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OMI > SEC Filings for OMI > Form 10-Q on 3-May-2013All Recent SEC Filings

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


3-May-2013

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, 2012. 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, 2012.

First quarter of 2013 compared with first quarter of 2012

Overview

Owens & Minor, Inc., along with its subsidiaries, (we, us, or our) is a leading national distributor of name-brand medical and surgical supplies and a healthcare logistics company. We report our business under two segments:
Domestic and International. The Domestic segment includes all services in the United States relating to our role as a medical supply logistics company serving healthcare providers and manufacturers. The International segment provides third-party logistics for the pharmaceutical and medical device industries in the European market. Segment financial information is provided in Note 14 of Notes to Consolidated Financial Statements included in this quarterly report.

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
                                                                       March 31,
(Dollars in thousands except per share data)                     2013              2012
Operating earnings, as reported (GAAP)                         $  47,884         $ 51,872
Acquisition-related and exit and realignment charges               2,010               -

Operating earnings, adjusted (non-GAAP) (Adjusted
Operated Earnings)                                             $  49,894         $ 51,872

Adjusted Operating Earnings as a percent of revenue
(non-GAAP)                                                          2.19 %           2.34 %

Net income (GAAP)                                              $  26,098         $ 29,360
Acquisition-related and exit and realignment charges, net
of tax                                                             1,521               -

Net income, adjusted (non-GAAP) (Adjusted Net Income)          $  27,619         $ 29,360


Net income per diluted common share, as reported (GAAP)        $    0.41         $   0.46
Acquisition-related and exit and realignment charges, per
diluted common share                                                0.03               -

Net income per diluted common share, adjusted (non-GAAP)
(Adjusted EPS)                                                 $    0.44         $   0.46

Adjusted EPS (non-GAAP) declined to $0.44 in 2013 compared with $0.46 in 2012 due to a decrease in Adjusted Operating Earnings (non-GAAP) of $2.0 million. Domestic segment operating earnings increased $1.0 million to $52.9 million. International segment operating losses were $3.0 million for the first quarter of 2013.

Use of Non-GAAP Measures

This 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 our 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 and reconciliations to those financial statements set forth above should be carefully evaluated.

Acquisition-related charges in the first quarter of 2013 consist primarily of costs to transition Movianto's information technology and other operations and administrative functions from the former owner. Exit and realignment charges are associated with optimizing our operations and include the consolidation of distribution centers and closure of offsite


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warehouses in the United States and Europe. Unless otherwise stated, our analysis hereinafter excludes acquisition-related and exit and realignment charges. More information about these charges is provided in Notes 3 and 6 of Notes to Consolidated Financial Statements included in this quarterly report.

Results of Operations

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



                                                        Three Months Ended
                                                             March 31,
                                                         2013           2012
       Gross margin                                        12.26 %       9.66 %
       Selling, general and administrative expenses         9.57 %       7.01 %
       Adjusted Operating Earnings (non-GAAP)               2.19 %       2.34 %

Net revenue. Net revenue was $2.28 billion for the first quarter of 2013, representing an increase of 2.6% from $2.22 billion for the first quarter of 2012. For the first quarter of 2013, Domestic segment net revenue was $2.15 billion, and International segment net revenue was $121.0, of which approximately 50% was fee-for-service revenues. The increase in consolidated net revenue was primarily due to net revenues contributed by Movianto, which was acquired in the third quarter of 2012.

The decline in quarter-over-quarter Domestic segment net revenues is partially due to our rationalization of smaller, less profitable healthcare provider customers and suppliers. Consistent with prior periods, additional factors contributing to the decline in Domestic segment net revenues for the first quarter of 2013 included lower hospital utilization and reduced government purchases. Domestic segment revenue declined 1.3% quarter-over-quarter on a per sales day basis, which was a lower rate of decline than in the fourth quarter of 2012.

Gross margin.Gross margin dollars increased $64.7 million to $279.1 million for the first quarter of 2013 compared to the first quarter of 2012. The increase in gross margin dollars and gross margin percentage for 2013 versus 2012 is primarily due to gross margin contributed by Movianto. Domestic segment gross margin as a percentage of segment net revenues versus the first quarter of 2012 benefitted from supplier price changes. We are expecting a portion of this benefit to be offset in future quarters of 2013 as other contract terms are affected by the supplier price changes. International segment gross margin as a percentage of segment net revenue was approximately 50% for the first quarter. We expect this metric to vary in future quarters based on seasonality and mix of buy-sell versus fee-for-service business.

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.

SG&A expenses increased $62.1 million to $217.7 million for the first quarter of 2013 compared to $155.6 million for the same period in 2012, primarily as a result of the acquisition of Movianto in the third quarter of 2012. International segment SG&A expenses also include ongoing costs for information technology and other transition services. Domestic segment SG&A expenses increased $2.0 million in 2013 primarily due to greater workers' compensation and consulting expenses.


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Depreciation and amortization expense. Depreciation and amortization expense for the first quarter of 2013 increased $4.1 million to $12.6 million from $8.6 million for the first quarter of 2012, primarily related to warehouse equipment and information technology hardware and software acquired with Movianto.

Other operating income, net. Other operating income, net, was $1.2 million for the first quarter of 2013 compared to $1.7 million for the first quarter of 2012, including finance charge income of $0.6 million and $1.0 million, respectively. Other operating income in the first quarter of 2012 benefited from income of $0.5 million related to the settlement of a class action litigation compared to 2013.


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Interest expense, net. Interest expense, net of interest earned on cash balances, was $3.2 million for the first quarter of 2013, as compared with $3.4 million for the first quarter of 2012. The following table presents the components of our effective interest rate and average borrowings for the three months ended March 31, 2013 and 2012.

                (Dollars in millions)
                Three months ended March 31,     2013         2012
                Interest on senior notes           6.35 %       6.35 %
                Commitment and other fees          0.62         1.26
                Interest rate swaps               (0.84 )      (0.85 )
                Other, net of interest income     (0.14 )      (0.33 )

                Total effective interest rate      5.99 %       6.43 %


                Average total debt              $ 216.7      $ 214.2

For the three months ended March 31, 2013, the effective interest rate decreased 44 basis points, primarily as a result of replacing our revolving credit facility in the second quarter of 2012 with a new revolving credit facility with lower commitment fees.

Income taxes. The provision for income taxes was $18.6 million for the first quarter of 2013 compared to $19.1 million for the same period in 2012. The effective tax rate increased to 41.6% for the first quarter of 2013 from 39.4% for the same period of 2012, largely due to the impact of foreign taxes.

Financial Condition, Liquidity and Capital Resources

Financial condition. Cash and cash equivalents increased to $218.6 million at March 31, 2013 from $97.9 million at December 31, 2012. Nearly all of our cash and cash equivalents are held in cash depository accounts with major banks in the United States and Europe or invested in high-quality, short-term liquid investments.

Accounts receivable, net of allowances, increased $27.6 million, or 5.0%, to $581.1 million at March 31, 2013, from $553.5 million at December 31, 2012. Consolidated accounts receivable days outstanding (DSO) was 22.3 and 21.2 at March 31, 2013 and December 31, 2012 due to an increase in International segment receivables outstanding. Domestic segment DSO was 19.6 days at March 31, 2013, and 19.1 days at December 31, 2012, based on three months' sales, and has ranged from 19.1 to 20.7 days over the prior four quarters.

Merchandise inventories decreased 2.7% to $743.2 million at March 31, 2013, from $763.8 million at December 31, 2012. Consolidated average inventory turnover was 10.7 for the first quarter of 2013. Domestic segment average inventory turnover was 10.6 in the first quarter of 2013, based on three months' sales, and has ranged from 10.2 to 10.8 over the prior four quarters.

The International segment's net working capital deficit of approximately $5.1 million at March 31, 2013, excluding cash and cash equivalents, is comprised of accounts receivable of $93.8 million, financing receivables and other current assets of $135.9 million, inventories of $16.7 million, accounts payable of $65.8 million and financing payables and other current liabilities of approximately $185.7 million. See Note 4 to the Notes to Consolidated Financial Statements for further information regarding financing receivables.


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Liquidity and capital expenditures. The following table summarizes our consolidated statements of cash flows for the three months ended March 31, 2013 and 2012:

            (in millions)
            Three months ended March 31,             2013         2012
            Net cash provided by (used for)
            Operating activities                    $ 154.6      $ 101.9
            Investing activities                      (14.7 )       (8.3 )
            Financing activities                      (17.4 )      (15.6 )
            Effect of exchange rate changes            (1.8 )         -

            Increase in cash and cash equivalents   $ 120.7      $  78.0

Cash provided by operating activities was $154.6 million in the first quarter of 2013, compared to $101.9 million in the first quarter of 2012. The increase in cash from operating activities in the first quarter of 2013 compared to the prior year quarter was primarily the result of an increase in accounts payable due to timing of payments.

Capital expenditures were $14.8 million in the first quarter of 2013, compared to $8.4 million in the same period of 2012. Capital expenditures in 2013 and 2012 primarily relate to our strategic and operational efficiency initiatives, particularly initiatives relating to information technology enhancements in the Domestic and International segments and optimizing our domestic distribution network. Capital expenditures in 2012 primarily related to similar initiatives in the Domestic segment.

Cash used for financing activities in the first quarter of 2013 was $17.4 million, compared to $15.6 million used in the first quarter of 2012. During the first quarter of 2013, we paid dividends of $15.2 million, repurchased common stock under a share repurchase program for $2.3 million of cash, and received proceeds of $1.8 million from the exercise of stock options. During the first quarter of 2012, we paid dividends of $14.0 million, repurchased common stock under a share repurchase program for $3.8 million, and received proceeds of $3.4 million from the exercise of stock options.

Capital resources. Our sources of liquidity include cash and cash equivalents and a revolving credit facility. We have a five-year $350 million Credit Agreement with Wells Fargo Bank, N.A., JPMorgan Chase Bank, N.A. and a syndicate of financial institutions (the Credit Agreement). Under this credit facility, we have the ability to request two one-year extensions and to request an increase in aggregate commitments by up to $150 million. The interest rate on the new credit facility, which is subject to adjustment quarterly, is based on the London Interbank Offered Rate (LIBOR), the Federal Funds Rate or the Prime Rate, plus an adjustment based on the better of our debt ratings or leverage ratio (Credit Spread) as defined by the Credit Agreement. We are charged a commitment fee of between 17.5 and 42.5 basis points on the unused portion of the facility. The terms of the credit agreement limit the amount of indebtedness that we may incur and require us to maintain ratios for leverage and interest coverage, including on a pro forma basis in the event of an acquisition. At March 31, 2013, we had no borrowings and letters of credit of approximately $5.0 million outstanding on the revolving credit facility, leaving $345.0 million available for borrowing. We also have a $1.4 million letter of credit outstanding as of March 31, 2013, which supports our European leased facilities.

We may utilize the revolving credit facility for long-term strategic growth, capital expenditures, working capital and general corporate purposes. If we were unable to access the revolving credit facility, it could impact our ability to fund these needs. During the first three months of 2013, we had no borrowings or repayments under the credit facilities. Based on our leverage ratio at March 31, 2013, the interest rate under the new credit facility is LIBOR plus 1.375%. We have $200 million of senior notes outstanding, which mature in 2016 and bear interest at 6.35%, payable semi-annually on April 15 and October 15. The revolving credit facility and senior notes contain cross-default provisions which could result in the acceleration of payments due in the event of default of either agreement. We believe we were in compliance with the debt covenants at March 31, 2013.

In the first quarter of 2013, we paid cash dividends on our outstanding common stock at the rate of $0.24 per share, which represents a 9% increase over the rate of $0.22 per share paid in the first quarter of 2012. We anticipate continuing to pay quarterly cash dividends in the future. However, the payment of future dividends remains within the discretion of the Board of Directors and will depend upon our results of operations, financial condition, capital requirements and other factors.

In February 2011, the Board of Directors authorized a share repurchase program of up to $50 million of our outstanding common stock to be executed at the discretion of management over a three-year period, expiring in February 2014. During the first quarter of 2013, we repurchased 74,112 shares at $2.3 million under this program. The remaining amount authorized for repurchases under this program is $16.6 million at March 31, 2013.


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We earn a portion of our operating earnings in foreign jurisdictions outside the U.S., which we consider to be indefinitely reinvested. Accordingly, no U.S. federal and state income taxes and withholding taxes have been provided on these earnings. Our cash, cash-equivalents, short-term investments, and marketable securities held by our foreign subsidiaries totaled $55.2 million as of March 31, 2013. We do not intend, nor do we foresee a need, to repatriate these funds or other assets held outside the U.S. In the future, should we require more capital to fund discretionary activities in the U.S. than is generated by our domestic operations and is available through our borrowings, we could elect to repatriate cash or other assets from foreign jurisdictions that have previously been considered to be indefinitely reinvested. Upon distribution of these assets, we could be subject to additional U.S. federal and state income taxes and withholding taxes payable to foreign jurisdictions, where applicable.

We believe available financing sources, including cash generated by operating activities and borrowings under the revolving credit facility, will be sufficient to fund our working capital needs, capital expenditures, long-term strategic growth, payments under long-term debt and lease arrangements, payments of quarterly cash dividends, share repurchases and other cash requirements. While we believe that we will have the ability to meet our financing needs in the foreseeable future, changes in economic conditions may impact (i) the ability of financial institutions to meet their contractual commitments to us,
(ii) the ability of our customers and suppliers to meet their obligations to us and/or (iii) our cost of borrowing.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements, see Note 16 in the Notes to Consolidated Financial Statements, included in this Quarterly Report on Form 10-Q for the quarterly period ended on March 31, 2013.

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 we believe our expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of our knowledge of our 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:

competitive pressures in the marketplace, including intense pricing pressure;

our ability to retain existing and attract new customers in a market characterized by significant customer consolidation and intense cost-containment initiatives;

our dependence on sales to certain customers or the loss or material reduction in purchases by key customers;

our dependence on distribution of product of certain suppliers;

our ability to successfully identify, manage or integrate acquisitions, including the management and integration of our acquisition of Movianto;

our ability to successfully manage our international operations, including risks associated with changes in international trade regulations, foreign currency volatility, changes in regulatory conditions, deteriorating economic conditions, adverse tax consequences, and other risks of operating in international markets;

uncertainties related to and our ability to adapt to changes in government regulations, including healthcare laws and regulations (including the Affordable Care Act);

risks arising from possible violations of legal, regulatory or licensing requirements of the markets in which we operate;

uncertainties related to general economic, regulatory and business conditions;

our ability to successfully implement our strategic initiatives;

the availability of and modifications to existing supplier funding programs and our ability to meet the terms to qualify for certain of these programs;

our ability to adapt to changes in product pricing and other terms of purchase by suppliers of product;

the ability of customers and suppliers to meet financial commitments due to us;

changes in manufacturer preferences between direct sales and wholesale distribution;

changing trends in customer profiles and ordering patterns and our ability to meet customer demand for additional value-added services;

our ability to manage operating expenses and improve operational efficiencies in response to changing customer profiles;

our ability to meet performance targets specified by customer contracts under contractual commitments;

availability of and our ability to access special inventory buying opportunities;

the ability of business partners and financial institutions to perform their contractual responsibilities;

the effect of price volatility in the commodities markets, including fuel price fluctuations, on our operating costs and supplier product prices;

our ability to continue to obtain financing at reasonable rates and to manage financing costs and interest rate risk;

the risk that information systems are interrupted or damaged or fail for any extended period of time or that there is a data security breach;

the risk that a decline in business volume or profitability could result in an impairment of goodwill or other long-lived assets;


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

the costs associated with and outcome of outstanding and any future litigation, including product and professional liability claims; and

adverse changes in U.S. and foreign tax laws and the outcome of outstanding tax contingencies and legislative and tax proposals;

other factors described in "Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2012.

We undertake no obligation to update or revise any forward-looking statements, except as required by applicable law.

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