UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2008
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) 723-7000
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 ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of Owens & Minor, Inc.’s common stock outstanding as of October 31, 2008, was 41,376,591 shares.
Owens & Minor, Inc. and Subsidiaries
Index
Part I. Financial Information
Condensed Consolidated Statements of Income – Three Months and Nine Months Ended September 30, 2008 and 2007
Part II. Other Information
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Condensed 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
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 condensed consolidated financial statements.
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Condensed Consolidated Balance Sheets
Assets
Current assets
Cash and cash equivalents
Accounts and notes receivable, net of allowances of $31,480 and $24,912
Merchandise inventories
Other current assets
Total current assets
Property and equipment, net of accumulated depreciation of $75,656 and $67,868
Goodwill, net
Intangible assets, 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, excluding current portion
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 – 41,404 shares and 40,874 shares
Paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
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Condensed Consolidated Statements of Cash Flows
Operating activities
Adjustments to reconcile net income to cash provided by operating activities:
Provision for losses on accounts and notes receivable
Provision for LIFO reserve
Amortization of direct-response advertising
Deferred direct-response advertising costs
Share-based compensation expense
Loss on interest rate swaps
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
Acquisition of intangible assets
Net cash received related to acquisitions of businesses
Cash used for investing activities
Financing activities
Cash dividends paid
Net payments on revolving credit facility
Proceeds from exercise of stock options
Excess tax benefits related to share-based compensation
Increase in drafts payable
Proceeds from termination of interest rate swaps
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
Supplemental disclosure of cash flow information
Income taxes paid, net
Interest paid
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Notes to Condensed Consolidated Financial Statements
(in thousands, unless otherwise indicated)
The accompanying unaudited condensed 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, 2008, and December 31, 2007, and the consolidated results of operations for the three- and nine-month periods and cash flows for the nine-month periods ended September 30, 2008 and 2007, in conformity with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
During the third quarter of 2008, the company identified errors in its previously filed condensed consolidated balance sheets as of December 31, 2007 and 2006 and condensed consolidated statement of cash flows for the nine months ended September 30, 2007. The errors were considered immaterial; however, the company has revised the balance sheet as of December 31, 2007, and the statement of cash flows for the nine months ended September 30, 2007, included in this filing. The errors were the result of the company incorrectly classifying bank overdrafts of $8.3 million and $2.9 million as of December 31, 2007 and 2006, respectively, in cash and cash equivalents rather than in accounts payable, and the company incorrectly classifying an increase in bank overdrafts of $2.3 million for the nine months ended September 30, 2007, as a change in cash and cash equivalents rather than as a change in drafts payable in cash used for financing activities. The correction of these errors did not impact previously reported net income, shareholders’ equity, net income per share or cash flows provided by operating activities for any of the periods presented.
The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.
The following table presents the activity in capitalized direct-response advertising costs for the three and nine months ended September 30, 2008 and 2007:
Beginning, direct-response advertising costs, net
Amortization
Ending, direct-response advertising costs, net
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Intangible assets at September 30, 2008 and December 31, 2007, are as follows:
At September 30, 2008:
Gross intangible assets
Accumulated amortization
Net intangible assets
At December 31, 2007:
Weighted average useful life
Amortization expense for intangible assets was $2.2 million and $2.6 million for the three months ended September 30, 2008 and 2007, and $7.0 million and $8.9 million for the nine months ended September 30, 2008 and 2007.
Based on the current carrying value of intangible assets subject to amortization, estimated future amortization expense is as follows: Remainder of 2008 – $2.0 million; 2009 – $5.9 million; 2010 – $3.6 million; 2011 – $2.1 million; 2012 – $1.5 million.
The components of net periodic pension cost of the company’s retirement plans for the three and nine months ended September 30, 2008 and 2007, 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 company had a $350 million revolving credit facility as of September 30, 2008 and December 31, 2007. In July 2008, this facility was amended to change certain restrictions and to release certain guarantors. On October 1, 2008, Lehman Brothers, Inc. defaulted on its commitment under the revolving credit facility, thereby decreasing the company’s total borrowing capacity to $306 million.
During the three- and nine-month periods ended September 2008 and 2007, the company held interest rate swaps related to a portion of the company’s $200 million fixed-rate debt (Senior Notes).
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The swaps were designated as a fair value hedge of the Senior Notes. Accordingly, no net gains or losses were recorded on the statement of income related to the company’s underlying debt and interest rate swap agreements. The fair value of the swaps was determined using observable market inputs (Level 2), as defined by, and in accordance with, the fair value hierarchy of Statement of Financial Accounting Standards No. (SFAS) 157, Fair Value Measurements.
During the third quarter of 2008, Lehman Brothers Holdings Inc., guarantor of one of the swaps, declared bankruptcy. The company determined at that date that the swaps were no longer expected to be effective in offsetting interest rate risk. The company discontinued accounting for the swaps as a fair value hedge as of that date. The company terminated the swaps in September 2008 and received proceeds of $3.8 million, plus accrued interest of $0.9 million. The company realized a loss of $3.1 million, included in interest expense, net, in the third quarter of 2008. This loss represents the difference between the fair value of the swaps as of the date that hedge accounting was discontinued and the proceeds received on the termination of the swaps. The fair value adjustment of $6.9 million to the carrying value of the related debt, recorded prior to the discontinuance of hedge accounting, is being recognized as an offset to interest expense using the interest method over the remaining life of the debt.
The company’s comprehensive income for the three and nine months ended September 30, 2008 and 2007, is shown in the table below:
Other comprehensive income – adjustments related to retirement benefit plans, net of tax
Reclassification of gain on cash-flow hedge derivatives, net of tax
Comprehensive income
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
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The following sets forth the amounts contributed by the DTC distribution business for the three and nine months ended September 30, 2008 and 2007:
Operating (losses) earnings
Intercompany expense included in operating (losses) earnings
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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 Senior Notes; and the non-guarantor subsidiaries of the Senior 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.
Condensed Consolidating Financial Information
For the three months ended September 30, 2008
Statements of Operations
Operating earnings (loss)
Income (loss) before income taxes
Income tax provision (benefit)
Net income (loss)
For the three months ended September 30, 2007
Interest (income) expense, net
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For the nine months ended September 30, 2008
For the nine months ended September 30, 2007
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September 30, 2008
Balance Sheets
Accounts and notes receivable, net
Intercompany advances, net
Property and equipment, net
Intercompany receivables
Intercompany investments
Intercompany long-term debt
Common stock
Retained earnings (deficit)
Accumulated other comprehensive income (loss)
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December 31, 2007
Intercompany receivable
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Statements of Cash Flows
Change in intercompany advances
Cash provided by (used for) financing activities
Net increase (decrease) in cash and cash equivalents
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Increase in intercompany investments
Net cash paid for acquisitions of business
Cash provided by (used for) investing activities
Increase intercompany investment, net
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SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements. In February 2008, the effective date of SFAS 157 was deferred to fiscal years beginning after November 15, 2008, for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The company adopted SFAS 157 beginning in the interim period ended March 31, 2008, for financial assets and liabilities. The adoption had no impact on the company’s financial statements for the periods presented herein. The company is evaluating the impact of adoption of SFAS 157 for nonfinancial assets and nonfinancial liabilities on the company’s financial position and results of operations.
In October 2008, FASB Staff Position (FSP) FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, was issued. This FSP clarifies the application of SFAS 157 in a market that is not active. The company has considered the guidance provided by FSP FAS 157-3 in its determination of estimated fair values as of September 30, 2008, and there was no impact on the company’s financial position or results of operations for either of the three- or nine-month periods ended September 30, 2008.
The company adopted SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, as of January 1, 2008. This statement permits the company the irrevocable option to account for most financial assets and financial liabilities at fair value, rather than at historical cost, with changes in the fair value recognized in earnings. The adoption had no impact on the company’s consolidated financial statements for the three and nine months ended September 30, 2008, as the company has not elected the fair value option for any of its financial assets or financial liabilities.
The company adopted Emerging Issues Task Force Issue No. (EITF) 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards, as of January 1, 2008, on a prospective basis. EITF 06-11 requires income tax benefits from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified nonvested equity shares, nonvested equity share units, and outstanding equity share options to be recognized as an increase to additional paid-in capital. The impact of the adoption of EITF 06-11 on the three and nine months ended September 30, 2008 was not material.
In March 2008, SFAS 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133, was issued. This statement requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS 161 will be effective for the company in the first quarter of 2009, and the impact to the company’s consolidated financial statements will be limited to changes in disclosures.
In April 2008, FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, was issued. FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. This FSP is effective for fiscal years beginning after December 15, 2008, with prospective application to intangible assets acquired after the effective date. The adoption of FSP FAS 142-3 is not expected to have a material impact on the company’s consolidated financial statements.
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In May 2008, SFAS 162, The Hierarchy of Generally Accepted Accounting Principles, was issued. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States (the GAAP hierarchy). SFAS 162 makes the GAAP hierarchy explicitly and directly applicable to preparers of financial statements, a step that recognizes preparers’ responsibilities for selecting the accounting principles for their financial statements, and sets the stage for making the framework of FASB Concept Statements fully authoritative. SFAS 162 is effective in the fourth quarter of 2008. The adoption of SFAS 162 is not expected to have an impact on the company’s consolidated financial statements.
In June 2008, FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, was issued. This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method described in SFAS 128, Earnings per Share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The company is evaluating the impact of this pronouncement on the consolidated financial statements.
On October 1, 2008, the company acquired certain assets and liabilities of The Burrows Company, a Chicago-based, privately-held distributor of medical and surgical supplies to the acute care market. The purchase price was $23.7 million of cash, plus $56.1 million of assumed debt, which was paid off on the acquisition date. The company borrowed approximately $80 million under its revolving credit facility to fund this acquisition and the related payment of assumed debt. In conjunction with this acquisition, the company also entered into an agreement to purchase certain real estate used in the operation of this business. The purchase is expected to be completed by year-end 2008 for a purchase price in the range of $20 million.
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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, 2007. Trends of a material nature are discussed to the extent known and considered relevant. This discussion should be read in conjunction with the condensed 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, 2007.
Results of Operations
Third quarter and first nine months of 2008 compared with 2007
Overview. In the third quarter and first nine months of 2008, the company earned net income of $25.3 million and $73.1 million, improved from $21.2 million and $50.3 million in the comparable periods of 2007. Net income per diluted common share was $0.61 for the third quarter and $1.76 for the first nine months of 2008, increased from $0.52 and $1.23 in the comparable periods of 2007. Operating earnings, which were $46.2 million, or 2.55% of revenue, in the third quarter of 2008, increased from $40.9 million, or 2.43% of revenue, in the third quarter of 2007. In the first nine months of 2008, operating earnings were $131.2 million, or 2.45% of revenue, also increased from operating earnings in the first nine months of 2007, which were $102.4 million, or 2.03% of revenue. Operating earnings in the first nine months of 2007 were negatively affected by the cost of integrating the acquired acute-care distribution business of McKesson Medical-Surgical Inc.
Included in operating earnings for the third quarter and first nine months of 2008 are $0.3 million and $1.8 million of operating losses from the direct-to-consumer (DTC) distribution business, including corporate charges of $0.3 million and $0.8 million. In the comparable periods of 2007, the DTC distribution business had operating earnings of $1.2 million and $2.5 million, including corporate charges of $0.4 million and $1.2 million.
On October 1, 2008, the company acquired certain assets and liabilities of The Burrows Company, a privately-held distributor of medical and surgical supplies to the acute care market. The Burrows Company reported sales of $603 million for the year ended December 31, 2007. The purchase price was $23.7 million of cash, plus $56.1 million of assumed debt, which was paid off on the acquisition date. In conjunction with this acquisition, the company also entered into an agreement to purchase certain real estate used in the operation of this business. The purchase is expected to be completed by year-end 2008 for a purchase price in the range of $20 million.
Revenue. Revenue increased 7.3%, or $123.7 million, to $1.81 billion in the third quarter of 2008, from $1.69 billion in the third quarter of 2007. For the first nine months of 2008, revenue increased 6.1%, or $306.1 million, from the comparable period in 2007. In comparing the third quarter and first nine months of 2008 to the comparable periods of 2007, the increases resulted primarily from greater sales to existing customers as well as sales to new customers, partially offset by decreases in revenue from the acquired McKesson business.
The DTC distribution business contributed $23.6 million and $72.7 million of revenue in the third quarter and first nine months of 2008, as compared with $26.6 million and $81.5 million in the comparable periods of 2007. The decline in revenue of the DTC distribution business is primarily due to lower Medicare reimbursements for certain respiratory products, higher contractual allowances,
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which were adjusted for 2008 based on historical payment trends, and a slightly lower patient count. There were approximately 182,000 DTC customers at September 30, 2008, as compared with 187,000 at September 30, 2007. The Medicare Improvements for Patients and Providers Act of 2008, enacted on July 15, 2008, will reduce reimbursement rates for certain items included in Medicare’s competitive bidding program that are offered by the DTC distribution business. For these products, reimbursement rates will be reduced by 9.5% nationwide beginning January 1, 2009. This Act also delayed the competitive bidding program for at least 18 months from the enactment date and cancelled all contracts previously awarded. Therefore, when this program restarts, new contracts will be necessary.
Gross margin. Gross margin dollars were $193.7 million and $571.0 million in the third quarter and first nine months of 2008. For the same periods of 2007, gross margin dollars were $178.3 million and $529.8 million. As a percentage of revenue, gross margin was 10.70% and 10.66% for the third quarter and first nine months of 2008, as compared with 10.57% and 10.49% for the same periods of 2007. In comparing quarter-to-quarter, the 13 basis point gross margin improvement was primarily due to greater manufacturers’ price increases and additional sales of value-added programs and services, including an approximate 30% increase in revenue from higher margin MediChoice® products, the company’s private-label brand of select medical/surgical products. In comparing the first nine months of 2008 to the same period of 2007, gross margin as a percent of revenue increased 17 basis points. This increase resulted from: (i) improved gross margin from the acquired McKesson business as this business transitioned to O&M systems; (ii) additional sales of programs and services; (iii) greater supplier incentives; and (iv) greater manufacturers’ price increases, which were partially offset by an increase in the reserve for last-in, first-out (LIFO) inventory valuation.
The company values inventory for its healthcare provider distribution business under the LIFO method. Had inventory been valued under the first-in, first-out (FIFO) method, gross margin would have been 20 basis points greater in the first nine months of 2008 and 15 basis points greater in the first nine months of 2007.
Selling, general and administrative (SG&A) expenses. SG&A expenses were $141.0 million and $419.6 million for the third quarter and first nine months of 2008, as compared with $131.4 million and $407.6 million in the comparable periods of 2007. As a percentage of revenue, SG&A expense was 7.79% in the third quarter and 7.83% in the first nine months of 2008, consistent with 7.79% in the third quarter of 2007 and improved from 8.07% in the first nine months of 2007. In comparing the third quarter of 2008 to the same period of 2007, SG&A expense increased as a result of increases in fuel costs of $1.1 million, information technology outsourcing fees of $1.0 million, distribution center personnel expenses of $1.4 million, and incentive compensation expense, including equity-based compensation, of $5.5 million.
In comparing the first nine months of 2008 to the same period of 2007, SG&A expense as a percentage of revenue improved as a result of the company leveraging its infrastructure over greater sales. Also, costs associated with the integration of the acquired McKesson business and service fees paid to McKesson for operational support during the transition period of $6.7 million were incurred in 2007 but did not recur in 2008. For the first nine months of 2008 as compared with the same period of 2007, increases in expense included: (i) incentive compensation expense, including equity-based compensation, of $13.8 million; (ii) fuel costs of $3.4 million; (iii) the provision for losses on receivables from DTC distribution business customers of $2.8 million; (iv) employee benefit expense of $2.4 million; (v) workers compensation expense of $1.8 million; and (vi) information technology outsourcing fees of $1.8 million. The increase in incentive compensation expense reflects improved achievement against certain performance-based measures, as well as the impact of an increase in the price of the company’s common stock. These expense increases were offset by a decrease in selling costs of $2.3 million in the first nine months of 2008 compared to the same period of 2007.
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Depreciation and amortization expense for the third quarter and first nine months of 2008 was $7.8 million and $23.4 million, a slight increase from $7.7 million in the third quarter of 2007 and a slight decrease from $23.9 million in the first nine months of 2007. Amortization of intangible assets was $0.4 million and $1.8 million less for the third quarter and first nine months of 2008 than for the same periods of 2007, due to the accounting for the McKesson purchase transaction being finalized, and lower amortization expense for acquired intangibles in the DTC distribution business, which are amortized at rates that decline during the amortization period. This decrease in amortization was partially offset by greater depreciation from capital additions made to facilitate the growth in the healthcare provider business. There were no acquisitions of intangible assets in the DTC distribution business in 2007 or in the first nine months of 2008.
Interest expense, net. Net interest expense was $6.3 million for the third quarter and $12.6 million for the first nine months of 2008, an increase from $5.4 million for the third quarter of 2007 and a decrease from $19.2 million for the first nine months of 2007. Decreased interest expense in the first nine months of 2008 was primarily due to lower balances outstanding under the company’s revolving credit agreement, as the company has significantly reduced borrowings under this facility since the second quarter of 2007. Interest expense also decreased in the 2008 periods due to a more favorable interest rate environment. This decrease was partially offset by interest expense recognized during the third quarter of 2008 on the interest rate swaps hedging the company’s $200 million fixed-rate debt. These swaps were designated as a fair value hedge until Lehman Brothers Holdings Inc., guarantor of one of the swaps, declared bankruptcy. The company determined at that date that the swaps were no longer expected to be effective in offsetting interest rate risk. The company discontinued accounting for the swaps as a fair value hedge as of that date and realized a loss of $3.1 million in the third quarter of 2008, representing the difference between the fair value of the swaps as of the date that hedge accounting was discontinued and the proceeds received on termination of the swaps of $3.8 million. The fair value adjustment of $6.9 million to the carrying value of the related debt is being recognized as an offset to interest expense using the interest method over the remaining life of the debt.
In the first nine months of 2008, the company’s effective interest rate was 6.3%, excluding interest expense recognized related to the interest rate swaps, on average borrowings of $206.8 million, compared to 6.8% on average borrowings of $384.2 million in the first nine months of 2007.
Income taxes. The provision for income taxes was $14.7 million and $45.5 million in the third quarter and first nine months of 2008, compared to $14.3 million and $33.0 million in the same periods of 2007. The effective tax rate was 36.7% and 38.3% for the third quarter and first nine months of 2008, compared to 40.4% and 39.6% in the same periods of 2007. The lower effective rates in 2008 were due to a decrease in tax accruals related to potential tax liabilities as a result of the resolution of outstanding tax issues.
Financial Condition, Liquidity and Capital Resources
Liquidity. In the first nine months of 2008, cash and cash equivalents increased by $10.4 million to $25.7 million at September 30, 2008. In the first nine months of 2008, the company generated $123.6 million of cash from operations, compared to $202.0 million in the first nine months of 2007. Cash from operations in the first nine months of 2008 was negatively affected by increases in accounts receivable and inventories, while the first nine months of 2007 were positively affected by decreases in both of these items. Cash flows in the first nine months of 2008 and 2007 were positively affected by the timing of payments for inventory.
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Cash used for investing activities increased to $20.2 million in the first nine months of 2008 from $5.9 million in the same period of 2007, primarily due to cash received in 2007 related to the acquisition of the McKesson business, partially offset by capital expenditures in 2007 to accommodate the acquired McKesson business. Capital expenditures were $20.2 million in the first nine months of 2008, compared to $20.4 million in the same period of 2007. Capital expenditures in the third quarter of 2008 included the purchase of land for future expansion of the company’s headquarters for approximately $5.4 million.
Financing activities used $88.0 million of cash in the first nine months of 2008, and $195.3 million in the first nine months of 2007. In both periods, cash was used primarily to reduce the company’s revolving credit facility and to pay dividends. Cash used to pay dividends was $24.7 million in the first nine months of 2008, increased from $20.7 million in the same period of 2007, as the company paid a dividend per share of $0.60 in the first nine months of 2008 as compared with $0.51 per share in the first nine months of 2007.
Accounts receivable days sales outstanding (DSO) at September 30, 2008, were 23.8 days, representing a decline from 24.3 days at December 31, 2007, and 27.7 days at September 30, 2007, based on three month’s sales. Inventory turnover was 10.3 in the third quarter of 2008, 10.6 in the fourth quarter of 2007 and 9.8 in the third quarter of 2007.
The company has $200 million of senior notes outstanding, which mature in 2016 and bear interest at 6.35%, payable semiannually. During the third quarter of 2008, the company terminated its interest rate swap agreements, under which the company paid counterparties variable rates based on LIBOR, and the counterparties paid the company a fixed interest rate of 6.35% on a notional amount of $100 million, effectively converting one-half of the notes to variable-rate debt. The company received cash proceeds on termination of the swap agreements totaling $4.7 million, of which $3.8 million related to the fair value of the swaps is included in cash used for financing and $0.9 million related to accrued interest is included in cash provided by operating activities.
The company has a $350 million revolving credit facility. In July 2008, the credit agreement was amended to improve the company’s flexibility by changing certain restrictions and by releasing certain guarantors. The interest rate on the facility 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, as defined by the credit agreement. The company is charged a commitment fee of between 0.05% and 0.15% on the unused portion of the facility, which includes a 0.05% reduction in the fee based on the company’s investment grade rating. At September 30, 2008, approximately $339 million was available for borrowing. On October 1, 2008, Lehman Brothers, Inc. defaulted on its commitment under the revolving credit facility, thereby decreasing the company’s total borrowing capacity to $306 million.
On October 1, 2008, the company acquired certain assets and liabilities of The Burrows Company, in exchange for cash consideration of $23.7 million, plus $56.1 million of assumed debt, which was paid off on the acquisition date. The company borrowed approximately $80 million under its revolving credit facility to fund this acquisition and the related payment of assumed debt. In conjunction with this acquisition, the company also entered into an agreement to purchase certain real estate used in the operation of this business. The purchase is expected to be completed by year-end 2008 for a purchase price in the range of $20 million.
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The company believes its available financing sources will be sufficient to fund working capital needs and long-term strategic growth, although this cannot be assured. Based on the company’s leverage ratio at September 30, 2008, the company’s interest rate under its revolving credit facility, which is subject to adjustment quarterly, will remain unchanged at LIBOR plus 50 basis points at the next adjustment date.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, see note 12 in the Notes to Condensed Consolidated Financial Statements.
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;
the ability of customers to meet financial commitments due to the company;
the ability to retain existing customers and the success of marketing and other programs in attracting new customers;
dependence on suppliers;
the ability to adapt to changes in product pricing and other terms of purchase by suppliers of product;
changes in manufacturer preferences between direct sales and wholesale distribution;
competition;
changing trends in customer profiles and ordering patterns;
the ability of the company to meet customer demand for additional value-added services;
the availability of supplier incentives;
access to special inventory buying opportunities;
the ability of business partners and financial institutions to perform their contractual responsibilities;
the ability to manage operating expenses;
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the effect of price volatility in the commodities markets, including fuel price fluctuations, on company operating costs and supplier product prices;
the ability of the company to continue to obtain financing at reasonable rates and 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 acquisitions;
the costs associated with and outcome of outstanding and any future litigation, including product and professional liability claims;
the outcome of outstanding tax contingencies;
the ability to manage reimbursements from Medicare, Medicaid, private healthcare insurers and individual customers;
changes in government regulations, including healthcare laws and regulations; and
changes in reimbursement guidelines of Medicare and Medicaid and/or reimbursement practices of private healthcare insurers.
O&M provides credit, in the normal course of business, to its customers. The company performs ongoing credit evaluations of its customers and maintains reserves for credit losses.
The company has $200 million of outstanding fixed-rate debt maturing in 2016. During the first nine months of 2008, O&M used interest rate swaps to modify the company’s balance of fixed and variable rate financing, thus hedging its interest rate risk. The company was exposed to certain losses in the event of nonperformance by the counterparties to these swap agreements and to market risk from changes in interest rates related to these swap agreements. The company terminated these swap agreements during the third quarter of 2008.
The company is exposed to market risk from changes in interest rates related to its revolving credit facility. The company had no outstanding borrowings and $10.7 million in letters of credit under its revolving credit facility at September 30, 2008. A hypothetical increase in interest rates of 100 basis points would result in a potential reduction in future pre-tax earnings of approximately $0.1 million per year for every $10 million of outstanding borrowings under the revolving credit facility.
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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, as of the end of such period, 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, 2008, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
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, 2007. Through September 30, 2008, there have been no material developments in any legal proceedings reported in such Annual Report.
Certain risk factors that the company believes could affect its business and prospects are described in the company’s Annual Report on Form 10-K for the year ended December 31, 2007. Through September 30, 2008, there have been no material changes in any risk factors reported in such Annual Report.
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2.1
2.2
3.1
4.1
10.1
10.2
10.3
31.1
31.2
32.1
32.2
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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.
/s/ CRAIG R. SMITH
/s/ JAMES L. BIERMAN
/s/ OLWEN B. CAPE
Exhibits Filed with SEC
Exhibit #
27