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OMI > SEC Filings for OMI > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for OWENS & MINOR INC/VA/


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis describes results of operations and material changes in the financial condition of Owens & Minor, Inc. and its subsidiaries since December 31, 2011. 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 our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Third quarter and first nine months of 2012 compared with 2011

Acquisition. Owens & Minor, Inc. (we, us, or our) is a leading national distributor of name-brand medical and surgical supplies and a healthcare supply-chain management company. As a result of the August 31, 2012 acquisition of Movianto, we will now report Movianto as a separate International business segment. Prior to the acquisition, we had one reportable business segment, which now comprises the Domestic business segment. Accordingly, the Domestic business segment includes traditional distribution, OM HealthCare Logistics, and other supply-chain management services, such as OM SolutionsSM, which provide solutions to healthcare providers and suppliers of medical and surgical products in the United States. Segment information for revenues, operating earnings, depreciation and amortization, capital expenditures and total assets are provided in Note 14 of the Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Financial Highlights. The following table provides a reconciliation of reported operating earnings, net income and diluted net income per common share to non-GAAP measures used by management:

                                                Three Months Ended              Nine Months Ended
(Dollars in thousands except EPS data)            September 30,                   September 30,
                                               2012            2011           2012            2011
Operating earnings, as reported (GAAP)       $  46,663       $ 58,465       $ 151,712       $ 160,501
Acquisition-related and exit and
realignment charges                              7,831            351           8,448             351

Operating earnings, adjusted (Non-GAAP)
(Adjusted Operated Earnings)                 $  54,494       $ 58,816       $ 160,160       $ 160,852
Adjusted Operating Earnings as a percent
of revenue (Non-GAAP)                             2.50 %         2.70 %          2.43 %          2.50 %
Net income, as reported (GAAP)               $  24,597       $ 33,352       $  84,070       $  91,256
Acquisition-related and exit and
realignment charges, after-tax                   6,588            213           6,963             213

Net income, adjusted (Non-GAAP) (Adjusted
Net Income)                                  $  31,185       $ 33,565       $  91,033       $  91,469
Net income per diluted common share, as
reported (GAAP)                              $    0.39       $   0.53       $    1.33       $    1.44
Acquisition-related and exit and
realignment charges                               0.10             -             0.11              -

Net income per diluted common share,
adjusted (Non-GAAP) (Adjusted EPS)           $    0.49       $   0.53       $    1.44       $    1.44

Use of Non-GAAP Measures

Our management's discussion and analysis contains financial measures that are not calculated in accordance with U.S. generally accepted accounting principles (GAAP). In general, the measures exclude items and charges that (i) management does not believe reflect our core business and relate more to strategic, multi-year corporate activities; or (ii) relate to activities or actions that may have occurred over multiple or in prior periods without predictable trends. Management uses these non-GAAP financial measures internally to evaluate our performance, evaluate the balance sheet, engage in financial and operational planning and determine incentive compensation.

Management provides these non-GAAP financial measures to investors as supplemental metrics to assist readers in assessing the effects of items and events on its financial and operating results and in comparing our performance to that of our competitors. However, the non-GAAP financial measures used by us may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies.

The non-GAAP financial measures disclosed by us should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and the financial results calculated in accordance with GAAP.

There were no exit and realignment expenses in the first nine months of 2012 or 2011. Acquisition-related expenses are associated with Movianto in 2012 and with the establishment of our joint venture in China in 2011. During the third quarter and first nine months of 2012 and 2011, the difference between our GAAP and Non-GAAP measures were related entirely to acquisition-related costs. Unless otherwise stated, our analysis hereinafter excludes acquisition-related and exit and realignment expenses.

Adjusted EPS (Non-GAAP) declined by four cents in the third quarter of 2012 compared with the third quarter of last year due to a decrease in Adjusted Operating Earnings (Non-GAAP) of $4.3 million or 7.3%. The decrease in Adjusted Operating Earnings (Non-GAAP) for this period was primarily due to lower Domestic segment revenues and gross margin (Domestic gross margin declined by $8.2 million) and an operating loss of $0.6 million for the International segment, partially offset by lower Domestic segment SG&A expenses of $6.6 million. In addition, the third quarter of 2011 included income of $2.2 million relating to an anti-trust lawsuit that did not exist in 2012.


Table of Contents

Adjusted EPS (Non-GAAP) for the first nine months of this year was flat compared with the same period last year. Adjusted Operating Earnings (Non-GAAP) for the first nine months of 2012 declined slightly ($0.7 million or 0.4%) compared to last year as lower Domestic segment gross margin of $9.2 million was partially offset by lower Domestic SG&A expenses of $8.1 million. Also contributing to the change between these periods was higher other operating income of $1.7 million in 2012 partially offset by the International segment operating loss of $0.6 million and higher Domestic depreciation and amortization in 2012 of $0.4 million.

The following table presents our consolidated statements of income on a percentage of revenue basis:

                                            Three Months Ended                     Nine Months Ended
                                              September 30,                          September 30,
                                         2012                2011              2012                2011
Gross margin                               10.46 %              9.95 %            9.93 %             10.00 %
Selling, general and
administrative expenses                     7.58 %              7.02 %            7.16 %              7.15 %
Adjusted Operating Earnings
(Non-GAAP)                                  2.50 %              2.70 %            2.43 %              2.50 %

Results of Operations

Net revenue. Net revenue was $2.18 billion for the third quarter of 2012 and 2011. Net revenue increased 2.4% to $6.58 billion for the first nine months of 2012 from $6.43 billion for the comparable period in 2011.

The following tables present the components of the increase in net revenue for the three- and nine-month periods ended September 30, 2012 and 2011, compared with the same periods in the prior year, and present Domestic segment new customer changes net of lost customer activity ("net new (lost)"). Domestic segment fee-for-service revenue represents revenue from services provided to customers in the U.S. that are not directly related to sales of product through our traditional distribution services and includes revenue from our OM Healthcare Logistics and OM SolutionsSM businesses.

(Dollars in millions)
Increase (decrease) for the three months ended September 30,                     2012 versus 2011                                    2011 versus 2010
                                                                                                Contribution                                        Contribution
                                                                      Net Revenue                 to Total                 Net Revenue                to Total
Domestic segment:
Revenue from sales of products to:
Existing customers                                                   $        (29.5 )                    (1.4 )%          $         89.0                      4.3 %
Net new (lost) customers                                                      (13.7 )                    (0.6 )%                    13.6                      0.7 %
Fee-for-service revenue                                                        (3.3 )                    (0.2 )%                    10.3                      0.5 %

Domestic segment                                                              (46.5 )                    (2.2 )%                   112.9                      5.5 %
International segment                                                          49.7                       2.3 %                       -                        -

Consolidated                                                         $          3.2                       0.1 %           $        112.9                      5.5 %


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(Dollars in millions)
Increase (decrease) for the nine months ended September 30,                    2012 versus 2011                                   2011 versus 2010
                                                                                              Contribution                                       Contribution
                                                                     Net Revenue                to Total                Net Revenue                to Total
Domestic segment:
Revenue from sales of products to:
Existing customers                                                  $         84.1                      1.3 %          $        305.5                      5.1 %
Net new (lost) customers                                                      15.3                      0.2 %                    53.3                      0.9 %
Fee-for-service revenue                                                        2.1                      0.1 %                    19.8                      0.3 %

Domestic segment                                                             101.5                      1.6 %                   378.6                      6.3 %
International segment                                                         49.7                      0.8 %                      -                        -

Consolidated                                                        $        151.2                      2.4 %          $        378.6                      6.3 %

In the third quarter of 2012, Domestic segment revenues were $2.13 billion, a decrease of $46.5 million compared to the same quarter of 2011. The decline resulted from a combination of factors, including: one less sales day in the quarter, lower comparative utilization of healthcare services coupled with reduced product price inflation, and a lower level of government purchasing, as well as ongoing rationalization of the company's supplier base. The decline in the existing Domestic segment sales growth rate for the first nine months was primarily due to the same factors.

The International segment net revenue represents the net revenue of Movianto for one month since its acquisition on August 31, 2012.

Gross margin. The following tables present gross margin information by segment for the three- and nine-month periods ended September 30, 2012 and 2011.

(Dollars in millions)
                                                                   Three months ended                   Nine months ended
Gross margin                                                          September 30,                       September 30,
                                                                 2012               2011              2012              2011
Domestic segment                                             $      208.5       $      216.7      $      634.3      $      643.5
International segment                                                19.6                 -               19.6                -

Consolidated gross margin                                    $      228.1       $      216.7      $      653.9      $      643.5


                                                                   Three months ended                   Nine months ended
Gross margin by segment as a percentage of related revenue            September 30,                       September 30,
                                                                 2012               2011              2012              2011
Domestic segment                                                     9.79 %             9.95 %            9.71 %           10.00 %
International segment                                               39.39 %               -              39.39 %              -
Consolidated gross margin as percentage of revenue                  10.46 %             9.95 %            9.93 %           10.00 %

The following tables present the components of the increase or decrease in consolidated gross margin for the three- and nine-month periods ended September 30, 2012 and 2011. Domestic segment gross margin includes gross margin from customer contracts related to sales of product and contribution to gross margin relating to supplier incentives (traditional distribution), fees generated from other services, including OM Healthcare Logistics, OM Solutions and other supply-chain services that are not directly related to sales of product (fee-for-service) and the effect of inventory valuation and other operational components, excluding the impact of applying the last-in first-out (LIFO) method (other).


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(Dollars in millions)
Increase (decrease) for the three months ended September 30,              2012 versus 2011                          2011 versus 2010
                                                                                       Impact on                                 Impact on
                                                                                         gross                                     gross
                                                                                      margin as a                               margin as a
                                                                    Gross             percent of              Gross             percent of
                                                                    Margin              revenue               Margin              revenue
Domestic segment:
Traditional distribution                                           $   (5.5 )                (0.06 )%        $    4.9                  (0.20 )%
Fee-for-service                                                        (3.3 )                (0.14 )%            10.3                   0.43 %
Provision for LIFO                                                       -                      -                  -                      -
Other                                                                   0.6                   0.04 %             (2.5 )                (0.16 )%

Domestic segment                                                       (8.2 )                (0.16 )%            12.7                   0.07 %
International segment                                                  19.6                   0.67 %               -                      -

Consolidated                                                       $   11.4                   0.51 %         $   12.7                   0.07 %

(Dollars in millions)
Increase (decrease) for the nine months ended September 30,              2012 versus 2011                          2011 versus 2010
                                                                                      Impact on                                 Impact on
                                                                                        gross                                     gross
                                                                                     margin as a                               margin as a
                                                                   Gross             percent of              Gross             percent of
                                                                   Margin              revenue               Margin              revenue
Domestic segment:
Traditional distribution                                          $   (9.4 )                (0.26 )%        $   26.7                  (0.10 )%
Fee-for-service                                                        2.1                   0.03 %             19.8                   0.28 %
Provision for LIFO                                                     6.0                   0.09 %             (2.8 )                (0.04 )%
Other                                                                 (7.9 )                (0.15 )%            (0.1 )                (0.04 )%

Domestic segment                                                      (9.2 )                (0.29 )%            43.6                   0.10 %
International segment                                                 19.6                   0.22 %               -                      -

Consolidated                                                      $   10.4                  (0.07 )%        $   43.6                   0.10 %

The decline in Domestic gross margin in the third quarter of 2012 versus last year is primarily due to lower sales resulting in $4.0 million of the $5.5 million decline for traditional distribution. Lower fee-for-service revenue also contributed to the lower gross margin for the quarter, including OM Healthcare Logistics which had higher fees last year from higher costs incurred to convert a large new customer.

The decline in Domestic gross margin for the first nine months of 2012 versus last year is primarily due to lower percentage margins driven by changes in customer mix, including lower margin on new contracts with large integrated health networks and competitive pressures representing 26 basis points of the decline. The decline in gross margin dollars resulting from these new contracts was partially offset by an increase in gross margin of $9.3 million from increased sales for the year-to-date period.

The International segment gross margin represents the gross margin for Movianto for one month since its acquisition on August 31, 2012, which resulted in a contribution to consolidated gross margin as a percentage of net revenue of 67 basis points in the third quarter and 22 basis points for the first nine months of 2012 compared with 2011.

Selling, general and administrative (SG&A) expenses. SG&A expenses include labor, warehousing, handling and delivery costs associated with our distribution and third-party logistics services, as well as labor costs for our supply-chain consulting services. The costs to convert new customers to our information systems are generally incurred prior to the recognition of revenues from the new customers.

The following table presents SG&A expenses by segment for the three- and nine-month periods ended September 30, 2012 and 2011.


Table of Contents
(Dollars in millions)
                                                     Three months ended            Nine months ended
SG&A expenses                                          September 30,                 September 30,
                                                     2012           2011           2012          2011
Domestic segment                                  $    146.1       $ 152.8      $    452.0      $ 460.1
International segment                                   19.2            -             19.2           -

Consolidated selling, general, and
administrative expenses                           $    165.3       $ 152.8      $    471.2      $ 460.1

                                                       Three months ended           Nine months ended
SG&A by segment as a percentage of related revenue        September 30,               September 30,
                                                        2012           2011          2012          2011
Domestic segment                                           6.86 %       7.02 %          6.92 %      7.15 %
International segment                                     38.56 %         -            38.56 %        -
Consolidated SG&A as a percentage of revenue               7.58 %       7.02 %          7.16 %      7.15 %

The International segment represents SG&A expenses of Movianto for one month since its acquisition on August 31, 2012.

The decrease in Domestic segment SG&A expenses of $6.6 million or 4.3% for the third quarter of 2012 compared to the third quarter of 2011 is primarily due to decreases of $4.5 million for fee-for-service operations, including lower costs for our third-party logistics business that was converting a large new customer during the second and third quarters of 2011. SG&A expenses unrelated to fee-for-service operations decreased by $2.1 million due mainly to lower incentive compensation and benefit costs and lower expenses resulting from our organizational realignment in the fourth quarter of 2011.

The decrease in Domestic segment SG&A expenses of $8.1 million or 1.8% for the first nine months of 2012 compared to the same period in 2011 is primarily due to decreases of $5.3 million related to fee-for service operations and a decline of $2.8 million in other SG&A expenses. The reason for the decline in Domestic SG&A expenses in these areas for the first nine months is primarily the same as the third quarter described above.

Depreciation and amortization expense. Depreciation and amortization expense increased to $10.1 million from $8.5 million for the third quarter and to $27.2 million from $25.5 million for the first nine months of 2012 compared with the same periods of 2011. The increase is primarily related to the Movianto acquisition, which resulted in additional depreciation and amortization expense of $1.3 million.

Other operating income, net. Other operating income, net, was $1.8 million for the third quarter of 2012 compared to other operating income, net of $3.4 million for the third quarter of 2011, including finance charge income of $0.8 million in both of the quarterly periods. Other operating income, net, was $4.6 million for the first nine months of 2012 compared to $2.9 million for the comparable period of 2011, including finance charge income of $2.8 million and $2.2 million, respectively. Other operating income for the third quarter and year-to-date period of 2011 benefitted from $2.2 million received from settlement of an anti-trust class action lawsuit. In addition, other operating income in the first nine months of 2011 included expenses of $1.7 million primarily for the development of a model for partnering with customers.

Interest expense, net. Interest expense, net of interest earned on cash balances, was $3.1 million for the third quarter of 2012, as compared with $3.4 million for the third quarter of 2011, and $10.0 million for the first nine months of 2012 as compared with $10.2 million for the first nine months of 2011.

The following table presents the components of our effective interest rate and average borrowings for first nine months of September 30, 2012 and 2011.


Table of Contents
(Dollars in millions)

              Nine months ended September 30,    2012          2011
              Interest on senior notes             6.35 %        6.35 %
              Commitment and other fees            0.83 %        1.27 %
              Interest rate swaps                 (1.08 )%      (1.33 )%
              Other, net of interest income        0.16 %        0.11 %

              Total effective interest rate        6.26 %        6.40 %


              Average total debt                $ 214.0       $ 212.4

For the nine months ended September 30, 2012, the effective interest rate decreased 14 basis points, primarily due to a 44 basis point decrease as a result of replacing our revolving credit facility in June 2012 with a new revolving credit facility with lower commitment fees (refer to Capital Resources in Management's Discussion and Analysis of Financial Condition for a description of the new revolving credit facility). The decrease in commitment fees was partially offset by a decline in interest income from interest rate swaps, which were terminated in the third quarter of 2012.

Income taxes. The provision for income taxes was $19.0 million and $57.7 million for the third quarter and first nine months of 2012, compared to $21.7 million and $59.1 million for the comparable periods in 2011. The effective tax rate was 43.6% and 40.7% for the third quarter and first nine months of 2012, compared to 39.4% and 39.3% for the comparable periods of 2011. Excluding the acquisition-related costs in 2012, of which approximately $4.7 million are not expected to be tax deductible, the effective tax rate was 39.4% for the third quarter and first nine months of 2012. The 39.4% effective tax rate for the third quarter of 2012 included a benefit to the rate of 0.7% primarily for the recognition of tax benefits due to the expiration of the statute of limitations for the 2008 U.S. federal income tax return, offset by the effect of valuation allowances recognized on potential income tax benefits from losses in certain foreign jurisdictions. A similar impact for both items exists for the year-to-date effective income tax rate.

Net income. Adjusted Net Income (Non-GAAP) declined to $31.2 million in the third quarter of 2012 compared with $33.6 million in the third quarter of 2011. Adjusted Net Income (Non-GAAP) declined to $91.0 million in the first nine months of 2012 from $91.5 million in the first nine months of 2011. The changes in Adjusted Net Income (Non-GAAP) were due to the changes in Adjusted Operating Earnings (Non-GAAP), net interest expense and income taxes discussed above.

Financial Condition, Liquidity and Capital Resources

Financial condition. Cash and cash equivalents decreased to approximately $80 million at September 30, 2012 from $136 million at December 31, 2011, primarily as a result of the Movianto acquisition in the third quarter of 2012. Nearly all of our cash and cash equivalents are held in cash depository accounts with major banks or invested in high-quality, short-term liquid investments.

Accounts receivable, net of allowances, increased $76 million, or 15.0%, to $583 . . .

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