UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31,June 30, 2006
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
For the transition period from to
Commission file number 1-9810
Owens & Minor, Inc.
(Exact name of Registrant as specified in its charter)
Virginia | 54-1701843 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
9120 Lockwood Boulevard, Mechanicsville, Virginia | 23116 | |
(Address of principal executive offices) | (Zip Code) |
Post Office Box 27626, Richmond, Virginia | 23261-7626 | |
(Mailing address of principal executive offices) | (Zip Code) |
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 Securities 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 May 1,July 31, 2006, was 40,088,62640,180,897 shares.
Owens & Minor, Inc. and Subsidiaries
Index
Owens & Minor, Inc. and Subsidiaries
Consolidated Statements of Income
(unaudited)
Three Months Ended March 31, | ||||||||||||||||||||||||
(in thousands, except per share data)
| Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||||
Revenue | $ | 1,261,999 | $ | 1,193,600 | $ | 1,300,315 | $ | 1,210,894 | $ | 2,562,314 | $ | 2,404,494 | ||||||||||||
Cost of revenue | 1,125,809 | 1,067,762 | 1,159,086 | 1,082,126 | 2,284,895 | 2,149,888 | ||||||||||||||||||
Gross margin | 136,190 | 125,838 | 141,229 | 128,768 | 277,419 | 254,606 | ||||||||||||||||||
Selling, general and administrative expenses | 101,056 | 93,952 | 104,764 | 96,075 | 205,820 | 190,027 | ||||||||||||||||||
Depreciation and amortization | 5,628 | 3,447 | 6,251 | 5,147 | 11,879 | 8,594 | ||||||||||||||||||
Other operating income and expense, net | (920 | ) | (1,111 | ) | (1,012 | ) | (960 | ) | (1,932 | ) | (2,071 | ) | ||||||||||||
Operating earnings | 30,426 | 29,550 | 31,226 | 28,506 | 61,652 | 58,056 | ||||||||||||||||||
Interest expense, net | 3,057 | 3,325 | 2,346 | 2,905 | 5,403 | 6,230 | ||||||||||||||||||
Loss on early extinguishment of debt | 11,411 | — | 11,411 | — | ||||||||||||||||||||
Income before income taxes | 27,369 | 26,225 | 17,469 | 25,601 | 44,838 | 51,826 | ||||||||||||||||||
Income tax provision | 10,866 | 10,306 | 6,980 | 9,628 | 17,846 | 19,934 | ||||||||||||||||||
Net income | $ | 16,503 | $ | 15,919 | $ | 10,489 | $ | 15,973 | $ | 26,992 | $ | 31,892 | ||||||||||||
Net income per common share – basic | $ | 0.42 | $ | 0.40 | ||||||||||||||||||||
Net income per common share - basic | $ | 0.26 | $ | 0.40 | $ | 0.68 | $ | 0.81 | ||||||||||||||||
Net income per common share – diluted | $ | 0.41 | $ | 0.40 | ||||||||||||||||||||
Net income per common share - diluted | $ | 0.26 | $ | 0.40 | $ | 0.67 | $ | 0.80 | ||||||||||||||||
Cash dividends per common share | $ | 0.15 | $ | 0.13 | $ | 0.15 | $ | 0.13 | $ | 0.30 | $ | 0.26 | ||||||||||||
See accompanying notes to consolidated financial statements.
Owens & Minor, Inc. and Subsidiaries
Consolidated Balance Sheets
(unaudited)
(in thousands, except per share data) | March 31, 2006 | December 31, 2005 | June 30, 2006 | December 31, 2005 | ||||||||||||
Assets | ||||||||||||||||
Current assets | ||||||||||||||||
Cash and cash equivalents | $ | 72,715 | $ | 71,897 | $ | 74,104 | $ | 71,897 | ||||||||
Accounts and notes receivable, net of allowances of $12,874 and $13,333 | 378,066 | 353,102 | ||||||||||||||
Accounts and notes receivable, net of allowances of $14,016 and $13,333 | 377,283 | 353,102 | ||||||||||||||
Merchandise inventories | 444,722 | 439,887 | 470,230 | 439,887 | ||||||||||||
Other current assets | 30,104 | 29,666 | 32,069 | 29,666 | ||||||||||||
Total current assets | 925,607 | 894,552 | 953,686 | 894,552 | ||||||||||||
Property and equipment, net of accumulated depreciation of $66,604 and $70,481 | 56,035 | 51,942 | ||||||||||||||
Property and equipment, net of accumulated depreciation of $66,597 and $70,481 | 56,105 | 51,942 | ||||||||||||||
Goodwill, net | 242,626 | 242,620 | 242,749 | 242,620 | ||||||||||||
Intangible assets, net | 19,075 | 18,383 | 20,543 | 18,383 | ||||||||||||
Other assets, net | 32,058 | 32,353 | 32,481 | 32,353 | ||||||||||||
Total assets | $ | 1,275,401 | $ | 1,239,850 | $ | 1,305,564 | $ | 1,239,850 | ||||||||
Liabilities and shareholders’ equity | ||||||||||||||||
Current liabilities | ||||||||||||||||
Accounts payable | $ | 403,903 | $ | 387,833 | $ | 443,520 | $ | 387,833 | ||||||||
Accrued payroll and related liabilities | 11,018 | 12,701 | 9,497 | 12,701 | ||||||||||||
Other accrued liabilities | 95,238 | 88,334 | 82,503 | 88,334 | ||||||||||||
Total current liabilities | 510,159 | 488,868 | 535,520 | 488,868 | ||||||||||||
Long-term debt | 203,009 | 204,418 | 197,698 | 204,418 | ||||||||||||
Other liabilities | 35,001 | 34,566 | 38,361 | 34,566 | ||||||||||||
Total liabilities | 748,169 | 727,852 | 771,579 | 727,852 | ||||||||||||
Shareholders’ equity | ||||||||||||||||
Preferred stock, par value $100 per share; authorized - 10,000 shares | — | — | ||||||||||||||
Common stock, par value $2 per share; authorized - 200,000 shares; issued and outstanding – 40,085 shares and 39,890 shares | 80,169 | 79,781 | ||||||||||||||
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 – 40,143 shares and 39,890 shares | 80,286 | 79,781 | ||||||||||||||
Paid-in capital | 137,493 | 133,653 | 139,679 | 133,653 | ||||||||||||
Retained earnings | 317,853 | 307,353 | 322,321 | 307,353 | ||||||||||||
Accumulated other comprehensive loss | (8,283 | ) | (8,789 | ) | (8,301 | ) | (8,789 | ) | ||||||||
Total shareholders’ equity | 527,232 | 511,998 | 533,985 | 511,998 | ||||||||||||
Total liabilities and shareholders’ equity | $ | 1,275,401 | $ | 1,239,850 | $ | 1,305,564 | $ | 1,239,850 | ||||||||
See accompanying notes to consolidated financial statements.
Owens & Minor, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended March 31, | ||||||||||||||||
(in thousands)
| Six Months Ended June 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Operating activities | ||||||||||||||||
Net income | $ | 16,503 | $ | 15,919 | $ | 26,992 | $ | 31,892 | ||||||||
Adjustments to reconcile net income to cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 5,628 | 3,447 | 11,879 | 8,594 | ||||||||||||
Loss on early extinguishment of debt | 11,411 | — | ||||||||||||||
Provision for LIFO reserve | 4,590 | 5,100 | 5,070 | 5,493 | ||||||||||||
Stock-based compensation expense | 1,003 | 453 | 2,945 | 1,051 | ||||||||||||
Provision for losses on accounts and notes receivable | 1,664 | 1,061 | 4,535 | 1,697 | ||||||||||||
Deferred direct-response advertising costs | (1,987 | ) | (826 | ) | (4,842 | ) | (2,421 | ) | ||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts and notes receivable | (26,628 | ) | 7,116 | (28,184 | ) | 6,901 | ||||||||||
Merchandise inventories | (9,425 | ) | 27,540 | (35,320 | ) | 27,853 | ||||||||||
Accounts payable | 27,570 | 58,534 | 59,811 | 45,553 | ||||||||||||
Net change in other current assets and liabilities | 2,641 | 3,272 | (12,249 | ) | (8,362 | ) | ||||||||||
Other, net | 78 | 1,411 | 22 | 3,135 | ||||||||||||
Cash provided by operating activities | 21,637 | 123,027 | 42,070 | 121,386 | ||||||||||||
Investing activities | ||||||||||||||||
Additions to property and equipment | (5,131 | ) | (5,338 | ) | (8,286 | ) | (14,093 | ) | ||||||||
Additions to computer software | (1,312 | ) | (825 | ) | (2,869 | ) | (1,510 | ) | ||||||||
Acquisition of intangible assets | (2,090 | ) | — | (2,090 | ) | — | ||||||||||
Net cash paid for acquisitions of businesses | (64 | ) | (57,920 | ) | (3,721 | ) | (60,619 | ) | ||||||||
Other, net | 3 | 1 | (493 | ) | 11 | |||||||||||
Cash used for investing activities | (8,594 | ) | (64,082 | ) | (17,459 | ) | (76,211 | ) | ||||||||
Financing activities | ||||||||||||||||
Net proceeds of issuance of long-term debt | 198,134 | — | ||||||||||||||
Repayment of long-term debt | (210,449 | ) | — | |||||||||||||
Cash dividends paid | (6,003 | ) | (5,157 | ) | (12,024 | ) | (10,340 | ) | ||||||||
Proceeds from exercise of stock options | 2,619 | 942 | 2,924 | 3,452 | ||||||||||||
Excess tax benefits related to stock-based compensation | 1,165 | — | 1,221 | — | ||||||||||||
Decrease in drafts payable | (11,500 | ) | (36,246 | ) | (4,500 | ) | (19,877 | ) | ||||||||
Other, net | 1,494 | (46 | ) | 2,290 | (122 | ) | ||||||||||
Cash used for financing activities | (12,225 | ) | (40,507 | ) | (22,404 | ) | (26,887 | ) | ||||||||
Net increase in cash and cash equivalents | 818 | 18,438 | 2,207 | 18,288 | ||||||||||||
Cash and cash equivalents at beginning of period | 71,897 | 55,796 | 71,897 | 55,796 | ||||||||||||
Cash and cash equivalents at end of period | $ | 72,715 | $ | 74,234 | $ | 74,104 | $ | 74,084 | ||||||||
See accompanying notes to consolidated financial statements.
Owens & Minor, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
1. | Accounting Policies |
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (which are comprised only of normal recurring accruals and the use of estimates) necessary to present fairly the consolidated financial position of Owens & Minor, Inc. and its wholly-owned subsidiaries (O&M or the company) as of March 31,June 30, 2006 and December 31, 2005, and the consolidated results of operations for the three- and six-month periods and cash flows for the three-monthsix-month periods ended March 31,June 30, 2006 and 2005, in conformity with U.S. generally accepted accounting principles.
These financial statements are presented on a consolidated basis, and do not include condensed consolidating financial information, because:because i) all registered securities of the company are issued by the parent company, which has no independent assets or operations, ii) all securities that are guaranteed are fully, unconditionally, jointly and severally guaranteed by all significant subsidiaries, and iii) any subsidiaries of the parent company other than the subsidiary guarantors are minor.
Certain prior year amounts have been reclassified to conform to the current year presentation.
2. | Interim Results of Operations |
The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.
3. | Acquisitions |
Effective February 24, 2006, Access Diabetic Supply, LLC (Access), a subsidiary of Owens & Minor,the company acquired certain operating assets of a direct-to-consumer distributor of diabetic supplies for $2.3 million in total consideration. The assets acquired consisted primarily of customer relationships.
Effective June 30, 2006, the company acquired a Michigan-based, direct-to-consumer diabetes-supply company for $3.6 million in total consideration. The purchase price is subject to adjustment upon a final determination of the net working capital and total number of customers acquired. A preliminary allocation of the purchase price resulted in approximately $0.3 million of net tangible assets and $3.3 million of intangible assets, which consist primarily of customer relationships. The allocation of the purchase price is expected to be finalized after the valuation of certain acquired assets is complete.
The company acquired Accessentered the direct-to-consumer diabetic supply business on January 31, 2005, and from this date through March 31,June 30, 2006, Accessthe company has completed a series of acquisitions in the direct-to-consumer diabetic supplythis business. For the quartersthree-month periods ended March 31,June 30, 2006 and 2005, the direct-to-consumer diabetic supply business contributed $17.8$21.2 million and $8.4$14.5 million of revenue and ($0.3)$0.3 million and $1.4$0.8 million of operating earnings (loss) to the company. For the six-month periods ended June 30, 2006 and 2005, the direct-to-consumer diabetic supply business contributed $39.0 million and $22.9 million of revenue. Operating earnings were $0.0 million for the six-month period ended June 30, 2006, and $2.2 million for the corresponding period of 2005.
4. | Stock-Based Compensation |
The company maintains stock-based compensation plans (Plans) that provide for the granting of stock options, stock appreciation rights (SARs), restricted common stock and common stock. The Plans are administered by the Compensation and Benefits Committee of the Board of Directors and allow the company to award or grant to officers, directors and employees incentive, non-qualified and deferred compensation stock options, SARs and restricted and unrestricted stock. At March 31,June 30, 2006, approximately 3.03.2 million common shares were available for issuance under the Plans.
Stock options awarded under the Plans are generally subject to graded vesting over three years and expire seven to ten years from the date of grant. The options are granted at a price equal to fair market value at the date of grant. Restricted stock awarded under the Plans generally vests over three or five years. Certain restricted stock grants contain accelerated vesting provisions, based on the satisfaction of certain performance criteria, related to the achievement of certain financial and operational results. At March 31,June 30, 2006, there were no SARs outstanding.
The company has a Management Equity Ownership Program. This program requires each of the company’s officers to own the company’s common stock at specified levels, which gradually increase over five years. Officers and certain other employees who meet specified ownership goals in a given year are awarded restricted stock under the provisions of the program.
The company also awards restricted stock under the Plans to officers and certain other employees based on pre-established objectives.
Effective January 1, 2006, the company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 123(R),Share-Based Payment, a revision of SFAS 123,Accounting for Stock-Based Compensation.SFAS 123(R) also supersedes Accounting Principles Board Opinion No. (APB) 25,Accounting for Stock Issued to Employees,and amends SFAS 95,Statement of Cash Flows.SFAS 123(R) requires that all share-based payments to employees, including grants of employee stock options, be recognized in the income statement based on their fair values, while SFAS 123 as originally issued provided the option of recognizing share-based payments based on their fair values or based on their intrinsic values with pro forma disclosure of the effect of recognizing the payments based on their fair values. The company adopted the provisions of SFAS 123(R) using the modified prospective method, in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date and are expected to vest. The following table presents the effect of adopting SFAS 123(R) on the results of operations for the three months ended March 31, 2006:operations:
(in thousands, except per share data)
| For the Three Months Ended June 30, 2006 | For the Six Months Ended June 30, 2006 | |||||||||||||||||||
As Reported | Effect of SFAS 123(R) | As Reported | Effect of SFAS 123(R) | As Reported | Effect of SFAS 123(R) | ||||||||||||||||
Income before income taxes | $ | 27,369 | $ | (449 | ) | $ | 17,469 | $ | (1,167 | ) | $ | 44,838 | $ | (1,617 | ) | ||||||
Net income | 16,503 | (274 | ) | 10,489 | (712 | ) | 26,992 | (986 | ) | ||||||||||||
Net income per basic common share | $ | 0.42 | $ | (0.01 | ) | $ | 0.26 | $ | (0.02 | ) | $ | 0.68 | $ | (0.02 | ) | ||||||
Net income per diluted common share | 0.41 | (0.01 | ) | 0.26 | (0.02 | ) | 0.67 | (0.02 | ) | ||||||||||||
Cash provided by operating activities | $ | 21,637 | $ | (1,165 | ) | $ | 20,433 | $ | (55 | ) | $ | 42,070 | $ | (1,221 | ) | ||||||
Cash used for financing activities | $ | 12,225 | $ | 1,165 | $ | 10,179 | $ | 55 | $ | 22,404 | $ | 1,221 |
The adoption of the provisions of SFAS 123(R) did not have a material cumulative effect on the company’s financial position or results of operations at January 1, 2006.
Prior to January 1, 2006, the company used the intrinsic value method, as defined by Accounting Principles Board Opinion No. 25, to account for stock-based compensation. This method required compensation expense to be recognized for the excess of the quoted market price of the stock at the grant date or the measurement date over the amount an employee must pay to acquire the stock. The following table presents the effect on net income and earnings per share had the company used the fair value method to account for stock-based compensation prior to 2006:
(in thousands, except per share data) | Three Months Ended June 30, 2005 | Six Months Ended June 30, 2005 | ||||||||||
Three months ended March 31, | 2005 | |||||||||||
Net income | $ | 15,919 | $ | 15,973 | $ | 31,892 | ||||||
Add: Stock-based employee compensation expense included in reported net income, net of tax | 276 | 251 | 527 | |||||||||
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax | (540 | ) | (743 | ) | (1,283 | ) | ||||||
Pro forma net income | $ | 15,655 | $ | 15,481 | $ | 31,136 | ||||||
Per common share - basic: | ||||||||||||
Net income, as reported | $ | 0.40 | $ | 0.40 | $ | 0.81 | ||||||
Pro forma net income | $ | 0.40 | $ | 0.39 | $ | 0.79 | ||||||
Per common share - diluted: | ||||||||||||
Net income, as reported | $ | 0.40 | $ | 0.40 | $ | 0.80 | ||||||
Pro forma net income | $ | 0.39 | $ | 0.39 | $ | 0.78 |
The following table summarizes the activity and terms of outstanding options for the threesix months ended March 31,June 30, 2006:
Number of (000’s) | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Aggregate (000’s) | Number of (000’s) | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Aggregate (000’s) | |||||||||||||||
Options outstanding at December 31, 2005 | 1,838 | $ | 20.49 | 1,838 | $ | 20.49 | ||||||||||||||||
Granted | — | n/a | 309 | 31.98 | ||||||||||||||||||
Exercised | (196 | ) | 18.45 | (210 | ) | 18.66 | ||||||||||||||||
Forfeited | (1 | ) | 23.00 | (18 | ) | 20.29 | ||||||||||||||||
Options outstanding at March 31, 2006 | 1,641 | 20.73 | 4.53 | $ | 19,754 | |||||||||||||||||
Options outstanding at June 30, 2006 | 1,919 | 22.55 | 4.77 | $ | 11,604 | |||||||||||||||||
Exercisable options at March 31, 2006 | 1,069 | 17.30 | 3.94 | $ | 16,541 | |||||||||||||||||
Vested or expected to vest at June 30, 2006 | 1,865 | 22.32 | 4.72 | $ | 11,719 | |||||||||||||||||
Exercisable options at June 30, 2006 | 1,339 | 19.34 | 4.18 | $ | 12,403 |
The total intrinsic value of options exercised in the threesecond quarter was $0.1 million and was $2.6 million for the six months ended March 31, 2006 andJune 30, 2006. In 2005, total intrinsic value of options exercised in the second quarter was $2.8$2.7 million and $1.4 million.was $4.2 million for the six months ended June 30. The weighted average fair value of options granted in the threesecond quarter and the first six months ended March 31,of 2006 was $8.42. In 2005, was $6.45. Nothe weighted average fair value of options were granted in the threesecond quarter was $6.84 and in the six months ended March 31, 2006. June 30, was $6.80.
The grant-date fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Use of a valuation model requires management to make certain assumptions with respect to selected model inputs. Expected volatility was calculated based on the historical volatility of the company’s stock over the most recent period of time equal to the expected term of the option. The average expected life was based on the contractual term of the option and expected employee exercise and post-vesting employment termination behavior based on historical patterns. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of grant. Forfeitures are estimated based on historical voluntary termination behavior, as well as an analysis of actual option forfeitures. The following table summarizes the assumptions used to determine the fair value of options granted during the three months ended March 31, 2005:following periods:
| ||
| ||
| ||
|
The expected term is based on the historical average length of time between the date of grant and the date of exercise. Expected volatility is based on historical volatility over the most recent period of time equal to the expected term of the option.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||
2006 | 2005 | 2006 | 2005 | |||||
Expected term | 5.1-5.8 years | 4 years | 5.1-5.8 years | 4 years | ||||
Expected volatility | 24.6%-28.0% | 28.7%-28.9% | 24.6%-28.0% | 28.7%-30.1% | ||||
Expected dividend yield | 1.9% | 2.0%-2.2% | 1.9% | 2.0%-2.3% | ||||
Risk-free interest rate | 4.94%-4.95% | 3.6%-3.8% | 4.94%-4.95% | 3.6%-3.8% |
The following table summarizes the activity and terms of nonvested restricted stock for the threesix months ended March 31,June 30, 2006:
Number of (000’s) | Weighted Average Grant- date Value | Number of Shares (000’s) | Weighted Average Grant-date Value | |||||||||
Nonvested shares at December 31, 2005 | 218 | $ | 24.12 | 218 | $ | 24.12 | ||||||
Granted | 46 | 31.05 | 97 | 31.54 | ||||||||
Vested | (31 | ) | 16.15 | (31 | ) | 16.15 | ||||||
Forfeited | (1 | ) | 25.66 | (7 | ) | 27.10 | ||||||
Nonvested shares at March 31, 2006 | 232 | 26.56 | ||||||||||
Nonvested shares at June 30, 2006 | 277 | 27.54 | ||||||||||
The weighted average market value per share of restricted stock granted in the threesix months ended March 31,June 30, 2006 and 2005, was $31.05$31.54 and $28.74.$28.93. The total value of restricted stock vested during the threesix months ended March 31,June 30, 2006 and 2005, was $0.5 million and $0.8 million.
Total stock-based compensation expense for the threesix months ended March 31,June 30, 2006 and 2005, was $1.0$2.9 million and $0.5$0.9 million, with recognized tax benefits of $0.4$1.1 million and $0.2$0.4 million. As of March 31,June 30, 2006, the total unrecognized compensation cost related to nonvested awards was $6.2$7.7 million, expected to be recognized over a weighted-average period of 1.92.1 years.
Beginning with awards granted on or after January 1, 2006, unearned compensation is recognized as compensation expense ratably over the shorter of the vesting period or the period from the date of grant to the date that the employee is eligible for retirement. For awards issued prior to January 1, 2006, unearned compensation is recognized as compensation expense ratably over the vesting period. For grants which vest based on certain specified performance criteria, unearned compensation is recognized as compensation expense over the period of performance, once achievement of criteria is deemed probable. Had unearned compensation been recognized in the current manner for grants prior to 2006, stock compensation expense would have been higher by $79$17 thousand and $232$85 thousand for the three months ended March 31,June 30, 2006 and 2005, and higher by $96 thousand and $316 thousand for the six months ended June 30, 2006 and 2005.
5. | Direct-Response Advertising Costs |
Beginning with the acquisition of Access on January 31, 2005, the company capitalizes the costs of direct-response advertising of its direct-to-consumer diabetic supplies that meet the capitalization requirements of American Institute of Certified Public Accountants Statement of Position 93-7,Reporting on Advertising Costs. For the quarters ended March 31,June 30, 2006 and 2005, the company deferred $2.0$2.9 million and $0.8$1.6 million of direct-response advertising costscosts. The company recorded amortization of $0.7 million in the second quarter and $1.2 million in the first six months of 2006 and recorded amortization of $0.5$0.2 million and $35 thousand.in the comparable periods of 2005. At March 31,June 30, 2006 and December 31, 2005, deferred advertising costs of $5.2$7.4 million and $3.7 million, net of accumulated amortization of $2.1 million and $0.9 million, were included in other assets, net, on the company’s consolidated balance sheets.
6. | Goodwill and Intangible Assets |
The following table presents the activity in goodwill for the quartersix months ended March 31,June 30, 2006:
(in thousands) | |||
Balance, December 31, 2005 | $ | 242,620 | |
Additions | 6 | ||
Balance, March 31, 2006 | $ | 242,626 | |
(in thousands) Balance, December 31, 2005 Additions due to acquisitions Ending balance $ 242,620 129 $ 242,749
Intangible assets, net, at March 31,June 30, 2006 and December 31, 2005 are as follows:
(in thousands)
| ||||||||||||||||||||||||||||
Weighted | March 31, 2006 | December 31, 2005 | June 30, 2006 | December 31, 2005 | ||||||||||||||||||||||||
Gross amount | Accumulated amortization | Gross amount | Accumulated amortization | Weighted average useful life | Gross amount | Accumulated amortization | Gross amount | Accumulated amortization | ||||||||||||||||||||
Customer relationships | 4 years | $ | 19,637 | $ | 5,525 | $ | 17,334 | $ | 4,109 | 4 years | $ | 22,806 | $ | 7,106 | $ | 17,334 | $ | 4,109 | ||||||||||
Other intangibles | 6 years | 4,421 | 807 | 4,421 | 612 | 6 years | 4,496 | 1,002 | 4,421 | 612 | ||||||||||||||||||
24,058 | 6,332 | 21,755 | 4,721 | 27,302 | 8,108 | 21,755 | 4,721 | |||||||||||||||||||||
Unamortized intangible pension asset | 1,349 | — | 1,349 | — | 1,349 | — | 1,349 | — | ||||||||||||||||||||
Total | $ | 25,407 | $ | 6,332 | $ | 23,104 | $ | 4,721 | $ | 28,651 | $ | 8,108 | $ | 23,104 | $ | 4,721 | ||||||||||||
Amortization expense for intangible assets was $1.7$1.8 million and $0.1$1.5 million for the three months ended March 31,June 30, 2006 and 2005, and $3.4 million and $1.5 million for the six months ended June 30, 2006 and 2005.
Based on the current carrying value of intangible assets subject to amortization, estimated future amortization expense is as follows: Remainder of 2006 - $5.3$3.7 million; 2007 - $5.3$6.0 million; 2008 - $4.2$5.3 million; 2009 - $1.9$2.7 million; 2010 - $0.4$0.8 million.
7. | Long-term Debt |
In April 2006, the company issued $200.0 million of 6.35% Senior Notes maturing on April 15, 2016 (Notes). Interest on the Notes is payable semi-annually on April 15 and October 15, beginning October 15, 2006. The Notes are redeemable at the company’s option, subject to restrictions. The Notes are unconditionally guaranteed on a joint and several basis by all significant subsidiaries of the company. The net proceeds from the Notes, together with cash on hand, were used to retire the 8 1/2% Senior Subordinated Notes due in 2011 (2011 Notes).
The early retirement of the 2011 Notes resulted in loss of $11.4 million, comprised of $8.0 million of retirement cost in excess of carrying value, a $3.0 million write-off of debt issuance costs, and $0.4 million of fees.
Also in April 2006, the company amended its $250.0 million revolving credit facility in order to reduce the applicable borrowing rates and fees payable, eliminate the borrowing base limitation applicable to borrowings under the revolving credit facility, increase the amount of certain types of indebtedness that can be incurred under the facility and to extend the term of the agreement to May 2011.
8. | Derivative and Hedging Activities |
The company generally enters into interest rate swaps as part of its interest rate risk management strategy. The purpose of these swaps is to maintain the company’s desired mix of fixed to floating rate financing and to minimize interest expense related to fixedvariable rate financing. TheIn conjunction with the 2011 Notes, the company had interest rate swap agreements of $100with a $100.0 million notional amountsvalue that effectively converted a portion of the company’s fixed rate financing instruments to variable rates. These swaps were terminated in March 2006. These swaps were designated as fair value hedges of a portion of the company’s 8 1/2% Senior Subordinated 10-year Notes due in 2011, and were assumed to have no ineffectiveness under the provisions of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities.
In March 2006, the company entered into forward contracts to hedge its future interest rate risk associated with the pricing of its April 2006 offering of $200 million of 6.35% Senior Notes (Notes).the Notes. See note 127 for further description of the Notes offering. At March 31, 2006, the fair value of outstanding forward contracts was $0.8 million, included in other assets, net, on the consolidated balance sheet. The contracts were terminated in April 2006, resulting in a gain of $0.8 million that will be recognized in interest expense, net, ratably over the life of the Notes.
In April 2006, in conjunction with the issuance of the Notes, the company entered into interest rate swap agreements, under which the company pays counterparties a variable rate based on LIBOR and the counterparties pay the company a fixed interest rate of 6.35% on a notional amount of $100.0 million, effectively converting one-half of the notes to variable-rate debt. These swaps were designated as fair value hedges and were assumed to have no ineffectiveness under the provisions of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities.
Retirement Plans |
The components of net periodic pension cost of the company’s retirement plans for the three and six months ended March 31,June 30, 2006 and 2005 are as follows:
Three Months Ended March 31, | ||||||||||||||||||||||||
(in thousands)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||||
Service cost | $ | 214 | $ | 378 | $ | 215 | $ | 140 | $ | 429 | $ | 518 | ||||||||||||
Interest cost | 766 | 805 | 766 | 806 | 1,532 | 1,611 | ||||||||||||||||||
Expected return on plan assets | (395 | ) | (405 | ) | (417 | ) | (409 | ) | (812 | ) | (814 | ) | ||||||||||||
Amortization of prior service cost | 39 | 39 | 40 | 40 | 79 | 79 | ||||||||||||||||||
Recognized net actuarial loss | 282 | 350 | 262 | 295 | 544 | 645 | ||||||||||||||||||
Net periodic pension cost | $ | 906 | $ | 1,167 | $ | 866 | $ | 872 | $ | 1,772 | $ | 2,039 | ||||||||||||
Comprehensive Income |
The company’s comprehensive income for the three and six months ended March 31,June 30, 2006 and 2005 is shown in the table below:
(in thousands) | Three Months Ended March 31, | Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||
Net income | $ | 16,503 | $ | 15,919 | ||||||||||||||||
Net Income | $ | 10,489 | $ | 15,973 | $ | 26,992 | $ | 31,892 | ||||||||||||
Other comprehensive income – change in value of cash-flow hedge derivatives, net of tax | 506 | — | (5 | ) | — | 501 | — | |||||||||||||
Reclassification of gain on cash-flow hedge derivative to net income, net of tax | (12 | ) | — | (12 | ) | — | ||||||||||||||
Comprehensive income | $ | 17,009 | $ | 15,919 | $ | 10,472 | $ | 15,973 | $ | 27,481 | $ | 31,892 | ||||||||
Net Income per Common Share |
The following sets forth the computation of net income per basic and diluted net income per common share:
(in thousands, except per share data) | Three Months Ended March 31, | Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||
Numerator: | ||||||||||||||||||
Numerator for basic and diluted net income per common share – net income | $ | 16,503 | $ | 15,919 | $ | 10,489 | $ | 15,973 | $ | 26,992 | $ | 31,892 | ||||||
Denominator: | ||||||||||||||||||
Denominator for basic net income per common share – weighted average shares | 39,732 | 39,327 | 39,862 | 39,490 | 39,797 | 39,409 | ||||||||||||
Effect of dilutive securities - stock options and restricted stock | 521 | 536 | 481 | 531 | 511 | 542 | ||||||||||||
Denominator for diluted net income per common share – adjusted weighted average shares | 40,253 | 39,863 | ||||||||||||||||
Denominator for diluted net income common share – adjusted weighted average shares | 40,343 | 40,021 | 40,308 | 39,951 | ||||||||||||||
Net income per common share – basic | $ | 0.42 | $ | 0.40 | $ | 0.26 | $ | 0.40 | $ | 0.68 | $ | 0.81 | ||||||
Net income per common share – diluted | $ | 0.41 | $ | 0.40 | $ | 0.26 | $ | 0.40 | $ | 0.67 | $ | 0.80 |
Contingency |
In September 2004, the company received a notice from the Internal Revenue Service (IRS) proposing to disallow, effective for the 2001 tax year and all subsequent years, certain reductions in the company’s tax-basis last-in, first-out (LIFO) inventory valuation. The proposed adjustment involves the timing of deductions. Management believes that its tax-basis method of LIFO inventory valuation is consistent with a ruling received by the company on this matter from the IRS and is appropriate under the tax law. The company filed an appeal with the IRS in December 2004 and plans to contest the proposed adjustment pursuant to all applicable administrative and legal procedures. If the company were unsuccessful, the adjustment would be effective for the 2001 tax year and all subsequent years, and the company would have to pay a deficiency of approximately $41.6 million in federal, state, and local taxes for tax years through 2005 on which deferred taxes
have been provided, as well as interest, calculated at statutory rates, of approximately $6.8$7.5 million as of March 31,June 30, 2006, net of any tax benefits, for which no reserve has been established. No penalties have been proposed. The payment of the deficiency and interest would adversely affect operating cash flow for the full amount of the payment, while the company’s net income and earnings per share would be reduced by the amount of any liability for interest, net of tax. The ultimate resolution of this matter may take several years and a determination adverse to the company could have a material effect on the company’s cash flows and results of operations.
Subsequent Event |
On April 7,Subsequent to June 30, 2006, the company issued $200 million of 6.35% Senior Notes (Notes) which mature on April 15, 2016. Interest on the Notes is payable semi-annually on April 15 and October 15, beginning on October 15, 2006. The Notes are unconditionally guaranteed onsigned a joint and several basis bydefinitive agreement to acquire certain subsidiariesassets of the acute-care medical and surgical supply distribution business of McKesson Medical-Surgical Inc., a business unit of McKesson Corporation, for approximately $170 million in cash. The acquisition includes inventory estimated at approximately $130 million, acute-care customer contracts and certain fixed assets. The transaction is subject to various closing conditions, including regulatory approvals, and is expected to close no later than the fourth quarter of 2006.
In July 2006, the company including all significant subsidiaries. Proceeds from the Notes, together with available cash, were usedacquired certain operating assets of a California-based direct-to-consumer distributor of diabetic supplies for approximately $8.1 million in cash. The purchase price is subject to retire substantially alladjustment upon a final determination of the company’s $200 milliontotal number of 8 1/2% Senior Subordinated Notes due 2011.customers acquired. The early retirementassets acquired consist primarily of debt resulted in an estimated pretax charge of $11.5 million, which will be recorded in the company’s financial statements for the quarter ended June 30, 2006.customer relationships, other intangible assets and inventory.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis describes material changes in the financial condition and results of operations of Owens & Minor, Inc. and its wholly-owned subsidiaries (O&M or the company) since December 31, 2005. 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 2005 Annual Report on Form 10-K for the year ended December 31, 2005.
Results of Operations
FirstSecond quarter and first six months of 2006 compared with first quarter of 2005
Overview.Overview. In the second quarter and first quartersix months of 2006, the company earned net income of $16.5$10.5 million or $0.41and $27.0 million, decreases of 34% and 15% from the comparable periods of 2005. Net income per diluted common share compared with $15.9 million, or $0.40 per diluted common share, inwas $0.26 for the second quarter and $0.67 for the first six months of 2006, down from $0.40 for the second quarter and $0.80 for the first six months of 2005. The 4% increase in net incomeThese decreases resulted from a 3% increasesecond quarter pre-tax charge of $11.4 million related to the early retirement of debt, as the company refinanced $200 million in operating earnings and decreased net interest expense. Operating earnings were $30.4 million, or 2.4% of revenue, in the first quarter of 2006, compared to $29.6 million, or 2.5% of revenue, in the first quarter of 2005. Operating earnings in the first quarter of 2006 included the effect of the relocation of the company’s corporate headquartersdebt at a more favorable rate, and the expensing of stock options as a resultequity-based compensation associated with the adoption of adopting Statement of Financial Accounting Standards No. (SFAS) 123(R),Share-Based Payment., in the first quarter of 2006. These decreases were partially offset by increased operating earnings. Operating earnings, which were $31.2 million for the second quarter and $61.7 million for the first six months of 2006, increased by 10% from the second quarter and 6% from the first six months of 2005 primarily due to 7% revenue growth and productivity gains.
Acquisitions.On January 31, 2005, the company acquired Access Diabetic Supply, LLC (Access), a Florida-based, direct-to-consumer distributor of diabetic supplies and products for certain other chronic disease categories, for total consideration, including transaction costs, of approximately $58.8 million in cash. Access primarily markets blood glucose monitoring devices, test strips and other ancillary products used by diabetics for self-testing. The direct-to-consumer distribution business experiences significantly higher gross margins and selling, general and administrative (SG&A) expenses as a percent of revenue than the company’s core medical/surgical supply distribution business. Since January 31, 2005, Accessthe company has acquired either the stock or certain assets of threefour direct-to-consumer distributors of diabetic testing supplies for a total of $10.2$13.8 million. The assets acquired consist primarily of customer relationships, other intangible assets and inventory. AsDirect-to-consumer distribution revenue was $21.2 million in the second quarter and $39.0 million for the first six months of 2006, up from $14.5 million in the second quarter and $22.9 million in the first six months of 2005. The increase was a result of the acquisitions, customer growth through advertising, and the inclusion of threesix months of results in the first quarterhalf of 2006 compared to twofive months in the first half of 2005. Operating earnings were $0.3 million for the second quarter and $0.0 million for the first six months of 2006, while in 2005, direct-to-consumer distribution revenue increased from $8.4operating earnings were $0.8 million in the firstsecond quarter of 2005 to $17.8and $2.2 million infor the first quarter of 2006. Access contributed $1.4 million of operating earnings to the companysix months. Earnings were negatively affected by an increase in the first quarter of 2005, while in the first quarter of 2006, Access had a negative impact on operating earnings of $0.3 million, largely due toSG&A expenses and increased amortization of bothresulting from acquired customer relationships and direct-response advertising.
Also inIn 2005, O&M acquired certain assets of two small software companies to broaden the technology portfolio of OMSolutionsSM, for a total of $4.9 million in cash.
Revenue.Revenue. Revenue increased 6%, or $68.4 million,7% to $1.26$1.30 billion in the firstsecond quarter of 2006 from $1.19$1.21 billion in the firstsecond quarter of 2005. For the first six months of 2006, revenue also increased 7% over the comparable prior year period. The increase primarily resulted from a combination of higher sales volume to existing customers, whilewhich accounted for approximately 60% of the year-to-date increase and 50% of the second quarter increase, sales to new healthcare provider customers, accounted for approximately one-fourth30% of the increase. In addition, direct-to-consumer revenue through Access, acquired January 31, 2005, contributed $9.4 million of theincrease in both periods, and growth as Access grew its customer base and three months of sales were included in the first quarterdirect-to-consumer business of 2006, compared to two months of salesapproximately $6.7 million in the firstsecond quarter of 2005.and $16.1 million for the six months ended June 30, 2006.
Operating earnings. Operating earnings increased 3%10% to $30.4$31.2 million in the second quarter of 2006 from $28.5 million in the first quarter of 2006 from $29.62005, and increased 6% to $61.7 million in the first quartersix months of 2006 from $58.1 million in the first six months of 2005. As a percent of revenue, operating earnings decreased slightlyremained unchanged at 2.4% in the second quarter and the first six months of 2006 from 2.5%the comparable periods of 2005. Operating earnings include stock option expense of $1.2 million in the second quarter and $1.6 million in the first quartersix months of 2005 to 2.4% in the first quarter of 2006. The company began expensing stock options2006 as a result of adopting SFAS 123(R) in the first quarter of 2006, resulting in additional expense of $0.4 million, which is included in selling, general and administrative (SG&A) expenses.2006. The company also relocated its corporate headquarters in the first quarter of 2006, resulting in additional costs of approximately $0.9 million. Combined, the expensing of stock options and the corporate headquarters relocation reduced operating margin by approximately 0.1% of revenue.revenue in the second quarter and the first six months of 2006.
Gross margin was 10.9% of revenue for the second quarter and 10.8% of revenue for the first quartersix months of 2006, was 10.8% of revenue, up from 10.5%10.6% in the first quartercomparable periods of 2005. This increase resulted from increased sales in the direct-to-consumer sales, whosebusiness, which experiences higher gross margins are higher than the company’s healthcare provider distribution business. Gross margin from healthcare provider distribution was unchanged in the second quarter from the comparable period in 2005 and declined by approximately 0.1% of revenue.revenue in the first six months of 2006 from the comparable period in 2005.
The company values inventory for its corehealthcare provider distribution business under the last-in, first-out (LIFO) method. Had inventory been valued under the first-in, first-out (FIFO) method, gross margin would have been higher by 0.4%0.2% of revenue in the first six months of 2006 and 2005. Gross margin for the second quarters of 2006 and 2005.2005 would not have differed materially from reported amounts.
SG&A expenses were 8.0%8.1% of revenue in the second quarter and 8.0% in the first quartersix months of 2006, up from 7.9% of revenue in the first quartercomparable periods of 2005. The increase resulted primarily from increased expenses from Access,the direct-to-consumer business, which experiences higher expenses as a percentage of revenue than the first quarter of 2005 included only two months of Access’ results.healthcare provider distribution business. SG&A expenses in the healthcare provider distribution business for the second quarter and the first six months of 2006 decreased by 0.2%0.1% of revenue due to productivity improvements and lower employee healthcare costs underfrom the company’s self-insured plan.comparable periods in 2005.
Depreciation and amortization expense increasedfor the second quarter and first six months of 2006 was $6.3 million and $11.9 million, up $1.2 million and $3.3 million from $3.4 million in the first quartercomparable periods of 2005 to $5.6 million in the first quarter of 2006. This increase was2005. These increases were primarily driven by $1.6 million of additionalan increase in the amortization of intangible assetsintangibles of $0.3 million for the second quarter and $1.9 million for the first six months of 2006 due to acquisitions, as well as $0.5 million ofan increase in amortization of direct-response advertising costs.costs of $0.5 million for the second quarter and $1.0 million for the first six months of 2006.
Interest expense, net. Net interest expense decreased to $3.1$2.3 million for the second quarter and $5.4 million for the first quartersix months of 2006 from $3.3$2.9 million in the second quarter and $6.2 million in the first quartersix months of 2005, as the company realized increased interest income onas a result of higher interest rates and higher cash and cash equivalents balances relative tothan in the first quartercomparable periods of 2005.
Effective April 7, 2006, the company completed its offering of $200 million of 6.35% Senior Notes maturing in 2016 (Notes) and retired substantially all of its $200 million of 8 1/2% Senior Subordinated Notes due 2011.2011(2011 Notes). The company expects to continue to manage its financing costs by managing working capital levels. Future financing costs will be affected primarily by changes in short-term interest rates, as well asfunds used for acquisitions and working capital requirements.
Income taxes. The provision for income taxes was $10.9$7.0 million and $17.8 million in the second quarter and first quartersix months of 2006 compared with $10.3$9.6 million and $19.9 million in the same periodperiods of 2005, representing an2005. The effective tax rate of 39.7%was 40.0% and 39.8% for the second quarter and first quarterhalf of 2006, compared withto 39.0% for the full year of 2005. The tax rate was lower in 2005 than in the comparable periods of 2006 because of adjustments recorded in the second quarter of 2005 to the company’s reserve for tax liabilities for years no longer subject to audit.
Financial Condition, Liquidity and Capital Resources
Liquidity. The company’s liquidity remained strong in the first quartersix months of 2006, as its cash and cash equivalents increased $0.8$2.2 million to $72.7$74.1 million during the quarter.period. In the first quartersix months of 2006, the company generated $21.6$42.1 million of cash flow from operations, compared with $123.0$121.4 million in the first quarterhalf of 2005. Cash flows in both quartersperiods were positively affected by timing of payments for inventory, whileinventory. Cash flows in the first quartersix months of 2005 cash flows were also enhanced by improved collections of accounts receivable and inventory reductions. Cash used for investing activities decreased from $64.1$76.2 million in the first quartersix months of 2005 to $8.6$17.5 million in the first quarterhalf of 2006, as the company paid $57.9$60.6 million in the first quarterhalf of 2005 to purchase Access.fund acquisitions. Accounts receivable days sales outstanding at March 31,June 30, 2006, were 25.524.9 days, improved from 26.3 days at December 31, 2005, but up slightly from 24.424.8 days at March 31,June 30, 2005. Inventory turnover remained consistent at 10.3decreased to 10.1 in the second quarter of 2006 from 10.7 in the second quarter of 2005 primarily due to new customer growth.
The company’s financing activities used $22.4 million of cash in the first quarterssix months of both 2006 and 2005.
Subsequentprimarily due to the first quarter, on April 7, 2006,payment of dividends and the early retirement of debt. The company issued $200 million of 6.35% Senior Notes (Notes) maturing April 15, 2016. The net proceeds from thesethe Notes, together with available cash, were used to retire substantially all of the company’s $200 million of 8 1/2% Senior Subordinated Notes. Interest on the Notes will be paid semiannually on April 15 and October 15, beginning October 15, 2006. The company received an investment grade rating of “BBB-” from Fitch Ratings for the new Notes and an investment grade rating of “BBB-” from Standard & Poor’s, consistent with its existing corporate credit rating, and a rating of “Ba2” from Moody’s.
In March 2006, in anticipation of the Notes offering, the company entered into $100 million notional amount of forward contracts designated to hedge the interest rate risk related to the pricing of the offering. These contracts were terminated onin April 3, 2006, resulting in a gain of $0.8 million that will be recognized as a reduction of interest expense, net, over the life of the Notes.
In conjunction with the Notes, the company entered into interest rate swap agreements in April 2006, under which the company pays counterparties a variable rate based on LIBOR and the counterparties pay 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. These swaps were designated as fair value hedges and were assumed to have no ineffectiveness under the provisions of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. In addition, effective April 3, 2006, the company amended its $250 million revolving credit facility, extending its expiration to May 3, 2011.
On July 11, 2006, the company announced it signed a definitive agreement to acquire certain assets of the acute-care medical surgical supply distribution business of McKesson Corporation for approximately $170 million. The company intends to fund this acquisition with available credit under its revolving credit facility and cash balances on hand.
The company expects thatbelieves its available financing sources subsequent to this acquisition will be sufficient to fund its working capital needs and long-term strategic growth, although this cannot be assured. At March 31,June 30, 2006, the company had $237.8 million of available credit under its revolving credit facility.
Capital Expenditures.Expenditures. Capital expenditures were $6.4$11.2 million in the first quartersix months of 2006, compared to $6.2$15.6 million in the first quarterhalf of 2005. Construction of the corporate headquarters facility was completed in the first quarter of 2006.
Adoption of SFAS 123(R),Share-Based Payment
Effective January 1, 2006, the company adopted the provisions of SFAS 123(R),Share-Based Payment, a revision of SFAS 123,Accounting for Stock-Based Compensation.SFAS 123R also supersedes Accounting Principles Board Opinion No. (APB) 25,Accounting for Stock Issued to Employees,and amends SFAS 95,Statement of Cash Flows.SFAS 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the income statement based on their fair values, while SFAS 123 as originally issued provided the option of recognizing share-based payments based on their fair values or based on their intrinsic values with pro forma disclosure of the effect of recognizing the payments based on their fair values.
The company adopted the provisions of SFAS 123(R) using the modified prospective method. Under this method, compensation expense for all share-based payments granted after January 1, 2006, is recognized based on the requirements of SFAS 123(R), while compensation expense for all awards granted to employees prior to January 1, 2006 that remain unvested as of that date, is recognized based on the requirements of SFAS 123.
As permitted by SFAS 123, the company used the intrinsic value method as defined by APB 25 to account for share-based payments prior to January 1, 2006. As a result, the adoption of SFAS 123(R)
had, and is expected to continue to have, a material effect on the company’s results of operations, although it will not materially affect the company’s overall financial position. As the amount of expense to be recognized in future periods will depend on the levels of future grants, the effect of adoption of SFAS 123(R) cannot be predicted with certainty. However, had the company adopted SFAS 123(R) in prior periods, the effect of adoption would have approximated the effect of using the fair value method, as defined in SFAS 123, to account for share-based payment as disclosed in Note 4 to the company’s consolidated financial statements under the caption “Stock-Based Compensation.” ForSG&A expenses were $1.2 million higher in the second quarter and $1.6 million higher in the first quartersix months of 2006 selling, general and administrative expenses were $449 thousand higher than would have been recorded without the adoption of SFAS 123(R).
SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flows, rather than as operating cash flows as required prior to adoption. This requirement reduced net operating cash flows and increased net financing cash flows for the first quarterhalf of 2006 by $1.2 million. The company cannot estimate what these amounts will be in the future, as they depend on a number of factors including the timing of employee exercises of stock options and
the value of the company’s stock at the date of those exercises. However, had the company adopted SFAS 123(R) previously, the amount of cash flows recognized as financing cash flows rather than operating cash flows for such excess tax deductions would have been $0.6$1.4 million in the first quartersix months of 2005.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,” which is effective for fiscal years beginning after December 15, 2006, with earlier adoption encouraged. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The company is currently assessing the potential impact of the interpretation on its 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:
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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 is exposed to market risk from changes in interest rates related to its interest rate swaps and revolving credit facility. As of March 31,June 30, 2006, the company had $100 million notional amount of forward contracts designated to hedge the interest rate risk related to the pricing of its Notes offering. These contracts were terminated on April 3, 2006. Therefore, no market risk related to these instruments exists as of the date of this filing.
Subsequent to March 31, 2006, the company entered into interest rate swap agreements in April 2006swaps under which the company pays counterparties a variable rate based on LIBOR and the counterparties pay the company a fixed interest rate of 6.35% on a notional amount of $100 million. A hypothetical increase in interest rates of 100 basis points would result in a potential reduction in future pre-tax earnings of approximately $1.0 million per year in connection with the swaps.
The company is exposed to market risk from changes in interest rates related to its revolving credit facility. The company had no outstanding borrowings under its revolving credit facility at March 31,June 30, 2006. 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.
Item 4. Controls and Procedures
The company carried out an evaluation, with the participation of the company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the company’s disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the
company required to be included in the company’s periodic SEC filings. There has been no change in the company’s internal controls over financial reporting during the quarter ended March 31,June 30, 2006, 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, 2005. Through March 31,June 30, 2006, 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, 2005. Through March 31,June 30, 2006, there have been no material changes in any risk factors reported in such Annual Report.
Item 4. Submission of Matters to a Vote of Shareholders
The following matters were submitted to a vote of O&M’s shareholders at its annual meeting held on April 28, 2006, with the voting results designated below for each such matter:
(1) | Election of John T. Crotty, Richard E. Fogg, James E. Rogers, and James E. Ukrop, as directors of O&M for a three year term. |
Directors | Votes For | Votes Against Or Withheld | Abstentions | Broker Non-Votes | ||||
John T. Crotty | 37,266,669 | 658,476 | 0 | 0 | ||||
Richard E. Fogg | 37,271,738 | 653,407 | 0 | 0 | ||||
James E. Rogers | 36,673,277 | 1,251,868 | 0 | 0 | ||||
James E. Ukrop | 37,123,915 | 801,230 | 0 | 0 |
(2) | Ratification of the appointment of KPMG LLP as O&M’s independent registered public accountants for 2006. |
Votes For | Votes Against Or Withheld | Abstentions | ||
37,458,580 | 264,855 | 201,710 |
2.1 |
10.1 |
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.
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Exhibits Filed with SEC
31.1 | Certification of Chief Executive Officer pursuant to Rule | |
31.2 | Certification of Chief Financial Officer pursuant to Rule | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of |
* | The company has requested confidential treatment by the Commission of certain portions of this Agreement, which portions have been omitted and filed separately with the Commission. |
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.
Owens & Minor, Inc. | ||
(Registrant) | ||
Date August 3, 2006 | /s/ CRAIG R. SMITH | |
Craig R. Smith President & Chief Executive Officer | ||
Date August 3, 2006 | /s/ JEFFREY KACZKA | |
Jeffrey Kaczka | ||
Senior Vice President & Chief Financial Officer | ||
Date August 3, 2006 | /s/ OLWEN B. CAPE | |
Olwen B. Cape Vice President, Controller & Chief Accounting Officer |
22
Exhibits Filed with SEC
Exhibit #
2.1 | Asset Purchase and Sale Agreement dated as of July 10, 2006 among Owens & Minor Distribution, Inc., Owens & Minor, Inc., McKesson Medical-Surgical, Inc. and McKesson Corporation (incorporated herein by reference to the Company’s Current Report on Form 8-K dated July 14, 2006) | |
10.1 | Medical-Surgical Distribution Agreement between Novation, LLC and Owens & Minor Distribution, Inc. effective September 1, 2006* | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | The company has requested confidential treatment by the Commission of certain portions of this Agreement, which portions have been omitted and filed separately with the Commission. |