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, 2008. 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, 2008.

Results of Operations

First quarter of 2009 compared with first quarter of 2008

Overview. In the first quarter of 2009, the company earned net income of $14.0 million, decreased from $24.2 million in the first quarter of 2008. Net income per diluted common share was $0.34 for the first quarter of 2009, a decrease from $0.59 in the comparable period of 2008. Operating earnings were $39.9 million, or 2.05% of revenue, in the first quarter of 2009, a decline from $43.0 million, or 2.49% of revenue, in the first quarter of 2008. Operating earnings in the first three months of 2009 were negatively affected by the cost of integrating the acquired acute-care distribution business of The Burrows Company (Burrows).

Divestitures. In January 2009, the company exited its direct-to-consumer distribution business (the "DTC business"). Accordingly, the DTC business is presented as discontinued operations in the company's condensed consolidated financial statements, and all prior period information has been reclassified to be consistent with the current period presentation.

The following table presents highlights from the company's condensed consolidated statements of income on a percentage of revenue basis:

            For the three months ended March 31,          2009     2008
            Gross margin                                  9.42 %   9.85 %
            Selling, general and administrative expense   7.15 %   7.12 %
            Operating earnings                            2.05 %   2.49 %
            Income from continuing operations             1.15 %   1.39 %

Revenue. Revenue increased 12.8%, or $221.3 million, to $1.95 billion in the first quarter of 2009, from $1.73 billion in the first quarter of 2008. In comparing the first quarter of 2009 to the comparable period of 2008, approximately 70% of the increase resulted largely from the Burrows acquisition, as well as other net new business. The remaining revenue growth resulted from increased sales to existing accounts.

Gross margin. Gross margin dollars were $183.6 million in the first quarter of 2009 compared to $170.2 million for the same period of 2008. As a percentage of revenue, gross margin was 9.42% for the first quarter of 2009, as compared with 9.85% for the same period of 2008. In comparing quarter-to-quarter, the increase in gross margin dollars was primarily due to the increase in revenues. The decline of 43 basis points in gross margin as a percentage of revenue was primarily due to the deferral of revenue, in the first quarter of 2009, related to new contracts signed in 2008, as well as the impact of greater supplier price increases. The deferral of revenue, which totaled $4.4 million, relates to certain customer contracts with performance targets related to services to be performed by the company over the remaining term of the contracts. The supplier price increases were approximately 60% greater than increases experienced in the first quarter of 2008. As a result of these price increases, the LIFO provision increased $6.0 million to $16.4 million for the first quarter of 2009. A portion of the price increases was not eligible for supplier rebates, and as a result, in combination with the increase in the LIFO provision, there was a $4.5 million reduction in gross margin during the first quarter of 2009 as compared with the same period in the prior year.

The company values inventory under the LIFO method. Had inventory been valued under the first-in, first-out (FIFO) method, gross margin would have been 84 basis points greater in the first three months of 2009 and 61 basis points greater in the first three months of 2008.

Selling, general and administrative (SG&A) expenses. SG&A expenses were $139.4 million for the first quarter of 2009, as compared with $123.0 million in the comparable period of 2008. As a percentage of revenue, SG&A expense was 7.15% in the first quarter of 2009, increased from 7.12% in the first quarter of 2008. In comparing the first quarter of 2009 to the same period of 2008, SG&A expense increased by $6.6 million for salaries, $1.2 million for occupancy costs, $1.6 million for freight and $2.1 million for other transition expenses, all primarily related to the integration of the Burrows business. Additionally, SG&A expense included increases of $3.7 million in employee benefits and $1.9 million in information technology outsourcing fees. These increases were partially offset by decreases in management incentive expenses of $2.4 million and fuel expenses of $1.3 million.

Depreciation and amortization expense. Depreciation and amortization expense for the first quarter of 2009 was $5.8 million, a 10% increase from $5.3 million in the first quarter of 2008. The increase is primarily due to amortization of intangibles from the acquired Burrows business and computer software, as well as depreciation of warehouse equipment.

Interest expense, net. Net interest expense was $3.3 million for the first quarter of 2009, a decrease from $3.5 million for the first quarter of 2008. In the first three months of 2009, the company's effective interest rate was 6.0% on average borrowings of $228.0 million, compared to 6.9% on average borrowings of $214.1 million in the first three months of 2008.

Income taxes. The provision for income taxes was $14.2 million in the first quarter of 2009, compared to $15.4 million in the same period of 2008. The effective tax rate was 38.8% for the first quarter of 2009, compared to 39.0% in the same period of 2008. The lower effective rate in 2009 was due to lower interest expense related to potential tax liabilities.

Income from continuing operations. Income from continuing operations decreased to $22.4 million for the first quarter of 2009 compared to $24.0 million in the first quarter of 2008. The decrease was due to an increase in SG&A expense of $16.4 million, which was partially offset by an increase in gross margin of $13.4 million and a decline in income tax expense of $1.2 million.

Income (loss) from discontinued operations, net of tax. Loss from discontinued operations, net of tax, was $8.4 million for the first quarter of 2009 compared to income of $0.2 million in the first quarter of 2008. The decrease of $8.6 million was primarily due to charges associated with exiting the DTC business, partially offset by a $3.2 million gain on the sale of the business.

Financial Condition, Liquidity and Capital Resources



    For the three months ended March 31,                        2009        2008
    Net cash provided by (used for) continuing operations:
    Operating activities                                      $   83.1     $ 114.4
    Investing activities                                      $   (1.1 )   $  (4.3 )
    Financing activities                                      $ (156.5 )   $ (93.2 )
    Net cash provided by (used for) discontinued operations   $   77.1     $  (6.5 )

Liquidity. In the first three months of 2009, cash and cash equivalents increased by $2.6 million to $10.5 million at March 31, 2009. The company generated $83.1 million of operating cash from continuing operations, compared to $114.4 million in the first three months of 2008. Operating cash from continuing operations in the first three months of 2009 and 2008 was positively affected by the timing of payments for inventory and collections of accounts receivable and, for 2009, was negatively affected by increases in inventory, primarily related to new business and the transition of the Burrows business.

Cash used for investing activities decreased to $1.1 million in the first three months of 2009 from $4.3 million in the same period of 2008. The decrease was due to cash received in 2009 related to the Burrows acquisition, which partially offset increased capital expenditures for software and technology for distribution center efficiency improvements. Capital expenditures were $8.1 million in the first three months of 2009, compared to $4.3 million in the same period of 2008.

Financing activities used $156.5 million of cash in the first three months of 2009, and $93.2 million in the first three months of 2008. During the first quarter of 2009, cash from operating activities of continuing and discontinued operations, along with $63.0 million of proceeds from the sale of the DTC business, was used to reduce the company's borrowings under the revolving credit facility by $146.5 million and to pay dividends. During the same period of 2008, cash from operating activities of continuing operations was used to reduce the company's borrowings under the revolving credit facility and bank overdrafts, totaling $87.2 million, and to pay dividends. Cash used to pay dividends was $9.5 million in the first three months of 2009, increased from $8.2 million in the same period of 2008, as the company paid a dividend per share of $0.23 for the first three months of 2009 as compared with $0.20 per share for the first three months of 2008.

Accounts receivable days sales outstanding (DSO) were 23.6 days at March 31, 2009, 24.5 days at December 31, 2008, and 22.6 days at March 31, 2008, based on three months' sales. Inventory turnover was 10.3 in the first quarter of 2009 and 10.6 in the first quarter of 2008, based on three months' sales.

The company has $200 million of senior notes outstanding, which mature in 2016 and bear interest at 6.35%, payable semi-annually.

The company has a revolving credit facility with a total borrowing capacity of $306 million. The facility expires in May 2011. 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 March 31, 2009, the company had $15.1 million outstanding under the facility, including outstanding letters of credit, leaving $290.9 million available for borrowing.

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 March 31, 2009, the company's interest rate under its revolving credit facility, which is subject to adjustment quarterly, will decrease to 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 ability to meet performance targets specified by customer contracts under contractual commitments;

• 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;

• 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 ability to timely or adequately respond to technological advances in the medical supply industry;

• the risk that information systems are interrupted or damaged by unforeseen events or fail for any extended period of time;

• 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; and

• changes in government regulations, including healthcare laws and regulations.