million, 2009 - $0.6 million, 2010 - $0.3 million.
The components of net periodic pension cost of the company’s retirement plans for the three and six months ended June 30, 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
The following sets forth the computation of net income per basic and diluted common share:
Numerator:
Numerator for net income per basic and diluted common share – net income
Denominator:
Denominator for net income per basic common share – weighted average shares
Effect of dilutive securities - stock options and restricted stock
Denominator for net income per diluted common share – adjusted weighted average shares
Net income per common share – basic
Net income per common share – diluted
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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 $4.7 million as of June 30, 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.
For the three months ended June 30, 2005
Owens &
Minor, Inc.
Guarantor
Subsidiaries
Non-guarantor
Statements of Operations
Operating earnings (loss)
Income (loss) before income taxes
Income tax provision (benefit)
Net income (loss)
For the three months ended June 30, 2004
Interest (income) expense, net
Intercompany dividend income
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Condensed Consolidating Financial Information
For the six months ended June 30, 2005
For the six months ended June 30, 2004
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June 30, 2005
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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Statements of Cash Flows
Increase in intercompany investments
Change in intercompany advances
Increase in intercompany investments, net
Cash provided by (used for) financing activities
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Noncash intercompany dividend income
Net cash paid for acquisition
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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 and results of operations 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 Annual Report on Form 10-K for the year ended December 31, 2004.
Results of Operations
Second quarter and first six months of 2005 compared with 2004
Overview. In the second quarter and first six months of 2005, the company earned net income of $16.0 million and $31.9 million, increases of 4% and 6% over the comparable periods of 2004. Net income per diluted common share was $0.40 for the second quarter and $0.80 for the first six months of 2005, up from $0.39 for the second quarter and $0.76 for the first six months of 2004. These increases resulted from increased operating earnings combined with slightly lower financing costs. Operating earnings, which were $28.5 million for the second quarter and $58.1 million for the first six months of 2005, increased by 3% from the second quarter and 5% from the first six months of 2004. Operating earnings increased due to 8% revenue growth, including the addition of Access Diabetic Supply in January 2005, partially offset by lower supplier incentives and alternate source purchasing compared to 2004.
Acquisitions.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.
In April 2005, Access acquired certain assets of Direct Diabetic Supplies, Inc. (Direct), a Florida-based, direct-to-consumer distributor of diabetic supplies, for $1.6 million in cash. Also in April, Owens & Minor acquired certain assets of Cyrus Medical Systems, Inc., a software company that created and markets a tissue implant tracking system which will expand the technology product offerings of OMSolutionsSM, for $1.0 million in cash.
Revenue. Revenue increased 8% to $1.21 billion in the second quarter of 2005 from $1.12 billion in the second quarter of 2004. For the first six months of 2005, revenue increased 8% over the comparable prior year period. Excluding the effect of acquisitions, revenue increased 7% in the second quarter and first six months of 2005 over the comparable periods of 2004. This revenue increase resulted primarily from higher sales volume to existing customers as well as sales to new customers.
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Operating earnings. As a percentage of revenue, operating earnings decreased slightly to 2.4% in the second quarter and first six months of 2005 from 2.5% in the comparable periods of 2004. The following table presents the components of operating earnings as a percent of revenue for the second quarter and first six months of 2005 and 2004:
Three months ended
Six months ended
SG&A expense
Percentages may not foot due to rounding
Gross margin for the second quarter and first six months of 2005 was 10.6% of revenue, up from 10.3% in the comparable periods of 2004. The increase in overall gross margin resulted primarily from the addition of Access, whose gross margins are higher than the company’s core distribution business. Contributions from OMSolutionsSM had a slightly favorable effect on gross margin in both the second quarter and first six months of 2005 as compared to the same periods of 2004. These increases were partially offset by lower contributions from supplier incentives and alternate source purchasing compared to the same periods of 2004, having a combined unfavorable effect on gross margin of 0.3% of revenue for the second quarter and 0.2% of revenue for the first six months of 2005.
The company values inventory for its core distribution business 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 0.2% and 0.1% of revenue in the first six months of 2005 and 2004. Gross margin for the second quarters of 2005 and 2004 would not have differed materially from reported amounts.
SG&A expenses were 7.9% of revenue in both the second quarter and first six months of 2005, up from 7.6% in the comparable periods of 2004. The increase resulted from the acquisition of Access, which experiences higher expenses as a percentage of revenue than the core distribution business.
Depreciation and amortization expense for the second quarter and first six months of 2005 was $5.1 million and $8.6 million, up $1.3 million and $1.1 million from the comparable periods of 2004. These increases resulted from $1.4 million of amortization of intangible assets in the second quarter and first six months of 2005 for the acquisitions of Access and Direct.
Financing costs. Financing costs, which include interest expense and discount on accounts receivable securitization, totaled $2.9 million and $6.2 million for the second quarter and first six months of 2005, compared with $3.1 million and $6.6 million for the same periods of 2004. The decrease results from the absence of fees in 2005 for the receivables financing facility that the company terminated in May 2004.
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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 $9.6 million and $19.9 million in the second quarter and first six months of 2005 compared with $9.2 million and $18.6 million in the same periods of 2004. The effective tax rate was 37.6% and 38.5% for the second quarter and first half of 2005, compared to 38.0% for the full year of 2004. For the second quarter of both years, the tax rate was lower than the full year rate because of adjustments of the company’s reserve for tax liabilities for years subject to audit. The company expects that its effective tax rate for 2005 will be approximately 39.3%.
Financial Condition, Liquidity and Capital Resources
Liquidity. The company’s liquidity remained strong in the first six months of 2005, as its cash and cash equivalents increased $18.3 million to $74.1 million at June 30, and long-term debt decreased slightly from $207.5 million at December 31, 2004 to $206.4 million at June 30, 2005. In the first six months of 2005, the company generated $121.4 million of cash flow from operations, compared with $71.1 million in the first half of 2004. Operating cash flow improved due to reductions of inventory of $27.9 million in the first half of 2005, adjusted for LIFO provision, compared with an increase of $31.9 million in the first half of 2004. Cash flows in both periods benefited from timing of payments for inventory purchases and improved collections of accounts receivable. Accounts receivable days sales outstanding at June 30, 2005, were 24.8 days, improved from 26.5 days at December 31, 2004 and 25.5 days at June 30, 2004. Inventory turnover increased to 10.7 in the second quarter of 2005 from 10.0 in the second quarter of 2004.
Cash used for investing activities increased from $10.1 million in the first six months of 2004 to $76.2 million in the first six months of 2005, largely due to the acquisitions of Access for total consideration of $57.9 million, Direct for $1.6 million and Cyrus Medical for $1.0 million.
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 June 30, 2005, the company had $240.7 million of unused credit under its revolving credit facility.
Capital Expenditures. Capital expenditures were $15.6 million in the first six months of 2005, compared to $7.7 million in the first six months of 2004, as a result of 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.
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.
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
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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 recognized for such excess tax deductions would have been $1.4 million and $1.0 million in the first six months of 2005 and 2004.
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In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. The provisions of SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. 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.
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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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, 2004.
Item 4. Controls and Procedures
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 June 30, 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
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, 2004. Through June 30, 2005, there have been no material developments in any legal proceedings reported in such Annual Report.
Item 4. Submission of Matters to a Vote of Shareholders
The following matters were submitted to a vote of O&M’s shareholders at its annual meeting held on April 28, 2005, with the voting results designated below each such matter:
Directors
Votes For
Votes Against
Or Withheld
Abstentions
Broker
Non-Votes
G. Gilmer Minor, III
J. Alfred Broaddus, Jr.
Eddie N. Moore, Jr.
Peter S. Redding
Craig R. Smith
29,501,677
36,593,747
Item 6. Exhibits
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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 August 5, 2005
/s/ CRAIG R. SMITH
President & 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
Exhibit #