2002 ANNUAL REPORT & FORM 10-K BuildingOn A Foundation Of TRUST 14 Board of Directors 15 Corporate Officers Contents Company Content Overview Owens & Minor, Inc., a Fortune 500 company leading distributor of national name-brand medical and headquartered in Richmond, Virginia, ended 2002 with sales of $3.96 billion. As the nation’s Overview 24 Management’s Discussion 16 Financial Table of Contents 32 Consolidated Statements 17 Selected Financial Data 18 Business Description & Analysis of Income 33 Consolidated Balance Sheets 34 Consolidated Statements of Cash Flows 35 Consolidated Statements of Changes in Shareholders’ Equity 36 Notes to Consolidated Financial Statements 62 Independent Auditors’ Report 62 Report of Management 63 Quarterly Financial Information 64 Form 10-K Annual Report 68 Corporate Information Cover About the Cover Owens & Minor, Inc., established in 1882 in Richmond, Virginia, is the nation’s leading distributor of national name-brand medical and surgical supplies. Since its inception, the company has operated according to the guiding principles of trust, integrity, ethics, character and value. These core values formed the foundation for Owens & Minor’s successful history, and are the building blocks for its future. surgical supplies, the company serves its 4,000 customers from 41 distribution centers located strategically throughout the United States. Owens & Minor’s customers include acute-care hospitals, group purchasing organizations and integrated healthcare systems. Along with a wide range of medical and surgical products, the company offers its customers supply chain management solutions, innovative technology tools, and logistics services that improve efficiency and reduce cost in the healthcare marketplace. The company places a high priority on its mission, vision and values, which focus on the well-being of customers, supply chain partners, teammates and shareholders. The company has developed a culture of recognition, reinforcement and reward for its teammates, who are vital to its success. Owens & Minor believes that high integrity is the guiding principle of doing business. Owens & Minor common shares are traded on the New York Stock Exchange under the symbol OMI. As of December 31, 2002, there were approximately 34 million common shares outstanding. Financial Highlights (in thousands, except ratios, per share data and teammate statistics) Year ended December 31, Net sales As reported: Income before extraordinary item(2)(3) Income before extraordinary item per common share - basic(2)(3) Income before extraordinary item per common share - diluted(2)(3) Excluding goodwill amortization (1): Income before extraordinary item(2)(3) Income before extraordinary item per common share - basic(2)(3) Income before extraordinary item per common share - diluted(2)(3) Cash dividends per common share Book value per common share at year-end Stock price per common share at year-end Number of common shareholders Shares of common stock outstanding Return on average common equity excluding goodwill amortization and unusual items (1)(2)(3)(4) Return on total assets excluding goodwill amortization and unusual items(1)(2)(3)(4)(6) Gross margin as a percent of net sales Selling, general and administrative expenses as a percent of net sales(3) Outstanding financing (5) Capitalization ratio(6)(7) Average receivable days sales outstanding (6) Average inventory turnover Teammates at year-end 2002 2001 2000 02/01 $3,959,781 $3,814,994 $3,503,583 3.8% 01/00 8.9% Percent Change $ $ $ $ $ $ $ $ $ 47,217 1.40 1.26 47,217 1.40 1.26 0.31 7.96 16.42 13.1 34,113 $ $ $ $ $ $ $ $ $ 30,103 0.90 0.85 35,431 1.06 0.98 0.2725 6.97 18.50 13.9 33,885 $ $ $ $ $ $ $ $ $ 33,088 56.9% (9.0%) 1.01 55.6% (10.9%) 0.94 48.2% (9.6%) 38,417 33.3% (7.8%) 1.17 1.08 0.2475 6.41 17.75 15.0 33,180 32.1% (9.4%) 28.6% 13.8% 14.2% (11.2%) (5.8%) 0.7% (9.3%) 10.1% 8.7% 4.2% (7.3%) 2.1% 19.2% 4.8% 10.6% 7.8% 19.1% 19.2% 4.3% 10.7% 4.0% 10.7% 7.8% 7.7% $ 240,185 $ 273,449 $ 233,533 (12.2%) 17.1% 37.7% 32.0 9.6 2,968 42.6% 33.1 9.7 2,937 40.4% 33.3 9.5 2,763 1.1% 6.3% (1) Effective January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. As a result, goodwill is no longer amortized. Data for 2001 and prior periods have been restated to exclude the effect of goodwill amortization in order to present a more meaningful comparison. (2) In 2002, the company recorded reductions in a restructuring accrual of $0.5 million, or $0.3 million net of tax. In 2001, the company recorded an impairment loss of $1.1 million on an investment in marketable equity securities, a provision for disallowed income tax deductions of $7.2 million, and a reduction in a restructuring accrual of $1.5 million, or $0.8 million net of tax. In 2000, the company recorded a reduction in a restructuring accrual of $0.8 million, or $0.4 million net of tax. Excluding these unusual items, the charge mentioned in footnote 3 below, and goodwill amortization of $5.3 million, net of tax, in 2001 and 2000, income before extraordinary item per diluted common share in 2002, 2001 and 2000 was $1.30, $1.17 and $1.07. See Notes 1, 3, 6 and 14 to the Consolidated Financial Statements. (3) In 2002, the company recorded a charge of $3.0 million, or $1.8 million net of tax, due to the cancellation of the company’s contract for mainframe computer services. This charge was included in selling, general and administrative (SG&A) expenses. Excluding this charge, SG&A expenses as a percent of net sales were 7.7% in 2002. (4) Excludes extraordinary items. (5) Consists of debt and sales of accounts receivable outstanding under the company’s off balance sheet receivables financing facility. See Notes 8 and 9 to the Consolidated Financial Statements. (6) Assumes that receivables had not been sold under the company’s off balance sheet receivables financing facility. (7) Includes mandatorily redeemable preferred securities as equity. Dividends Return on Total Assets Net Sales (billions) ’00 ’01 ’02 $0.25 $0.27 $0.31 ’00 ’01 ’02 4.0% 4.3% 4.8% ’00 ’01 ’02 Diluted EPS (Before extraordinary item) (1) $3.50 $3.81 $3.96 ’00 ’01 ’02 $1.08 $0.98 $1.26 Dear Shareholders,Teammates,Customers, Suppliers and Friends, When I was growing up, my father would take my brother and me down to our old four-story down- town warehouse after church on Sunday. Owens & Minor was a wholesale drug company with a cou- ple of million dollars in sales but growing every year. This old ware- house was outfitted with a fairly elaborate system of conveyor belts and skate wheel rollers to move product down the aisles and between floors. My brother and I would get on the conveyor belt in a cardboard tote box, and with a Owens & Minor moved forward again in 2002 with splendid acceler- ation in all parts of our business. I have much to celebrate with you in this report, not only about our results in 2002 but also our new strategic direction. The Numbers Speak Please note that all of the pertinent numbers exclude unusual items and goodwill amortization de- scribed in the financial section of this annual report. In 2002, we met or exceeded most of our internal strengthened our goals, and to 4.8% in 2002. We generated $46 million in free cash flow in 2002, which allowed us to decrease financing by $33 outstanding million. As in the past, strong asset management helped carry the day. During the fourth quarter we announced a plan to repurchase up to $50 million of a combination of our common stock and our trust preferred convertible securities. That initiative is well underway. Productivity improvements continue to help our profitability. Sales per full time equivalent (FTE) increased 5.6%, extending a very “Our people, who care deeply about our company, will never give up in their quest to satisfy our customers and shareholders alike.” push of a button, ride the conveyor belt. One day I asked my father to push the button to reverse the belt so we wouldn’t have to walk all the way back. I’ll never forget his answer. He said that this belt always moves like our forward impact of that company. The simple statement set the tone for the rest of my life. just balance sheet while improving productivity. Sales for the year were up 4% to $3.96 billion. We sagged a little in mid-year, but ended with the strongest sales quarter in company history. Earnings per diluted share for the year were $1.30, or 11% above 2001. Income was $48.7 mil- lion, up 14% from last year. Gross margin remained at an acceptable level of 10.6%, down slightly from 10.7% in 2001. Selling, general and administrative expenses im- proved to 7.7% of sales, down from 7.8% last year. Asset management continued to improve with strong performances in managing receiv- ables and inventory. Return on total assets improved from 4.3% in 2001 positive year over year trend. Our gross margin per FTE continued to improve, by 4%, also extending this positive trend. Looking back at 1999, our sales were $3.2 billion and our FTE’s were 2,644. Since then, sales have grown 24% while our FTE count has only grown 3%. By using technology to help grow our business and operate it more effi- ciently, we have seen very little increase in our workforce, thus improving our profitability and without sacrificing our service one iota. Our share price fell 11.2% in 2002, less than the popular indices, but certainly not acceptable to me. The value of our company contin- ues to strengthen and we must do a better job of communicating that. 2 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T We increased our dividend in 2002 by 13.8%, and have continuously paid a dividend since the 1920s. Highlights for 2002 We signed a comprehensive seven- year technology services agreement with Perot Systems Corporation, putting all of our information tech- nology outsourcing under one roof. This seven-year agreement holds enormous benefit for us, especially the approximately $30 million in savings it will generate over the life of the contract. We will reinvest the majority of these savings to improve our value to customers and suppliers. We were honored to receive the 2002 VHA Service Excellence Award. This award, voted on by VHA members, salutes our out- standing performance in quality and customer service to the VHA membership. This is a tribute to every one of our teammates across the country. In 2002, InformationWeek ranked Owens & Minor as the #1 most innovative technology company in healthcare for the third year in a row. Overall, Owens & Minor was ranked #11 out of 500 American companies for the use of innovative technology. In an independent survey of the healthcare industry, Owens & Minor was again ranked as the #1 customer service provider. Our own customer satisfaction surveys, independent conducted by an research firm, found that overall customer satisfaction improved from 96% to 97%. It’s going to be hard to get much better than this, but we are sure going to try. We introduced Owens & Minor University (OMU) to our teammates in November and have In my opinion, any company worth its salt must reinvent itself every three to five years. For exam- ple, let’s take the last 20-plus years for us. In 1981, Owens & Minor acquired part of the Will Ross Com- pany, which put us on the map as a Sunbelt distribution company. In “We are always there when our customers need us. That dependability has been a hallmark of our company for a long, long time.” a full rollout of educational pro- grams and learning experiences ready for introduction in the first quarter of 2003. Our corporate credit and bank loan ratings have been upgraded by Standard & Poors to BB+ from BB, as a result of our improving financial strength. We introduced a private label program under the name of Medi- Choice™. Sales of these products exceeded our internal expectations for the first year. We expect this initiative to grow in the future. And finally, we introduced three strategic initiatives that will drive our company forward over the next three to five years. Strategic Direction “Extra, extra, read all about it,” cried the newspaper barker as he stood at the intersection of Good and Great Streets, “Owens & Minor introduces new strategic direc- tions.” Sounds a little corny to express excitement this way, but I feel excited about our new direction for the future. 1985 we were awarded the VHA supply company contract for our coverage area, which grew our busi- ness tremendously, and is still growing it today. In 1989 we acquired National Healthcare on the West Coast and became a national company. In 1994 we acquired Stuart Medical, which just about doubled the size of our com- pany. In 1998 we introduced the first wave of our leading edge technology such as WISDOMSM, CostTrackSM, and OMDirectSM, our Internet-based ordering and com- munications platform. And in 2002, we developed and launched new strategic initiatives. So, you see…a willingness to change, listening to our customers and being quick on our feet has served us well. We spent the better part of the last twelve months listening to our customers. As a result, we developed new strategic initiatives O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 3 “The opportunities are there, we have the right team on the field, and we have the right strategy to follow for success.” that will successfully carry us to the next level. These three initiatives are progressing very well. A more detailed description of these initia- tives follows in this annual report, but here they are in a nutshell. First, our core business objec- tive is to do a better job at the things we do so well today. We have estab- lished Owens & Minor University (OMU) to better educate and develop our teammates. And, we have launched improvements to our operations nationwide that will ensure consistent service from coast-to-coast. The second strategic initiative is OMSolutionsSM. This new unit brings together teammates from across the country who have been consulting on logistics and supply chain matters, as well as outsourc- ing, so that we can create a formal business to help provide solutions for our customers. We have also developed programs to provide sup- port to clinical areas of the hospital. And third, we are developing a third party logistics model (3PL) to provide manufacturers and health- care providers a creative alternative to getting products to the patient more efficiently and at less cost. We will update you regularly in 2003 on our progress in these three strategic areas. Changing of the Guard Recently, two long-term Owens & Minor teammates announced their retirement. Drew St. J. Carneal, senior vice president, general counsel and corporate secretary, relinquished the role of general counsel in mid-February 2003, and will retain the role of senior vice president, corporate secretary until his retirement later this year. Drew, who joined the company in 1988, has been the Rock of Gibraltar for our teammates and me personally. He has the highest respect and admiration possible from us all. Also, Hue Thomas, III, vice president, corporate relations, has announced his retirement. He will move back to his native state of Georgia in the spring. Since joining the company in 1970, Hue tackled just about every job in the company. He served in a field capacity in Georgia before moving to Rich- mond in 1984 to work primarily with our supplier partners. At every step along the way, Hue has distinguished himself by his loyalty to the company, our customers and his teammates. Also, Josiah Bunting, III, who recently announced his retirement as superintendent of the Virginia Military Institute, is not standing for re-election to our board of directors. He is finishing his second three-year term on our board and has provided us with wise counsel and great leadership during these years. Thank you, Si! And, Grace R. den Hartog joined our team as senior vice president, general counsel, in mid-February 2003. Grace, formerly a partner with McGuireWoods LLP, has concentrated in the manage- ment of national products liability defense litigation for the last 18 years. She has been recognized as one of the top 50 women in her field in the country. She brings to us her good judgment, sharp mind, a tremendous work ethic, high integrity, and a passion for doing what’s right. Welcome, Grace! Corporate Governance and Responsibility As the Chief Executive Officer, I am responsible for the integrity and credibility of our company. I gladly accept that responsibility and share it with our board of directors. In 1996, we established a Governance and Nominating Committee of the board to address collaboratively and proactively many of the issues defined now by the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission, and the New York Stock Exchange. We did this not only because it was the right decision for our shareholders, teammates and the investment community, but also because it was a natural outgrowth of our company’s long history of integrity and credi- bility. The committee operates independently from management and works closely with our indepen- dent compensation and benefits committee and our independent audit committee. We accept and support the guidelines for strength- ening corporate governance as a 4 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T have the heart of a lion. Our people, who care deeply about our company, will never give up in their quest to satisfy our customers and shareholders alike. As we look ahead, the foundation for our new strategic initiatives will be based on other important characteristics as well. For example, we show up every day, rain or shine, and plug away at being the very best distribution company in our sector, maybe in all of healthcare. We are always there when our customers need us. That dependability has been a hallmark of our company for a long, long time. The blocking and tackling philosophy of taking care of busi- ness is not fancy, but it works for us and we keep on growing the value of our company. And, we grow with the highest integrity as a guiding principle. That’s worth its weight in gold. Now, you see why I’m so excited. The opportunities are there, we have the right team on the field, and we have the right strategy to follow for success. I’m grateful to our shareholders for their patience in a very tough market environment; grateful to our suppliers for collaborating with us in a team approach; and grateful to our customers who give us a chance every day to earn their business; and I’m grateful to my teammates, who show up every day with the heart of a lion. Warm regards, Craig R. Smith President and Chief Operating Officer G. Gilmer Minor, III Chairman and Chief Executive Officer means of restoring confidence in corporate America. Please refer to Annex A of our proxy for our state- ment of Corporate Governance Guidelines, or refer to our company web site, www.owens-minor.com and click on Investor Relations and then Corporate Governance. In 2002, like all public compa- nies, we re-examined our processes for ensuring that we are making complete and timely disclosure to investors. Our fundamental processes were and continue to be sound. Jeff Kaczka, our senior vice president and chief financial officer, and I have signed the certifications required by the Sarbanes-Oxley Act, and you can find these certifications at the end of this report. In Conclusion I want to pay a final tribute to two teammates who passed away this past year. Bob Ricord was a sales representative par excellence in Shreveport, Louisiana, for 28 years. David Hutchison was a buyer and manager in Knoxville, Tennessee, for 35 years. I have had the distinct pleasure of working side by side with these two guys through the years, and I loved them for their spirit, their loyalty, their integrity, their compassion and their success. The highest compliment I can ever pay them is that they cared more about their customers and team- mates than themselves. Bob and Hutch will be sorely missed. We must always remember that every day offers us a new opportunity to excel. We have the technology tools, the service, the relationships, the trust of our customers and suppliers, but most importantly, we Owens & Minor Our Business At A Glance Core Business Owens & Minor is the nation’s leading distributor of national name-brand medical and surgical supplies for 4,000 around healthcare the nation. customers OMSolutionsSM Owens & Minor offers supply chain management consulting and implementation services through a newly created professional services arm for its hospital customers. This package of supply chain services reaches far beyond the conventional boundaries of physical distribution of supplies to produce operational efficiencies and cost savings. Third Party Logistics Through its third party logistics (3PL) business model, Owens & Minor will focus on providing 3PL to manufacturers and aggregating orders for healthcare provider customers nationwide. services 6 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T How Owens & Minor contracts with healthcare customers to provide distrib- ution services. O&M then purchases and stores this inventory in its 41 distribution centers nationwide. Using state-of-the-art forecasting and planning systems, Owens & Minor ensures that customers have the products they need when they need them. How Through OMSolutionsSM, Owens & Minor’s supply chain logistics profession- als target the hospital’s biggest supply chain cost-drivers to eliminate redun- dant activities and other inefficiencies. Addressing customers’ specific needs, O&M puts the right people, products, technology and processes to work, whether it means business planning and benchmarking, total operating room redesign or managing all of a hospital’s supply chain activities. How Owens & Minor will leverage its existing warehouse and transportation systems, award-winning technology and long standing supply chain relationships to streamline delivery of healthcare products through a broad array of 3PL services for both healthcare providers and suppliers. Why By adapting and using technology to its fullest, Owens & Minor can help customers design a customized delivery system from bulk distribution to low unit of measure, just-in-time or stockless services. In addition, O&M helps customers with product standardization through MediChoiceTM, a private label program; FOCUSTM, a product consolidation program with market-leading and OMSpecialitiesSM, a clinically-focused pro- gram for high-dollar inventory in the operating room and beyond. suppliers; Why The needs of each hospital customer vary and require customized solutions. With OMSolutionsSM, O&M provides the level and extent of service appropriate for each customer—from assessment to implementa- tion to integration. Why O&M’s entry into third party logistics is a natural extension of its distribution experience and expertise and meets its goal to streamline the total supply chain with cost-saving solutions. Results By using the best in supply chain management techniques, technology and services, Owens & Minor helps hospitals reduce cost, improve asset management and enhance overall operational efficien- cies. Customers believe in Owens & Minor, with 97% saying they were satisfied with the quality of service they received from Owens & Minor during 2002. Results With OMSolutionsSM, Owens & Minor focuses on improving the customer’s total supply chain, allowing the healthcare provider to focus on patient care. This con- sulting arm packages the best of Owens & Minor’s solutions to fulfill supply chain needs for customers nationwide. Results Through its 3PL services, the company expects to offer the aggregation of supply chain services to the healthcare industry. The company expects to lower costs, improve efficiency and streamline the supply chain. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 7 CoreBusiness Delivering Medical and Surgical Supplies to the Healthcare Industry Owens & Minor conducted a significant strategic planning effort in 2002, involving the entire senior management team and many teammates throughout the organization. The team developed and launched a three-pronged strategy designed to expand Owens & Minor’s presence in healthcare. The resulting strategic in the core business; launching a supply chain consulting and management arm; and creating a third party logistics (3PL) service for healthcare. initiatives are focused on: improving productivity Owens & Minor’s distribution business continues to drive the company’s success, allowing it to explore new opportunities within the healthcare industry. As a result of its strategic planning effort, the company identified a series of operational, supplier and training initiatives designed to enhance productivity in its facilities nationwide. By using technology, logistics management and top-notch customer service, O&M focuses on the supply chain, empowering customers to focus on patient care. t s u r T , s c i h t E , y t i r g e t n I , e u l a V , r e t c a r a h C To improve operations, Owens & Minor is working with each of its 41 distribution centers to stan- dardize procedures on a best-practices model, called the OM Model. As a result, Owens & Minor expects to achieve improved pro- ductivity and provide additional capacity to accommodate its 3PL effort. Owens & Minor is working with its supplier partners to ensure it offers the right mix of products to customers. For example, Owens & Minor plans to enroll more suppliers in its FOCUSTM program, which Within its 41 distribution centers around the nation, Owens & Minor is undertaking an initiative to improve operations and standardize procedures. 8 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T including: leadership, sales training, opera- tions and finance. The company seeks to put the best-trained and best-prepared teammates in the field every day in order to maintain and improve its top-ranked customer service ratings, its leadership in technology and its healthcare market share. Most importantly for Owens & Minor, the company stakes its reputation on customer service. Each year, the company conducts an independent customer survey to assess how well it is performing. In 2002, Owens & Minor achieved a 97% satisfaction rating from its customers, an improvement over a 96% satisfaction rating the year before. This comprehensive atten- tion to customer service, and to providing value to customers and business partners, has long been a hallmark of Owens & Minor, and with the new strategic initiatives it will continue to be a major focus for the company. InformationWeek 500. Owens & Minor was ranked 11th overall in this prestigious list. Also in 2002, Owens & Minor committed to a wide-scale training initiative, which will give team- mates opportunities to enhance job skills and career preparation. As a result, Owens & Minor has created an in-house university called Owens & Minor University (OMU). Course work includes on-line classroom-based programs on a variety of subjects and helps grow market share for preferred suppliers. Also, in 2002, the company successfully launched a private label line called Medi- ChoiceTM, which has given new options to customers and new opportunity to suppliers. This pri- vate label program offers a growing catalog of commodity-type prod- ucts including: bandages, gowns, shoe covers and thermometers. MediChoiceTM, well-received by cus- tomers, easily exceeded early sales goals. New product launches are planned for the year ahead. Owens & Minor has earned a reputation as an innovative user of technology in the healthcare and medical field. In fact, for the third year in a row, Owens & Minor was the top ranked healthcare in the and medical company With OMU, the company provides teammates access to in-house and on-line classes in operations, sales, management and leadership. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 9 OMSolutionsSM Delivering Professional Supply Chain Management Services to the Healthcare Industry A s a result of the 2002 strategic planning effort, Owens & Minor launched a new business initiative called OMSolutionsSM, packaging supply chain management services for healthcare customers and business partners through a newly created consulting arm. Through customer research and interac- tion, Owens & Minor knows that healthcare providers are seeking a trusted partner to help them take cost out of the supply chain. Executive Offices Specialty Areas (Cath Lab; Radiology) Purchasing/ Procurement Accounts Payable PAR Areas (Nursing Floors) Off-site Warehouse Operating Room Receiving Storeroom Traditionally, O&M served its hospital customers from off-site warehouses and the receiving dock. Today, O&M has crossed barriers and now serves departments throughout the hospital with the latest in technology, logistics management and supply chain management consulting. 10 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T existing customers, but also with customers who do not use the company’s distribution services. Through OMSolutionsSM con- sultants work with customers on-site to design and implement solutions. In some cases, OMSolu- tionsSM will outsource positions for hospital customers, such as materials managers. In these cases OMSolutionsSM will take on the responsibility of managing the hospital’s materials management function. In each case, Owens & Minor will evaluate the customer’s needs, and then apply the right people, products, technology and processes as a solution. With OMSolutionsSM, Owens & Minor will focus on making the supply chain more efficient, allow- ing healthcare provider customers to focus on patient care. Owens & Minor now serves many depart- ments within the hospital walls, from the chief executive’s office to clinical areas to the receiving dock, Owens & Minor is crossing bound- aries to serve its customers. With more than two dozen projects already in the works, the company expects to add new projects steadily in 2003. Market demand for these services is strong. O&M expects to improve financial results for customers and itself with its new OMSolutionsSM supply chain management consulting arm. , r e t c a r a h C t s u r T , s c i h t E , y t i r g e t n I , e u l a V Just as O&M teammates work together to improve service to customers, the new initiatives complement one another in the company’s ongoing effort to improve productivity and profitability. include: Programs offered by OMSolu- tionsSM outsourced materials management, clinical inventory management, physical inventory management, and part- nership programs. Other programs include of Owens & Minor’s award-winning WISDOM2 SM programs, on-site pro- ject management, management consulting and outsourcing. The company is collaborating within its core business and with outside con- sultants, working not only with implementation As physicians and clinicians more frequently make supply chain decisions, O&M offers new tools and techniques to improve this important materials management process. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 11 Third Party Logistics Delivering 3PL Services to the Healthcare Industry A lso in 2002, Owens & Minor created a third party logistics service (3PL) designed to provide supply chain services to hospitals and healthcare manufacturers. Industry research, along with customer demand, allowed Owens & Minor to identify a clear need for logistics, transportation and aggregation services in healthcare. Owens & Minor also found that the penetration by traditional 3PL com- panies in healthcare is minimal, offering a compelling opportunity. Owens & Minor, through its 3PL service, will offer logistics and supply chain management services in three main categories: distribu- tion and transportation management; technology services; and consulting services. In order to capitalize on this opportunity, Owens & Minor intends to tap its existing relationships with suppliers and healthcare providers. The company will also use its industry-leading, In its distribution centers around the nation, Owens & Minor utilizes advanced supply chain management techniques and streamlines processes with technology. Using a fleet of leased trucks and its own drivers, O&M serves customers nationwide. O&M has launched a new effort to create and offer 3PL services to the healthcare industry. 12 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T t s u r T , s c i h t E , y t i r g e t n I , r e t c a r a h C , e u l a V the The company made strategic decision to work within healthcare, its core competency, where it knows there is significant opportunity to improve supply chain processes. Healthcare pro- viders have turned to Owens & Minor for solutions and Owens & Minor has responded. While each new initiative can stand alone, they also work together as a for complementary hospital customers and healthcare suppliers. With this new strategy, Owens & Minor is better posi- tioned than ever before to serve the needs of its healthcare customers, and to achieve new levels of growth, profitability and productivity. package activity-based costing expertise to streamline service. And finally, Owens & Minor will leverage its nationwide network of distribution facilities, existing transportation systems and award-winning infor- mation technology to provide innovative new 3PL services. This initiative meets a clear need in the healthcare market, as manufacturers are seeking ways to reduce supply chain cost, and hospitals are seeking ways to aggregate orders entering their facilities. For Owens & Minor, the 3PL effort offers an excellent avenue for diversification into a new area of healthcare service, without taking ownership of inventory as it does in its traditional distribution business. For Owens & Minor, existing relationships with suppliers and healthcare pro- viders, the scale of its distribution network, and the quality of its delivery capabilities, give it a unique competitive advantage. O&M teammates collaborate on new strategic initiatives that will improve productivity and increase capacity in existing facilities for 3PL services. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 13 Board of Directors Standing Left-Right Henry Berling, James Ukrop, Peter Redding, Vernard Henley, John Crotty, James Farinholt, Jr. Seated Left-Right Marshall Acuff, Gil Minor, III, James Rogers, Josiah Bunting, III, Anne Marie Whittemore A. Marshall Acuff, Jr. (63) 2,4,5 Retired Senior Vice President & Managing Director, Salomon Smith Barney, Inc. Henry A. Berling (60) 1,4 Executive Vice President, Owens & Minor, Inc. Josiah Bunting, III (63) 2,4,5 Retired Superintendent, Virginia Military Institute John T. Crotty (65) 2,3,4* Managing Partner, CroBern Management Partnership President, CroBern, Inc. James B. Farinholt, Jr. (68) 1,2*,4 Managing Director, Tall Oaks Capital Partners, LLC Vernard W. Henley (73) 2,3,5 Retired Chairman & CEO, Consolidated Bank & Trust Company G. Gilmer Minor, III (62) 1*,4 Chairman & CEO, Owens & Minor, Inc. Peter S. Redding (64) 2,3,4 Retired President & CEO, Standard Register Company James E. Rogers (57) 1,3*,4 President, SCI Investors Inc. James E. Ukrop (65) 3,4,5 Chairman, Ukrop’s Super Markets, Inc. Chairman, First Market Bank Anne Marie Whittemore (56) 1,3,5* Partner, McGuireWoods LLP Board Committees: 1Executive Committee, 2Audit Committee, 3Compensation & Benefits Committee, 4Strategic Planning Committee, 5Governance & Nominating Committee, *Denotes Chairperson 14 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Corporate Officers G. Gilmer Minor, III (62) Chairman & Chief Executive Officer Charles C. Colpo (45) Senior Vice President, Operations Jeffrey Kaczka (43) Senior Vice President & Chief Financial Officer Chairman of the Board since 1994 and Chief Executive Officer since 1984. Mr. Minor was President from 1981 to April 1999. Mr. Minor joined the company in 1963. Craig R. Smith (51) President & Chief Operating Officer President since 1999 and Chief Operating Officer since 1995. Mr. Smith has been with the company since 1989. Henry A. Berling (60) Executive Vice President Executive Vice President since 1995. Mr. Berling was Executive Vice President and Chief Sales Officer from 1996 to 1998. Mr. Berling has been with the company since 1966. Timothy J. Callahan (51) Senior Vice President, Sales & Marketing Senior Vice President, Sales and Marketing since September 2002. From 1999 to 2002, Mr. Callahan served as Senior Vice President, Distribution. Prior to that, Mr. Callahan was Regional Vice President, West from 1997 to 1999. Mr. Callahan has been with the company since 1997. Drew St. J. Carneal (64) Senior Vice President, Corporate Secretary Senior Vice President, Corporate Secretary since February 2003. From 1990 to February 2003, Mr. Carneal served as Senior Vice President, General Counsel and Secretary. Mr. Carneal has been with the company since 1989. Senior Vice President, Operations since 1999. From 1998 to 1999, Mr. Colpo was Vice Presi- dent, Operations. Prior to that, Mr. Colpo was Vice President, Supply Chain Process from 1996 to 1998. Mr. Colpo has been with the company since 1981. Erika T. Davis (39) Senior Vice President, Human Resources Senior Vice President, Human Resources since 2001. From 1999 to 2001, Ms. Davis was Vice President of Human Resources. Prior to that, Ms. Davis served as Director, Human Resources & Training in 1999 and Director, Compensa- tion & HRIS from 1995 to 1999. Ms. Davis has been with the company since 1993. Grace R. den Hartog (51) Senior Vice President & General Counsel Senior Vice President & General Counsel since February 2003. Ms. den Hartog previ- ously served as a Partner of McGuireWoods LLP from 1990 to February 2003. David R. Guzmán (47) Senior Vice President & Chief Information Officer Senior Vice President and Chief Information Officer since 2000. Mr. Guzmán was employed by Office Depot from 1999 to 2000, serving as Senior Vice President, Systems Development. From 1997 to 1998, he was employed by ALCOA as Chief Architect, Managing Director, Global Information Services. Senior Vice President and Chief Financial Officer since 2001. Mr. Kaczka served as Senior Vice President and Chief Financial Officer for Allied Worldwide, Inc. from 1999 to 2001. In 1995 he served as Chief Financial Officer for I-Net, Inc. which was acquired by Wang Laboratories in 1996. Mr. Kaczka con- tinued with Wang until 1998. Richard F. Bozard (55) Vice President, Treasurer Vice President and Treasurer since 1991. Mr. Bozard has been with the company since 1988. Olwen B. Cape (53) Vice President, Controller Vice President and Controller since 1997. Ms. Cape has been with the company since 1997. Hugh F. Gouldthorpe, Jr. (64) Vice President, Quality & Communications Vice President, Quality and Communications since 1993. Mr. Gouldthorpe has been with the company since 1986. Hue Thomas, III (63) Vice President, Corporate Relations Vice President, Corporate Relations since 1991. Mr. Thomas has been with the company since 1970. Mr. Thomas will retire in March 2003. Numbers inside parenthesis indicate age Left-Right David Guzman, Hugh Gouldthorpe, Jr, Hue Thomas, III, Richard Bozard, Craig Smith, Jeffrey Kaczka, Olwen Cape, Timothy Callahan, Drew St. J. Carneal, Charles Colpo, Erika Davis (not pictured: Gil Minor III, Henry Berling, Grace den Hartog) 2002 Financial Table of Contents 17 Selected Financial Data 18 Business Description 24 Management’s Discussion & Analysis 32 Consolidated Statements of Income 33 Consolidated Balance Sheets 34 Consolidated Statements of Cash Flows 35 Consolidated Statements of Changes in Shareholders’ Equity 36 Notes to Consolidated Financial Statements 62 Independent Auditors’ Report 62 Report of Management 63 Quarterly Financial Information 64 Form 10-K Annual Report 68 Corporate Information Selected Financial Data(1) Owens & Minor, Inc. and Subsidiaries (in thousands, except ratios and per share data) Summary of Operations: Net sales Income before extraordinary item(2)(3) Income before extraordinary item, excluding goodwill amortization(2)(3)(4) Per Common Share: Income before extraordinary item - basic Income before extraordinary item - diluted Average number of shares outstanding - basic Average number of shares outstanding - diluted Cash dividends Stock price at year-end Book value at year-end Per Common Share, Excluding Goodwill Amortization(4): Income before extraordinary item - basic Income before extraordinary item - diluted Summary of Financial Position: Working capital Total assets Long-term debt Mandatorily redeemable preferred securities Shareholders' equity Selected Ratios: Gross margin as a percent of net sales Selling, general and administrative expenses as a percent of net sales(3) Average receivable days sales outstanding(5) Average inventory turnover Return on average total equity before extraordinary items and goodwill amortization(4)(6) Return on average total equity before extraordinary items and goodwill amortization(4)(7) Current ratio Capitalization ratio(5)(6) Capitalization ratio(5)(7) 2002 2001 2000 1999 1998 $3,959,781 47,217 $ $3,814,994 30,103 $ $3,503,583 $ 3,194,134 $3,090,048 20,145 $ 27,979 $ 33,088 $ $ 47,217 $ $ $ $ $ $ $ 1.40 1.26 33,799 40,698 0.31 16.42 7.96 1.40 1.26 $ $ $ $ $ $ $ $ 35,431 $ 38,417 $ 32,807 $ 24,616 0.90 0.85 33,368 40,387 0.2725 18.50 6.97 1.06 0.98 $ $ $ $ $ $ $ 1.01 0.94 32,712 39,453 0.2475 17.75 6.41 1.17 1.08 $ $ $ $ $ $ $ 0.86 $ 0.82 $ 32,574 39,098 0.23 $ 8.94 $ 5.58 $ 0.56 0.56 32,488 32,591 0.20 15.75 4.94 1.01 $ 0.95 $ 0.70 0.69 $ 385,023 $1,009,477 $ 240,185 $ 125,150 $ 271,437 $ 311,778 $ 953,853 $ 203,449 $ 132,000 $ 236,243 $ 233,637 $ 867,548 $ 152,872 $ 132,000 $ 212,772 $ 219,448 $ 235,247 $ 865,000 $ 717,768 $ 174,553 $ 150,000 $ 132,000 $ 132,000 $ 182,381 $ 161,126 10.6% 7.8% 32.0 9.6 13.5% 18.6% 2.1 37.7% 57.4% 10.7% 10.7% 10.7% 10.8% 7.8% 33.1 9.7 7.7% 33.3 9.5 7.8% 34.9 9.2 8.0% 33.5 9.8 11.1% 12.8% 12.1% 9.9% 15.8% 1.8 42.6% 63.2% 19.4% 1.6 40.4% 63.2% 19.1% 1.6 47.2% 69.4% 11.7% 1.9 43.4% 68.9% (1) On July 30, 1999, the company acquired certain net assets of Medix, Inc. This acquisition was accounted for as a purchase. (2) In 1998, the company incurred $11.2 million, or $6.6 million net of tax, of nonrecurring restructuring expenses which are included in income before extraordinary item. In 2002, 2001, 2000 and 1999, income before extraordinary item included reductions in the restructuring accrual of $0.5 million, $1.5 million, $0.8 million and $1.0 million, or $0.3 million, $0.8 million, $0.4 million and $0.6 million net of tax. See Note 3 to the Consolidated Financial Statements. (3) In 2002, income before extraordinary item included a charge to selling, general and administrative expenses of $3.0 million, or $1.8 million net of tax, due to the cancellation of the company’s contract for mainframe computer services. In 2001, income before extraordinary item included an impairment loss of $1.1 million on an investment in marketable equity securities and a provision for disallowed income tax deductions of $7.2 million. See Notes 6 and 14 to the Consolidated Financial Statements. (4) Effective January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. As a result, goodwill is no longer amortized. Data for 2001 and prior periods have been restated to exclude the effect of goodwill amortization in order to present a more meaningful comparison. (5) Assumes that receivables had not been sold under the company’s off balance sheet receivables financing facility. See Note 9 to the Consolidated Financial Statements. (6) Includes mandatorily redeemable preferred securities as equity. (7) Includes mandatorily redeemable preferred securities as debt. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 17 Business Description The Company to the aging population and emerging medical technologies Owens & Minor, Inc. and subsidiaries (O&M or the company) resulting in new healthcare procedures and products. Over is the leading distributor of national name-brand medical and the years, healthcare providers have continued to change their surgical supplies in the United States, distributing over 120,000 health systems to meet the needs of the markets they serve. finished medical and surgical products produced by approxi- They have forged strategic relationships with national medical mately 1,100 suppliers to approximately 4,000 customers from and surgical supply distributors to meet the challenges of man- 41 distribution centers nationwide. The company’s customers aging the supply procurement and distribution needs of their are primarily acute-care hospitals and integrated healthcare entire network. The traditional role of distributors in warehous- networks (IHNs), which account for more than 90% of O&M’s ing and delivering medical and surgical supplies to customers net sales. Many of these hospital customers are represented by is evolving into the role of assisting customers to manage the national healthcare networks (Networks) or group purchasing entire supply chain. organizations (GPOs) that offer discounted pricing with suppliers In recent years, the overall healthcare market has been and contract distribution services with the company. Other cus- characterized by the consolidation of healthcare providers into tomers include alternate care providers such as clinics, home larger and more sophisticated entities seeking to lower their healthcare organizations, nursing homes, physicians’ offices, total costs. These providers have sought to lower total product rehabilitation facilities and surgery centers. The company costs by obtaining incremental value-added services from med- typically provides its distribution services under contractual ical and surgical supply distributors. These trends have driven arrangements ranging from three to five years. Most of O&M’s significant consolidation within the medical/surgical supply sales consist of consumable goods such as disposable gloves, distribution industry due to the competitive advantages enjoyed dressings, endoscopic products, intravenous products, needles by larger distributors, which include, among other things, the and syringes, sterile procedure trays, surgical products and ability to serve nationwide customers, buy inventory in volume gowns, urological products and wound closure products. and develop technology platforms and decision support systems. Founded in 1882 and incorporated in 1926 in Richmond, Virginia, as a wholesale drug company, the company redefined The Business its mission in 1992, selling the wholesale drug division to con- Through its core distribution business, the company purchases centrate on medical and surgical distribution. Since then, a high volume of medical and surgical products from suppliers, O&M has significantly expanded and strengthened its national warehouses these items at its distribution centers and provides presence through internal growth and acquisitions, generating delivery services to its customers. O&M’s 41 distribution centers nearly $4 billion of net sales in 2002. In November 2002, the are located throughout the United States and are situated close company announced new strategic initiatives to offer supply to its major customer facilities. These distribution centers chain management consulting services and third party logistics generally serve hospitals and other customers within a 200-mile services to the healthcare industry, leveraging its existing radius, delivering most medical and surgical supplies with a reputation and relationships in the healthcare market as well fleet of leased trucks. Almost all of O&M’s delivery personnel as its physical infrastructure. are employees of the company, providing more effective control The Industry of customer service. The company customizes its product pallets and truckloads according to the needs of its customers, thus Distributors of medical and surgical supplies provide a wide enabling them to reduce labor on the receiving end. variety of products and services to healthcare providers, Furthermore, delivery times are adjusted to customers’ needs, including hospitals and hospital-based systems, IHNs and alter- allowing them to streamline receiving activities. Contract nate care providers. The company contracts with these providers carriers and parcel services are used to transport all other directly and through Networks and GPOs. The medical/surgical medical and surgical supplies. supply distribution industry continues to experience growth due 18 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T O&M strives to make the supply chain more efficient Other services offered by the company include: through the use of advanced warehousing, delivery and • CostTrackSM: This activity-based management approach helps purchasing techniques, enabling customers to order and customers identify and track the cost drivers in their procure- receive products using just-in-time and stockless services. A ment and handling activities, giving them the information key component of this strategy is a significant investment in they need to drive workflow efficiencies, raise employee advanced information technology, which includes automated productivity and reduce costs. With CostTrackSM, the pricing warehousing technology as well as OMDirectSM, an Internet- of services provided to customers is based on the variety of based product catalog and direct ordering system, which services that they choose, as compared to a traditional cost- supplements existing EDI and XML technologies to plus pricing model. In 2002, 32% of the company’s net sales communicate with customers and suppliers. were generated through the CostTrackSM program, up from Products & Services nearly 28% in 2001. In addition to its core medical and surgical supply distribution • WISDOMSM: This Internet-accessed decision support tool service, the company offers value-added services in supply chain connects customers, suppliers and GPOs to the company’s management, logistics and information technology to help its data warehouse. WISDOMSM offers customers secure online customers control healthcare costs, improve inventory manage- access to a wide variety of reports, which summarize purchasing ment and increase profitability. In late 2002, the company history, contract compliance, product usage and other related announced two new initiatives designed to provide additional data. This timely information helps customers consolidate value-added services to the healthcare industry. purchasing information across their healthcare systems and identify opportunities for product standardization, contract • OMSolutions SM: OMSolutionsSM provides consulting and compliance and supplier consolidation. outsourcing services to customers. Programs offered by OMSolutionsSM include long-term partnership initiatives such • WISDOM2 SM: The second generation of WISDOMSM, this as outsourced materials management; integrated operating Internet-based decision support tool provides customers access room management; clinical inventory management; order optimization; and WISDOM2 SM implementation; and out- to purchasing information not only for their purchases from Owens & Minor, but for all medical/surgical manufacturers sourced warehousing. OMSolutionsSM also offers a menu of and suppliers recorded in their materials management infor- supply chain management services such as: receiving and mation systems. This timely information helps customers storeroom redesign; physical inventories; and reconfiguration identify opportunities for product standardization, contract of periodic automatic replenishment systems. These services compliance, order optimization and efficiencies in their are designed to improve supply chain efficiency and allow overall purchasing activity. the provider to focus on patient care. • PANDAC® Wound Closure Asset Management Program: This • Third Party Logistics (3PL): Owens & Minor offers logistics information-based program provides customers with an and supply chain management services in the following main evaluation of their current and historical wound closure categories: physical distribution to include warehousing and inventories and usage levels, helping them reduce their transportation management; and consulting services. In order investment in high-cost wound management supplies and to make the most of these opportunities, the company intends control their costs per operative case. to leverage its existing relationships with suppliers and end- users, its activity-based costing expertise, and its distribution facilities, transportation systems and information technology. The company's goal is to ensure that products reach the patient in the most cost-effective manner. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 19 Business Description (continued) • FOCUS™: This supplier partnership program drives product distributor for Broadlane, a GPO providing national contracting standardization and consolidation for the company and its for more than 490 acute-care hospitals and more than 1,500 customers. By increasing the volume of purchases from the sub-acute care facilities, including Tenet Healthcare Corporation, company’s most efficient suppliers, FOCUS™ provides one of the largest for-profit hospital chains in the nation. Sales operational benefits and cost savings throughout the supply to Broadlane members represented approximately 14% of chain. FOCUS™ centers around both commodity and O&M’s net sales in 2002. preference product standardization. IHNs • MediChoice™: In 2002, the company launched this private IHNs are typically networks of different types of healthcare label program designed to provide value and choice to providers that seek to offer a broad spectrum of healthcare customers. The MediChoice™ line currently includes services and comprehensive geographic coverage to a particular commodity products such as isolation gowns, shoe covers, local market. IHNs have become increasingly important because hot- and cold-packs, and crutches. The company plans to of their expanding role in healthcare delivery and cost contain- introduce additional products under the MediChoice™ ment and their reliance upon the hospital as a key component label in the future. Customers of their organizations. Individual healthcare providers within a multiple-entity IHN may be able to contract individually for distribution services; however, the providers’ shared economic The company currently provides its distribution services to interests create strong incentives for participation in distribution approximately 4,000 healthcare providers, including hospitals, contracts established at the system level. Because IHNs frequently IHNs and alternate care providers, contracting with them rely on cost containment as a competitive advantage, IHNs have directly and through Networks and GPOs. In recent years, become an important source of demand for O&M’s enhanced the company has also begun to provide logistics services to inventory management and other value-added services. manufacturers of medical and surgical products. Individual Providers Networks and GPOs In addition to contracting with healthcare providers at the IHN Networks and GPOs are entities that act on behalf of a group of level, and through Networks and GPOs, O&M contracts directly healthcare providers to obtain better pricing and other benefits with individual healthcare providers. that may be unavailable to individual members. Hospitals, physicians and other types of healthcare providers have joined Sales and Marketing Networks and GPOs to take advantage of improved economies O&M’s sales and marketing function is organized to support its of scale and to obtain services from medical and surgical supply decentralized field sales teams of approximately 200 people. distributors ranging from discounted product pricing to logisti- Based in the company’s distribution centers nationwide, the cal and clinical support. Networks and GPOs negotiate directly company’s local sales teams are positioned to respond to cus- with medical and surgical product suppliers and distributors on tomer needs quickly and efficiently. National account directors behalf of their members, establishing exclusive or multi-supplier work closely with Networks and GPOs to meet their needs and relationships. However, networks and GPOs cannot ensure that coordinate activities with their individual member facilities. In members will purchase their supplies from a given distributor. addition, O&M has a national field organization, OMSpecialtiesSM, O&M is a distributor for Novation, the supply company of VHA, which is focused on assisting customers in the clinical environ- Inc. and University HealthSystem Consortium, which represents ment. O&M provides special training and support tools to its the purchasing interests of more than 2,300 healthcare organi- sales team to help promote these programs and services. zations. Sales to Novation members represented approximately 50% of the company’s net sales in 2002. The company is also a 20 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Contracts and Pricing O&M also has arrangements that charge incremental fees Industry practice is for healthcare providers or their GPOs to for additional distribution and enhanced inventory manage- negotiate product pricing directly with suppliers and then nego- ment services, such as more frequent deliveries and distribution tiate distribution pricing terms with distributors. When product of products in small units of measure. Although the company’s pricing is not determined by contracts between the supplier and sales personnel based in the distribution centers negotiate the healthcare provider, it is determined by the distribution local arrangements and pricing levels with customers, corporate agreement between the healthcare provider and the distributor. management has established minimum pricing levels and a The majority of O&M’s distribution arrangements compen- contract review process. sate the company on a cost-plus percentage basis under which a negotiated fixed-percentage distributor fee is added to the Suppliers product cost agreed to by the customer and the supplier. The O&M believes that its size, strength and long-standing determination of this fee is typically based on customer size, as relationships enable it to obtain attractive terms from suppliers, well as other factors, and usually remains constant for the life including discounts for prompt payment and volume incentives. of the contract. In many cases, distribution contracts in the The company has well-established relationships with virtually medical/surgical supply industry specify a minimum volume all major suppliers of medical and surgical supplies, and works of product to be purchased and are terminable by the customer with its largest suppliers to create operating efficiencies in upon short notice. the supply chain. In some cases, the company may offer pricing that varies Approximately 16% of O&M’s net sales in 2002 were during the life of the contract, depending upon purchase volume sales of Johnson & Johnson Health Care Systems, Inc. products. and, as a result, the negotiated fixed percentage distributor fee Approximately 14% of O&M’s 2002 net sales were sales of may increase or decrease. Under these contracts, customers’ products of the subsidiaries of Tyco International, which include distribution fees may be re-set after a measurement period to The Kendall Company, United States Surgical and Mallinckrodt. either more or less favorable pricing based on significant changes in purchase volume. If a customer’s distribution fee Information Technology percentage is adjusted, the modified percentage distributor To support its strategic efforts, the company has developed fee applies only to a customer’s purchases made following the information systems to manage virtually all aspects of its change. Because customer sales volumes typically change operations, including warehouse and inventory management, gradually, changes in distributor fee percentages for individual asset management and electronic commerce. O&M believes customers under this type of arrangement have an insignificant that its investment in and use of technology in the management impact on total company results. of its operations provides the company with a significant Pricing under O&M’s CostTrackSM activity-based competitive advantage. pricing model differs from pricing under a traditional cost-plus In 2002, O&M signed a seven-year agreement with Perot model. With CostTrackSM, the pricing of services provided to Systems Corporation to outsource its information technology customers is based on the type and level of services that they (“IT”) operations, including the management, start-up and choose, as compared to a traditional cost-plus pricing model. operation of its mainframe computer and distributed services As a result, this pricing model more accurately aligns the processing as well as application support, development and distribution fees charged to the customer with the costs of enhancement services. This agreement extends and expands the individual services provided. a relationship that began in 1998. This relationship has allowed the company to provide resources to major IT initiatives, which support internal operations and enhance services to customers and suppliers. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 21 Business Description (continued) The company has focused its technology spending on Accounts Receivable electronic commerce, data warehousing and decision support, The company’s credit practices are consistent with those of supply chain management and warehousing systems, sales and other medical and surgical supply distributors. O&M actively marketing programs and services, as well as significant infra- manages its accounts receivable through a decentralized structure enhancements. O&M is an industry leader in the use approach that puts the company closer to the customer of electronic commerce to conduct business transactions with and enables it to effectively collect its receivables and to customers and suppliers, using OMDirectSM, an Internet-based minimize credit risk. product catalog and direct ordering system, to supplement existing EDI and XML technologies. Competition The company also provides distribution services for several The medical/surgical supply distribution industry in the United Internet-based medical and surgical supply companies. O&M is States is highly competitive and consists of three major nation- committed to an ongoing investment in an open, Internet-based wide distributors: O&M; Cardinal Health (formerly known as electronic commerce platform to support the company’s supply Allegiance Corp.); and McKesson Medical-Surgical, a subsidiary chain management initiatives and to enable expansion into new of McKesson HBOC, Inc. The industry also includes a number market segments for medical and surgical products. of regional and local distributors. Asset Management Competitive factors within the medical/surgical supply distribution industry include total delivered product cost, In the medical/surgical supply distribution industry, a significant product availability, the ability to fill and invoice orders investment in inventory and accounts receivable is required to accurately, delivery time, services provided, inventory manage- meet the rapid delivery requirements of customers and provide ment, information technology, electronic commerce capabilities high-quality service. As a result, efficient asset management is and the ability to meet special customer requirements. O&M essential to the company’s profitability. O&M is highly focused believes its emphasis on technology, combined with its customer- on effective control of inventory and accounts receivable, and focused approach to distribution and value-added services, draws on technology to achieve this goal. enables it to compete effectively with both larger and smaller distributors by being located near the customer and offering Inventory a high level of customer service. The significant and ongoing emphasis on cost control in the healthcare industry puts pressure on suppliers, distributors and healthcare providers to create more efficient inventory manage- ment systems. O&M has responded to these ongoing challenges by developing inventory forecasting capabilities, a client/server warehouse management system, a product standardization and consolidation initiative, and a vendor-managed inventory process. This vendor-managed inventory process allows some of the company’s major suppliers to monitor daily sales, inventory levels and product forecasts electronically so they can automatically and accurately replenish O&M’s inventory. 22 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Other Matters Regulation Properties O&M’s corporate headquarters are located in western Henrico The medical/surgical supply distribution industry is subject County, in a suburb of Richmond, Virginia, in facilities leased to regulation by federal, state and local government agencies. from unaffiliated third parties. The company owns two undevel- Each of O&M’s distribution centers is licensed to distribute oped parcels of land adjacent to its corporate headquarters. The medical and surgical supplies, as well as certain pharmaceutical company also owns an undeveloped parcel of land in nearby and related products. The company must comply with regula- Hanover County to be used for its future corporate headquarters. tions, including operating and security standards for each of its The company leases offices and warehouses for 40 of its distribu- distribution centers, of the Food and Drug Administration, the tion centers across the United States from unaffiliated third Occupational Safety and Health Administration, state boards parties. In addition, the company has an arrangement with a of pharmacy and, in certain areas, state boards of health. O&M warehousing company in Honolulu, Hawaii. In the normal course believes it is in material compliance with all statutes and regula- of business, the company regularly assesses its business needs and tions applicable to distributors of medical and surgical supply makes changes to the capacity and location of its distribution products and pharmaceutical and related products, as well as centers. The company believes that its facilities are adequate to other general employee health and safety laws and regulations. carry on its business as currently conducted. A number of leases Employees are scheduled to terminate within the next several years. The company believes that, if necessary, it could find facilities to At the end of 2002, the company had 2,968 full-time and part-time replace these leased premises without suffering a material employees. O&M believes that ongoing employee training is adverse effect on its business. critical to performance, and recently launched Owens & Minor University, an in-house training program including on-line and in-house classes in leadership, management development, finance, operations and sales. Management believes that relations with employees are good. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 23 Management’s Discussion & Analysis 2002 Financial Results The following table presents the company’s consolidated state- Overview. In 2002, O&M earned net income of $47.3 million, or ments of income on a percentage of net sales basis: Year ended December 31, 2002 2001 2000 100.0% 100.0% 100.0% $1.27 per diluted common share, compared with $23.0 million, or $0.68 per diluted common share in 2001, and $33.1 million, or $0.94 per diluted common share in 2000. Excluding unusual items and goodwill amortization, net income for 2002 increased to $48.7 million, or $1.30 per diluted common share, from Net sales Cost of goods sold Gross margin $42.8 million, or $1.17 per diluted common share, for 2001 and $38.0 million, or $1.07 per diluted common share, for Selling, general and administrative expenses 2000. The increase from 2001 to 2002 was the result of Depreciation and amortization increased sales, a reduction of financing costs and success in Amortization of goodwill controlling operating expenses and improving productivity. Interest expense, net The increase from 2000 to 2001 was primarily due to the increase in sales, a reduction of financing costs, and a lower effective tax rate for ongoing operations. Discount on accounts receivable securitization Impairment loss on investment 89.4 10.6 7.8 0.4 — 0.3 0.0 — (0.0) 8.6 2.0 0.8 1.2 89.3 89.3 10.7 10.7 7.8 0.4 0.2 0.3 0.1 0.0 7.7 0.4 0.2 0.3 0.2 — 0.2 (0.0) 0.2 (0.0) 9.0 9.0 1.7 0.9 1.7 0.8 0.8 0.9 0.0 1.2% (0.2) — 0.6% 0.9% Distributions on mandatorily redeemable preferred securities 0.2 Restructuring credit Total expenses Income before income taxes and extraordinary item Income tax provision Income before extraordinary item Extraordinary item, net of tax Net income Unusual items. In 2002, the company incurred a $3.0 million charge, or $1.8 million net of tax, due to the cancellation of a mainframe computer services contract that was replaced by a new information technology agreement. The company also realized a $50 thousand extraordinary gain, net of tax, resulting from the repurchase of mandatorily redeemable preferred secu- rities. In 2001, unusual items included a $1.1 million impairment loss on an investment in marketable equity securities, a $7.2 million additional tax provision related principally to disallowed interest deductions for corporate-owned life insurance for the years 1995 through 1998, and a $7.1 million after-tax extraordi- nary loss on the early retirement of debt. Net income in 2002, 2001 and 2000 also included reductions in a restructuring reserve, originally established in 1998, of $0.3 million, $0.8 million, and $0.4 million, net of tax. 24 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Goodwill amortization. On January 1, 2002, the company The following tables reconcile selected results of operations adopted the provisions of Statement of Financial Accounting as reported under generally accepted accounting principles to Standards No. (SFAS) 142, Goodwill and Other Intangible Assets, results excluding unusual items and goodwill amortization for under which the company no longer records goodwill the years ended December 31, 2002, 2001 and 2000: amortization expense. (in thousands, except per share data) Year ended December 31, 2002 As reported Unusual items As Adjusted % of net sales Selling, general and administrative expenses $ 307,015 $ (2,987) $304,028 Income before income taxes and extraordinary item Income tax provision Income before extraordinary item Extraordinary item, net of tax Net income Per common share - diluted: Income before extraordinary item Extraordinary item, net of tax Net income $ 78,197 30,980 $ 2,500 1,017 $ 80,697 31,997 47,217 50 1,483 (50) 48,700 — $ 47,267 $ 1,433 $ 48,700 $ $ 1.26 0.01 1.27 $ $ 1.30 — 1.30 Year ended December 31, 2001 7.7% 2.0% 0.8% 1.2% — 1.2% As reported Goodwill amortization Unusual items As Adjusted % of net sales Income before income taxes and extraordinary item $ 64,577 34,474 Income tax provision $ Income before extraordinary item Extraordinary item, net of tax 30,103 (7,068) 5,974 646 5,328 — $ (405) (7,817) 7,412 7,068 $ 70,146 27,303 42,843 — Net income $ 23,035 $ 5,328 $14,480 $ 42,843 1.8% 0.7% 1.1% — 1.1% Per common share - diluted: Income before extraordinary item Extraordinary item, net of tax Net income $ $ 0.85 (0.17) 0.68 $ $ 1.17 — 1.17 Year ended December 31, 2000 As reported Goodwill amortization Unusual items As Adjusted % of net sales Income before income taxes Income tax provision Net income Net income per diluted common share $ 60,160 27,072 $ 33,088 $ 0.94 $ $ 5,988 659 5,329 $ (750) (338) $ 65,398 27,393 $ (412) $ 38,005 1.9% 0.8% 1.1% $ 1.07 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 25 Management’s Discussion & Analysis (continued) Results of Operations Gross Margin % vs. SG&A % of Net Sales Net sales. Net sales increased by 4% to $3.96 billion for 2002, Gross Margin % from $3.81 billion for 2001. During 2002, the company’s sales 10.6% were impacted by losses of certain customers in late 2001 and 2.8% 2.9% 3.0% 2.9% 2.9% early 2002, including those who chose other distributors in 2001 in connection with the Novation contract renewal. Other new business awarded in early 2002 transitioned more slowly than expected; however, this new business, combined with penetra- SG&A % ’98 ’99 ’00 ’01 ’02 (1) Before unusual charge described below (1) 7.7% tion of existing accounts, more than offset the losses. Selling, general and administrative expenses. In July 2002, the Net sales increased by 9% to $3.81 billion for 2001, from company entered into a new, seven-year information technology $3.50 billion for 2000. This increase resulted from further pene- agreement with Perot Systems Corporation, expanding an exist- tration of existing accounts, as well as new business, including ing outsourcing relationship. As a result of the new agreement, the addition of several large customers. In April 2001, the com- O&M recorded a liability for termination costs of $3.0 million pany signed a new distribution agreement with Novation, the in connection with the impending cancellation of its existing supply company of VHA, Inc. and University HealthSystem contract for mainframe computer services. This charge is Consortium, continuing its long-standing relationship with included in selling, general and administrative (SG&A) these organizations. expense for 2002. The company anticipates sales growth for 2003 to be in Excluding the cancellation charge, SG&A expenses as a the 3 to 6 percent range. Net Sales (billions) ’02 ’01 ’00 ’99 ’98 $3.96 $3.81 $3.50 $3.19 $3.09 percentage of sales were 7.7% in 2002, compared with 7.8% in 2001 and 7.7% in 2000. The decrease from 2001 to 2002 is partly the result of a decrease in warehouse personnel costs made possible by the completion of significant customer and business transitions that occurred in 2001. Additionally, SG&A expenses continued to improve as a result of ongoing company- wide efforts to increase productivity and reduce expenses such as delivery expense and travel. The increase from 2000 to 2001 was primarily the result of higher personnel, warehouse and employee benefits costs driven Gross margin. Gross margin as a percentage of net sales for 2002 by customer and business transitions, including higher than nor- decreased slightly to 10.6% from 10.7% in 2001 and 2000. This mal activity levels related to customer sign-ups as a result of the decrease is the result of competitive pressures and more limited Novation contract renewal, the addition of several large new inventory buying opportunities. customer accounts, and changes in the levels of service For 2003, management anticipates continued competitive provided to certain customers, such as the addition of low pressure. The company will continue to pursue opportunities for unit-of-measure delivery. margin improvement, including an emphasis on providing value- In 2003, management expects increased investment in new added services to customers, as well as further development of strategic initiatives, such as its OMSolutionsSM hospital consulting the MediChoice™ private label product line. The company will and 3PL services, and in-house training programs. In addition, also continue to pursue available buying opportunities in order the company expects to implement operational standardization to reduce the cost of goods sold. initiatives that will ultimately result in productivity improvements. Net interest expense and discount on accounts receivable securitization (financing costs). Net financing costs totaled $12.2 million in 2002, compared with $17.7 million in 2001 and $19.4 million 26 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T in 2000. Net financing costs included collections of customer anticipated, the company has recorded reductions in the reserve finance charges of $4.2 million in 2002, compared with $4.5 in 2002, 2001 and 2000 of $0.5 million, $1.5 million and $0.8 million in 2001 and $5.3 million in 2000. Net financing costs million, which have increased net income by $0.3 million, $0.8 in 2002 also included a write-off of $0.2 million of deferred million and $0.4 million. These adjustments resulted primarily financing costs related to the replacement of the company’s from the re-utilization of warehouse space that had previously revolving credit facility and $0.7 million in fees related to the been vacated under the restructuring plan, the resolution of origination of a new off balance sheet receivables financing uncertainties related to potential asset write-offs, and changes in facility. Excluding these items and the collection of customer expectations regarding the sublease of vacated warehouse space. finance charges, financing costs decreased to $15.4 million from In 2002, 2001 and 2000, amounts of $0.4 million, $0.3 million $22.2 million in 2001 and $24.8 million in 2000. The decreases and $1.8 million were charged against the restructuring liability. in financing costs from year to year were primarily driven by The remaining accrual consists primarily of expected losses on a lower outstanding financing levels and lower effective interest lease commitment for vacated office space and a provision for rates. Effective interest rates improved as a result of both the refi- losses on disputed accounts receivable. nancing of the company’s long-term debt in mid-2001 and from decreases in short-term interest rates. O&M expects to continue Income taxes. The provision for income taxes was $31.0 million to manage its financing costs by managing working capital levels. in 2002, compared with $34.5 million in 2001 and $27.1 million Future financing costs will be affected primarily by changes in in 2000. Income tax expense for 2001 included a $7.2 million short-term interest rates, as well as working capital requirements. provision for estimated tax liabilities related principally to Financing (millions) $450 $300 $150 $0 ’98 ’99 ’00 ’01 ’02 Outstanding Financing Financing Costs $30 $20 $10 $0 interest deductions for corporate-owned life insurance claimed on the company’s tax returns for the years 1995 through 1998. Excluding this charge, goodwill amortization, and the other unusual items previously mentioned, O&M’s effective tax rate was 39.7% in 2002, compared with 38.9% in 2001 and 41.9% in 2000. The increase in rate from 2001 to 2002 resulted primarily from increases in certain non-deductible expenses. The reduction in rate from 2000 to 2001 resulted primarily from lower effective state income tax rates and decreases in the effect of certain nondeductible items. Impairment loss on investment. The company owns equity securities of a provider of business-to-business e-commerce services in the Financial Condition, Liquidity and Capital Resources healthcare industry. The market value of these securities fell Liquidity. Combined outstanding debt and off balance sheet significantly below the company’s original cost basis and, as receivables financing decreased by $33.3 million to $240.2 management believed that recovery in the near term was unlikely, million at December 31, 2002, from December 31, 2001, the company recorded an impairment charge of $1.1 million in as a result of favorable cash flow. Excluding sales of accounts the third quarter of 2001. receivable under the company’s off balance sheet receivables financing facility (Receivables Financing Facility), $55.7 million Restructuring credits. As a result of the cancellation of a significant of cash was provided by operating activities in 2002, compared customer contract in 1998, the company recorded a nonrecur- with $11.6 million in 2001 and $68.8 million in 2000. This ring restructuring charge of $6.6 million, after taxes, to increase in operating cash flow from 2001 to 2002 was the result downsize operations. The company periodically re-evaluates of slower sales growth in 2002, as well as inventory reductions its restructuring reserve, and since the actions under this plan made possible by the completion of customer transitions have resulted in lower projected total costs than originally that began in 2001. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 27 Management’s Discussion & Analysis (continued) On July 2, 2001, the company issued $200 million of 81⁄2% either commercial paper rates, the Prime Rate, or LIBOR. The Senior Subordinated Notes which will mature in July 2011. The terms of the new agreement require the company to maintain proceeds from these notes were used to retire the company’s certain levels of net worth, current ratio, leverage ratio and $150 million of 107⁄8% Senior Subordinated Notes and to reduce fixed charge coverage ratio, and restrict the company’s ability the amount of outstanding financing under the Receivables to materially alter the character of the business through consoli- Financing Facility. The retirement of the 107⁄8% Notes resulted dation, merger, or purchase or sale of assets. At December 31, in an extraordinary loss on the early retirement of debt of $7.1 2002, the company was in compliance with these covenants. million, net of income tax benefit. In conjunction with the new In November 2002, the company announced a repurchase notes, the company entered into interest rate swap agreements plan representing a combination of its common stock and its through 2011 under which the company pays counterparties a $2.6875 Term Convertible Securities, Series A issued by the variable rate based on London Interbank Offered Rate (LIBOR) company’s wholly owned subsidiary Owens & Minor Trust I and the counterparties pay the company a fixed interest rate of (“Trust Preferred Securities”). Under this plan, up to $50 million 81⁄2% on a notional amount of $100 million. of Trust Preferred Securities and common stock, with a maximum Effective April 30, 2002, the company replaced its revolving of $35 million in common stock, may be purchased by the com- credit facility with a new agreement expiring in April 2005. pany. The shares of common stock and Trust Preferred Securities The credit limit of the new facility is $150 million, of which may be acquired from time to time through December 31, 2003, $4.0 million is reserved for certain letters of credit. The interest in the open market, in block trades, in private transactions or rate is based on, at the company’s discretion, LIBOR, the otherwise. In December 2002, the company repurchased 137,000 Federal Funds Rate or the Prime Rate. Under the new facility, shares of Trust Preferred Securities resulting in an extraordinary the company is charged a commitment fee of between 0.30% gain of $50 thousand, net of tax. From January 1 through and 0.40% on the unused portion of the facility, and a utiliza- February 24, 2003, the company repurchased 661,500 shares of tion fee of 0.25% if borrowings exceed $75 million. The terms common stock and 250,000 shares of Trust Preferred Securities. of the new agreement limit the amount of indebtedness that Each share of Trust Preferred Securities represents 2.4242 shares the company may incur, require the company to maintain cer- of potential common shares for the purposes of computing tain levels of net worth, current ratio, leverage ratio and fixed earnings per diluted common share. charge coverage ratio, and restrict the ability of the company to The company expects that its available financing will be materially alter the character of the business through consolida- sufficient to fund its working capital needs and long-term tion, merger, or purchase or sale of assets. At December 31, strategic growth, although this cannot be assured. At December 2002, the company was in compliance with these covenants. 31, 2002, O&M had $118.1 million of unused credit under its Effective April 30, 2002, the company replaced its revolving credit facility and the ability to sell an additional Receivables Financing Facility with a new agreement expiring $225.0 million of accounts receivable under the Receivables in April 2005. Under the terms of the new facility, O&M Financing Facility. Funding, a wholly owned subsidiary, is entitled to sell, without The following is a summary of the company’s significant recourse, up to $225 million of its trade receivables to a group contractual obligations as of December 31, 2002: of unrelated third party purchasers at a cost of funds based on (in millions) Contractual obligations Long-term debt(1) Mandatorily redeemable preferred securities(2) Operating leases(3) Other contractual obligations(3) Payments due by period Total $ 227.9 125.2 72.2 200.6 Less than 1 year $ — — 24.0 34.4 1-3 years 4-5 years After 5 years $ 27.9 $ — 32.8 59.8 — — 12.8 59.4 $ 200.0 125.2 2.6 47.0 Total contractual obligations $ 625.9 $ 58.4 $ 120.5 $ 72.2 $ 374.8 (1) See Note 8 to the Consolidated Financial Statements. (2) See Note 11 to the Consolidated Financial Statements. (3) See Note 18 to the Consolidated Financial Statements. 28 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Capital Expenditures. Capital expenditures were approximately conditions, creditworthiness of customers, age of the receivables $9.8 million in 2002, down from $16.8 million in 2001. In 2001, and changes in customer payment patterns. At December 31, the company spent $3.3 million to purchase land for its future 2002, the company had accounts and notes receivable of corporate headquarters. The remaining decrease was a result $354.9 million, net of allowances of $6.8 million. An unexpected of lower spending on software development in 2002 and fewer bankruptcy or other adverse change in financial condition of a warehouse relocations. Critical Accounting Policies The company’s consolidated financial statements and customer could result in increases in these allowances, which could have a material impact on net income. The company actively manages its accounts receivable to minimize credit risk. accompanying notes have been prepared in accordance with Inventory valuation. In order to state inventories at the lower of generally accepted accounting principles. The preparation of LIFO cost or market, the company maintains an allowance for financial statements requires management to make estimates obsolete and excess inventory based upon the expectation that and assumptions that affect the reported amounts of assets and some inventory will become obsolete and be sold for less than liabilities, the disclosure of contingent assets and liabilities at the cost or become unsaleable altogether. The allowance is estimated date of the financial statements and the reported amounts of based on factors such as age of the inventory and historical revenues and expenses during the reporting periods. The com- trends. At December 31, 2002, the company had inventory of pany continually evaluates the accounting policies and estimates $351.8 million, net of an allowance of $1.9 million. Changes in it uses to prepare its financial statements. Management’s estimates product specifications, customer product preferences or the are generally based on historical experience and various other loss of a customer could result in unanticipated impairment in assumptions that are judged to be reasonable in light of the net realizable value that may have a material impact on cost of relevant facts and circumstances. Because of the uncertainty goods sold, gross margin, and net income. The company actively inherent in such estimates, actual results may differ. manages its inventory levels to minimize the risk of loss and has Critical accounting policies are defined as those policies consistently achieved a high level of inventory turnover. that relate to estimates that require a company to make assumptions about matters that are highly uncertain at the time Goodwill. On January 1, 2002, the company adopted the the estimate is made and could have a material impact on the provisions of SFAS 142, Goodwill and Other Intangible Assets. company’s results due to changes in the estimate or the use of The provisions of SFAS 142 state that goodwill should not be different estimates that could reasonably have been used. The amortized but should be tested for impairment upon adoption company believes its critical accounting policies and estimates of the standard and, at least annually, at the reporting unit include its allowances for losses on accounts and notes level. As a result, the company no longer records goodwill receivable, inventory valuation and accounting for goodwill. amortization expense. The company performs an impairment test of its goodwill Allowances for losses on accounts and notes receivable. The based on its reporting units as defined in SFAS 142 on an annual company maintains valuation allowances based upon the basis. In performing the impairment test, the company determines expected collectibility of accounts and notes receivable. The the fair value of its reporting units using valuation techniques allowances include specific amounts for accounts that are likely which can include multiples of the units’ earnings before interest, to be uncollectible, such as customer bankruptcies and disputed taxes, depreciation and amortization (EBITDA), present value amounts, and general allowances for accounts that may become of expected cash flows and quoted market prices. The EBITDA uncollectible. These allowances are estimated based on many multiples are based on an analysis of current market capital- factors such as industry trends, current economic izations and recent acquisition prices of similar companies. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 29 Management’s Discussion & Analysis (continued) The fair value of each reporting unit is then compared to its provisions of this statement will be effective for any exit or carrying value to determine potential impairment. The company’s disposal activities that the company may initiate after goodwill totaled $198.1 million at December 31, 2002. December 31, 2002. The impairment review required by SFAS 142 requires the In November 2002, the FASB issued Interpretation extensive use of accounting judgment and financial estimates. No. 45, Guarantor’s Accounting and Disclosure Requirements for The application of alternative assumptions, such as a change Guarantees, Including Indirect Guarantees of Indebtedness to Others, in discount rates or EBITDA multiples, or the testing for an interpretation of FASB Statements No. 5, 57 and 107 and a impairment at a different level of organization or on a different rescission of FASB Interpretation No. 34. This Interpretation organization structure, could produce materially different results. elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations Recent Accounting Pronouncements under guarantees issued. The Interpretation also clarifies that In September 2001, the Financial Accounting Standards a guarantor is required to recognize, at inception of a guaran- Board (FASB) issued SFAS 143, Accounting for Asset Retirement tee, a liability for the fair value of the obligation undertaken. Obligations. The provisions of SFAS 143 address financial The initial recognition and measurement provisions of the accounting and reporting for obligations associated with the Interpretation are applicable to guarantees issued or modified retirement of tangible long-lived assets and the associated asset after December 31, 2002, and are not expected to have a retirement costs. The company will be required to adopt the material effect on the company’s financial statements. The provisions of this standard beginning on January 1, 2003. disclosure requirements are effective for financial statements Management believes that adoption of this standard will not of interim and annual periods ending after December 15, 2002. have a material effect on the company’s financial condition In January 2003, the FASB issued Interpretation No. 46, or results of operations. In May 2002, the FASB issued SFAS 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. The most significant provisions of SFAS 145 address the termination of extraordinary item treatment for gains and losses on early retirement of debt. The company will be required to adopt the provisions of this standard beginning on January 1, 2003. Upon adoption of the standard, the company will modify the presentation of its 2001 and 2002 results with respect to its loss on early retirement of debt and its gain on the repurchase of mandatorily redeemable preferred securities. Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For variable interests in a variable interest entity created before February 1, 2003, the Interpretation is applicable as of July 1, 2003. The application of this Interpretation is not expected to have a material effect on the company’s financial statements. The Interpretation requires certain disclosures in financial statements issued after However, adoption of the standard will not affect the company’s January 31, 2003, if it is reasonably possible that the company financial condition or results of operations. will consolidate or disclose information about variable interest In July 2002, the FASB issued SFAS 146, Accounting for Costs entities when the Interpretation becomes effective. Associated with Exit or Disposal Activities. The provisions of SFAS 146 modify the accounting for the costs of exit and disposal activities by requiring that liabilities for those activities be recognized when the liability is incurred. Previous accounting literature permitted recognition of some exit and disposal liabilities at the date of commitment to an exit plan. The 30 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Customer Risk Forward-Looking Statements The company is subject to risks associated with changes in the Certain statements in this discussion constitute “forward-looking medical industry, including competition and continued efforts statements” within the meaning of the Private Securities to control costs, which place pressure on operating margin, Litigation Reform Act of 1995. Although O&M believes its changes in the way medical and surgical services are delivered, expectations with respect to the forward-looking statements are and changes in manufacturer preferences between the sale of based upon reasonable assumptions within the bounds of its product directly to hospital customers and the use of wholesale knowledge of its business and operations, all forward-looking distribution. The loss of one of the company’s larger customers statements involve risks and uncertainties and, as a result, actual could have a significant effect on its business. results could differ materially from those projected, anticipated Market Risk or implied by these statements. Such forward-looking statements involve known and unknown risks, including, but not limited O&M provides credit, in the normal course of business, to its to: general economic and business conditions; the ability of the customers. The company performs ongoing credit evaluations company to implement its strategic initiatives; dependence on of its customers and maintains reserves for credit losses. sales to certain customers; dependence on suppliers; changes The company is exposed to market risk relating to changes in manufacturer preferences between direct sales and wholesale in interest rates. To manage this risk, O&M uses interest rate distribution; competition; changing trends in customer profiles; swaps to modify the company's balance of fixed and variable the ability of the company to meet customer demand for addi- rate financing. The company is exposed to certain losses in the tional value-added services; the ability to convert customers to event of nonperformance by the counterparties to these swap CostTrackSM; the availability of supplier incentives; the ability to agreements. However, O&M's exposure is not significant and, capitalize on buying opportunities; the ability of business part- since the counterparties are investment grade financial institu- ners to perform their contractual responsibilities; the ability to tions, nonperformance is not anticipated. manage operating expenses; the ability of the company to man- The company is exposed to market risk from both changes age financing costs and interest rate risk; the risk that a decline in interest rates related to its interest rate swaps and changes in in business volume or profitability could result in an impairment discount rates related to its Receivables Financing Facility. of goodwill; the ability to timely or adequately respond to tech- Interest expense and discount on accounts receivable securitiza- nological advances in the medical supply industry; the ability to tion are subject to change as a result of movements in interest successfully identify, manage or integrate possible future acquisi- rates. As of December 31, 2002, O&M had $100 million of inter- tions; the outcome of outstanding litigation; and changes in est rate swaps on which the company pays a variable rate based government regulations. As a result of these and other factors, on LIBOR and receives a fixed rate. A hypothetical increase no assurance can be given as to the company’s future results. in interest rates of 100 basis points would result in a potential The company is under no obligation to update or revise any reduction in future pre-tax earnings of approximately $1.0 forward-looking statements, whether as a result of new million per year in connection with the swaps. The company information, future results, or otherwise. had no outstanding financing under its Receivables Financing Facility at December 31, 2002, but does sell receivables under the facility from time to time. 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 financing under the Receivables Financing Facility. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 31 2002 2001 2000 $3,959,781 3,539,911 $3,814,994 $3,503,583 3,406,758 3,127,911 419,870 307,015 15,926 – 10,403 1,782 – 7,034 (487) 408,236 375,672 296,807 268,205 16,495 5,974 13,363 4,330 1,071 7,095 (1,476) 15,527 5,988 12,566 6,881 – 7,095 (750) 341,673 343,659 315,512 78,197 30,980 47,217 50 64,577 34,474 30,103 (7,068) 60,160 27,072 33,088 – $ 47,267 $ 23,035 $ 33,088 $ $ $ $ $ $ 1.40 – 1.40 1.26 0.01 1.27 0.31 $ $ $ $ $ 0.90 (0.21) 0.69 0.85 (0.17) 0.68 0.2725 $ $ $ $ $ 1.01 – 1.01 0.94 – 0.94 0.2475 Consolidated Statements of Income (in thousands, except per share data) Year ended December 31, Net sales Cost of goods sold Gross margin Selling, general and administrative expenses Depreciation and amortization Amortization of goodwill Interest expense, net Discount on accounts receivable securitization Impairment loss on investment Distributions on mandatorily redeemable preferred securities Restructuring credit Total expenses Income before income taxes and extraordinary item Income tax provision Income before extraordinary item Extraordinary item, net of tax Net income Per common share – basic: Income before extraordinary item Extraordinary item, net of tax Net income Per common share – diluted: Income before extraordinary item Extraordinary item, net of tax Net income Cash dividends per common share See accompanying notes to consolidated financial statements. 32 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Consolidated Balance Sheets (in thousands, except per share data) December 31, Assets Current assets Cash and cash equivalents Accounts and notes receivable, net Merchandise inventories Other current assets Total current assets Property and equipment, net Goodwill Deferred income taxes Other assets, net Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable Accrued payroll and related liabilities Deferred income taxes Other accrued liabilities Total current liabilities Long-term debt Deferred income taxes Other liabilities Total liabilities Company-obligated mandatorily redeemable preferred securities of subsidiary trust, holding solely convertible debentures of Owens & Minor, Inc. Shareholders’ equity Preferred stock, par value $100 per share; authorized – 10,000 shares Series A; Participating Cumulative Preferred Stock; none issued Common stock, par value $2 per share; authorized – 200,000 shares; issued and outstanding – 34,113 shares and 33,885 shares Paid-in capital Retained earnings Accumulated other comprehensive loss Total shareholders’ equity Commitments and contingencies Total liabilities and shareholders’ equity See accompanying notes to consolidated financial statements. 2002 2001 $ 3,361 $ 953 354,856 351,835 19,701 729,753 21,808 198,139 3,950 55,827 264,235 389,504 24,760 679,452 25,257 198,324 – 50,820 $1,009,477 $953,853 $ 259,597 $286,656 12,985 20,369 51,779 344,730 240,185 – 27,975 12,669 27,154 41,195 367,674 203,449 364 14,123 612,890 585,610 125,150 132,000 – – 68,226 30,134 179,554 (6,477) 67,770 27,181 142,854 (1,562) 271,437 236,243 $1,009,477 $953,853 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 33 Consolidated Statements of Cash Flows (in thousands) Year ended December 31, Operating activities Income before extraordinary item Adjustments to reconcile income before extraordinary item to cash provided by (used for) operating activities: Depreciation and amortization Restructuring credit Impairment loss on investment Deferred income taxes Provision for LIFO reserve Provision for losses on accounts and notes receivable Changes in operating assets and liabilities: Net decrease in receivables sold Accounts and notes receivable, excluding sales of receivables Merchandise inventories Accounts payable Net change in other current assets and current liabilities Other liabilities Other, net Cash provided by (used for) operating activities Investing activities Additions to property and equipment Additions to computer software Other, net Cash used for investing activities Financing activities Net proceeds from issuance of long-term debt Payments to retire long-term debt Payments to repurchase mandatorily redeemable preferred securities Net proceeds from (payments on) revolving credit facility Cash dividends paid Proceeds from exercise of stock options Increase (decrease) in drafts payable Other, net Cash provided by (used for) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year 2002 2001 2000 $ 47,217 $ 30,103 $ 33,088 15,926 (487) – (8,002) 4,131 2,673 (70,000) (23,294) 33,538 (40,059) 14,668 6,534 2,893 (14,262) 22,469 (1,476) 1,071 11,268 4,264 2,347 21,515 (750) – (1,293) 2,973 1,920 (10,000) 5,323 (25,612) (11,286) (78,198) 23,935 10,049 (14,783) 48 1,053 3,320 1,641 8,926 708 3,814 43,155 (4,815) (4,942) 9 (10,147) (8,005) (6,686) (11,622) (858) (152) (9,748) (17,691) (19,779) – – (6,594) 27,900 (10,567) 1,992 13,000 687 26,418 2,408 953 194,331 (158,594) – (2,200) (9,182) 8,255 (14,900) (1,333) – – – (20,400) (8,156) 4,837 2,800 (2,500) 16,377 (23,419) 327 626 953 (43) 669 $ 626 Cash and cash equivalents at end of year $ 3,361 $ See accompanying notes to consolidated financial statements. 34 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Consolidated Statements of Changes in Shareholders’ Equity (in thousands, except per share data) Balance December 31, 1999 32,711 $ 65,422 $ 12,890 $ 104,069 $ – $ 182,381 Common Shares Outstanding Common Stock Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Total Shareholders’ Equity Balance December 31, 2000 33,180 66,360 18,039 129,001 (628) Net income Other comprehensive loss, net of tax: Unrealized loss on investment Comprehensive income Issuance of restricted stock, net of forfeitures 102 204 Unearned compensation Cash dividends Exercise of stock options Other 355 12 710 24 4,541 125 Net income Other comprehensive income (loss), net of tax: Unrealized gain on investment Reclassification of unrealized loss to net income Minimum pension liability adjustment Comprehensive income Issuance of restricted stock, net of forfeitures 55 110 Unearned compensation Cash dividends Exercise of stock options Other 696 (46) 1,392 9,237 (92) (735) Net income Other comprehensive loss, net of tax: Unrealized loss on investment Minimum pension liability adjustment Comprehensive income Issuance of restricted stock, net of forfeitures 53 106 Unearned compensation Cash dividends Exercise of stock options Other 219 (44) 438 2,842 (88) (736) 33,088 (628) 622 (139) (8,156) 23,035 272 642 (1,848) 813 (173) (9,182) 47,267 (222) (4,693) 909 (62) (10,567) Balance December 31, 2001 33,885 67,770 27,181 142,854 (1,562) 33,088 (628) 32,460 826 (139) (8,156) 5,251 149 212,772 23,035 272 642 (1,848) 22,101 923 (173) (9,182) 10,629 (827) 236,243 47,267 (222) (4,693) 42,352 1,015 (62) (10,567) 3,280 (824) Balance December 31, 2002 34,113 $68,226 $30,134 $179,554 $(6,477) $271,437 See accompanying notes to consolidated financial statements. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 35 Notes to Consolidated Financial Statements Note 1—Summary of Significant Accounting Policies Basis of Presentation. Owens & Minor, Inc. is the leading distributor of national name-brand medical and surgical supplies in the United States. The consolidated financial statements include the accounts of Owens & Minor, Inc. and its wholly owned subsidiaries (the company). All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation. Use of Estimates. The preparation of the consolidated financial statements in accordance with generally accepted accounting principles requires management to make assumptions and estimates that affect amounts reported. Estimates are used for, but not limited to, the accounting for the allowances for losses on accounts and notes receivable, inventory valuation allowances, depreciation and amor- tization, goodwill valuation, tax liabilities, and other contingencies. Actual results may differ from these estimates. Cash and Cash Equivalents. Cash and cash equivalents include cash and marketable securities with an original maturity or maturity at acquisition of three months or less. Cash and cash equivalents are stated at cost, which approximates market value. Accounts and Notes Receivable. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The company maintains valuation allowances based upon the expected collectibility of accounts and notes receivable. The allowances include specific amounts for accounts that are likely to be uncollectible, such as customer bankruptcies and disputed amounts, and general allowances for accounts that may become uncollectible. The allowances are estimated based on many factors such as industry trends, current economic conditions, creditworthiness of customers, age of the receivables and changes in customer payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recov- ery is considered remote. Allowances for losses on accounts and notes receivable of $6.8 million and $8.1 million have been applied as reductions of accounts receivable at December 31, 2002 and 2001. Merchandise Inventories. The company’s merchandise inventories are stated at the lower of cost or market. Inventories are valued on a last-in, first-out (LIFO) basis. Property and Equipment. Property and equipment are stated at cost or, if acquired under capital leases, at the lower of the present value of minimum lease payments or fair market value at the inception of the lease. Normal maintenance and repairs are expensed as incurred, and renovations and betterments are capitalized. Depreciation and amortization are provided for financial reporting pur- poses using the straight-line method over the estimated useful lives of the assets or, for capital leases and leasehold improvements, over the terms of the lease, if shorter. In general, the estimated useful lives for computing depreciation and amortization are four to eight years for warehouse equipment and three to eight years for computer, office and other equipment. Straight-line and accelerated methods of depreciation are used for income tax purposes. Goodwill. On January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 142, Goodwill and Other Intangible Assets. The provisions of SFAS 142 state that goodwill should not be amortized but should be tested for impairment upon adoption of the standard, and at least annually, at the reporting unit level. As a result, the company no longer records goodwill amortization expense. The provisions of SFAS 142 also require the company to evaluate its existing intangible assets and goodwill acquired in purchase business combinations, and to make any necessary reclassifications. At implementation, the company had no separately identifiable intangible assets from purchase business combinations that are recorded either separately or within goodwill. 36 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Prior to 2002, goodwill was amortized on a straight-line basis over 40 years from the dates of acquisition and was evaluated for impairment based upon management’s assessment of undiscounted future cash flows, in accordance with the provisions of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of. Amortization expense related to goodwill for 2001 and 2000 was $6.0 million each year. The following table presents the company’s income before extraordinary items and net income for the years 2002, 2001 and 2000, adjusted to exclude goodwill amortization expense and related tax benefits: (in thousands) Year Ended December 31, Income before extraordinary item Goodwill amortization, net of tax benefit Adjusted income before extraordinary item Net income Goodwill amortization, net of tax benefit Adjusted net income Per common share—basic: Adjusted income before extraordinary item Adjusted net income Per common share—diluted: Adjusted income before extraordinary item Adjusted net income 2002 2001 2000 $47,217 $30,103 $33,088 – 5,328 5,329 $47,217 $35,431 $38,417 $47,267 $23,035 $33,088 – 5,328 5,329 $47,267 $28,363 $38,417 $ $ $ $ 1.40 1.40 1.26 1.27 $ $ $ $ 1.06 0.85 0.98 0.81 $ $ $ $ 1.17 1.17 1.08 1.08 Computer Software. The company develops and purchases software for internal use. Software development costs incurred during the application development stage are capitalized. Once the software has been installed and tested and is ready for use, additional costs incurred in connection with the software are expensed as incurred. Capitalized computer software costs are amortized over the esti- mated useful life of the software, usually between 3 and 5 years. Computer software costs are included in other assets, net in the consolidated balance sheets. Unamortized software at December 31, 2002 and 2001 was $20.0 million and $22.8 million. Depreciation and amortization expense includes $7.7 million, $7.6 million and $6.1 million of software amortization for the years ended December 31, 2002, 2001 and 2000. Investment. The company owns equity securities that are classified as available-for-sale, in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and are included in other assets, net in the consolidated balance sheets at fair value, with unrealized gains and losses, net of tax, reported as accumulated other comprehensive income or loss. Declines in market value that are considered other than temporary are reclassified to net income. Revenue Recognition. In general, the company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price or fee is fixed or determinable, and collectibility is reasonably assured. The company records product revenue at the time of shipment. Distribution fee revenue, when calculated as a mark-up of the product cost, is also recognized at the time of shipment. Revenue for activity based distribution fees and other services is recognized once service has been rendered. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 37 The company provides for sales returns and allowances through a reduction in gross sales. This provision is based upon historical trends as well as specific identification of significant items. The company does not experience a significant volume of sales returns. In most cases, the company records revenue gross, as the company is the primary obligor in its sales arrangements and bears general and physical loss inventory risk. The company also has some discretion in supplier selection and carries all credit risk asso- ciated with its sales. From time to time, the company enters into arrangements where net revenue recognition is appropriate, and in these instances revenue is recognized accordingly. Stock-based Compensation. The company uses the intrinsic value method as defined by Accounting Principles Board Opinion No. 25 to account for stock-based compensation. This method requires 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. In December 2002, the company adopted the disclosure provisions of SFAS 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123. The provisions of SFAS 148 amend the disclosure provisions of SFAS 123, Accounting for Stock-Based Compensation, by requiring a tabular presentation of the effect on net income and earnings per share of using the fair value method, as defined in SFAS 123, to account for stock-based compensation. 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: (in thousands) Year Ended December 31, Net income Add: Stock-based employee compensation expense included in reported net income, net of tax Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax Pro forma net income Per common share—basic: Net income, as reported Pro forma net income Per common share—diluted: Net income, as reported Pro forma net income 2002 2001 2000 $47,267 $23,035 $33,088 572 464 381 (1,654) (1,672) (1,328) $46,185 $21,827 $32,141 $ $ $ $ 1.40 1.37 1.27 1.24 $ $ $ $ 0.69 0.65 0.68 0.64 $ $ $ $ 1.01 0.98 0.94 0.91 The weighted average fair value of options granted in 2002, 2001 and 2000 was $4.49, $5.37 and $2.69, per option. The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants: dividend yield of 1.6%-2.1% in 2002, 1.4%-1.7% in 2001 and 1.6%-3.0% in 2000; expected volatility of 39.1%-40.6% in 2002, 41.4% in 2001 and 36.7% in 2000; risk-free interest rate of 3.0%-4.3% in 2002, 4.4% in 2001 and 5.1% in 2000; and expected lives of 4 years in 2002 and 2001, and 5 years in 2000. Other disclosures required by SFAS 123 are included in Note 12. 38 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Derivative Financial Instruments. On January 1, 2001, the company adopted the provisions of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities measured at fair value. The accounting treatment for changes in the fair value of a derivative depends upon the intended use of the derivative and the resulting designation. The adoption of this standard did not have a material impact on the company’s results of operations or financial position. The company 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 in order to manage interest rate risk. These swaps are recog- nized on the balance sheet at their fair value, based on estimates of the prices obtained from a dealer. All of the company’s interest rate swaps since the implementation of SFAS 133 have been designated as hedges of the fair value of a portion of the company’s long- term debt and, accordingly, the changes in the fair value of the swaps and the changes in the fair value of the hedged item attributable to the hedged risk are recognized as a charge or credit to interest expense. The company assesses, both at the hedge’s inception and on an ongoing basis, whether the swaps are highly effective in offsetting changes in the fair values of the hedged items. If it is determined that an interest rate swap has ceased to be a highly effective hedge, the company discontinues hedge accounting prospectively. Prior to the adoption of the provisions of SFAS 133, the company entered into interest rate swaps as part of its interest rate risk management strategy. The instruments were designated as hedges of interest-bearing liabilities and anticipated cash flows associated with off balance sheet financing. Net payments or receipts were accrued as interest payable or receivable and as interest expense or income. Fees related to these instruments were amortized over the life of the instrument. If the outstanding balance of the underlying liability were to drop below the notional amount of the swap, the excess portion of the swap was marked to market, and the resulting gain or loss included in net income. Operating Segments. As defined in SFAS 131, Disclosures about Segments of an Enterprise and Related Information, as of December 31, 2002, the company had one operating segment. Other Recently Adopted Accounting Pronouncements. On January 1, 2002, the company adopted the provisions of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The provisions of SFAS 144 modify the accounting treatment for impairments of long- lived assets and discontinued operations. The adoption of this standard did not have a material effect on the company’s results of operations or financial condition. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 39 Note 2—Acquisition On July 30, 1999, the company acquired certain net assets of Medix, Inc. (Medix), a distributor of medical and surgical supplies. In connection with the acquisition, management adopted a plan for integration of the businesses that included closure of some Medix facilities and consolidation of certain administrative functions. An accrual was established to provide for certain costs of this plan. The integration accrual was re-evaluated in the fourth quarters of 2002 and 2001, resulting in reductions in the accrual of $0.2 million and $0.6 million. The accrual adjustments were recorded as reductions in goodwill, as they reduced the purchase price of the Medix acquisition. The following table sets forth the major components of the accrual and activity through December 31, 2002: (in thousands) Exit Plan Provision Charges Adjustments Balance at December 31, 2002 Losses under lease commitments $1,643 $1,055 Employee separations Other Total 395 685 350 427 $2,723 $1,832 $(473) (45) (218) $(736) $115 – 40 $155 The employee separations relate to severance costs for employees in operations and activities that were exited. Approximately 40 employees were terminated. While the integration of the Medix business was completed in 2001, the company continues to make payments under a lease commitment expiring in 2003 and other obligations. Note 3—Restructuring In 1998, the company recorded a nonrecurring restructuring charge of $11.2 million as a result of the cancellation of a significant medical/surgical distribution contract. The restructuring plan included reductions in warehouse space and in the number of employ- ees in those facilities that had the highest volume of business under that contract. The company periodically re-evaluates its estimate of the remaining costs to be incurred and, as a result, reduced the accrual by $0.5 million in 2002, $1.5 million in 2001 and $0.8 million in 2000. These adjustments resulted primarily from the reutilization of warehouse space that had previously been vacated under the restructuring plan, the resolution of uncertainties related to potential asset write-offs, and changes in expectations regarding the sub- lease of vacated warehouse space. Approximately 130 employees were terminated in connection with the restructuring plan. The following table sets forth the activity in the restructuring accrual through December 31, 2002: (in thousands) Losses under lease commitments Asset write-offs Employee separations Other Total Restructuring Provision Charges Adjustments Balance at December 31, 2002 $ 4,194 3,968 2,497 541 $11,200 $3,493 1,695 1,288 99 $6,575 $ (106) (1,956) (1,209) (442) $(3,713) $595 317 – – $912 40 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Note 4—Merchandise Inventories The company’s merchandise inventories are valued on a LIFO basis. If LIFO inventories had been valued on a current cost or first-in, first-out (FIFO) basis, they would have been greater by $40.0 million and $35.8 million as of December 31, 2002 and 2001. Note 5—Property and Equipment The company’s investment in property and equipment consists of the following: (in thousands) December 31, Warehouse equipment Computer equipment Office equipment and other Leasehold improvements Land and improvements Accumulated depreciation and amortization Property and equipment, net 2002 2001 $ 25,665 $ 24,906 36,598 13,094 11,716 5,263 92,336 (70,528) 36,449 12,991 11,440 5,065 90,851 (65,594) $ 21,808 $ 25,257 Depreciation and amortization expense for property and equipment in 2002, 2001 and 2000 was $8.2 million, $8.9 million and $9.4 million. Note 6—Investment The company owns equity securities of a provider of business-to-business e-commerce services to the healthcare industry. Net income for the year ended December 31, 2001 included an impairment charge of $1.1 million, as the market value of these securities fell sig- nificantly below the company’s original cost basis and management believed that recovery in the near term was unlikely. The following table summarizes the fair value (based on the quoted market price), gross unrealized gains and losses, and adjusted cost basis of the investment as of December 31, 2002 and 2001: (in thousands) December 31, Adjusted cost basis Gross unrealized gain Fair value 2002 2001 151 106 151 476 $257 $627 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 41 Note 7—Accounts Payable Accounts payable balances were $259.6 million and $286.7 million as of December 31, 2002 and 2001, of which $219.6 million and $259.7 million were trade accounts payable, and $40.0 million and $27.0 million were drafts payable. Drafts payable are checks written in excess of bank balances, to be funded upon clearing the bank. Note 8—Debt The company’s long-term debt consists of the following: (in thousands) December 31, 2002 2001 Carrying Amount Estimated Fair Value Carrying Amount Estimated Fair Value 8.5% Senior Subordinated Notes, $200 million par value, mature July 2011 $212,285 $213,250 $203,449 $210,000 Revolving Credit Facility with interest based on London Interbank Offered Rate (LIBOR), Federal Funds or Prime Rate, expires April 2005, credit limit of $150,000 Long-term debt 27,900 27,900 – – $240,185 $241,150 $203,449 $210,000 In July 2001, the company issued $200.0 million of 8.5% Senior Subordinated 10-year notes (2011 Notes) which mature on July 15, 2011. Interest on the 2011 Notes is payable semi-annually on January 15 and July 15, beginning January 15, 2002. The 2011 Notes are redeemable on or after July 15, 2006, at the company’s option, subject to certain restrictions. The 2011 Notes are unconditionally guaranteed on a joint and several basis by all significant subsidiaries of the company, other than O&M Funding Corp. (OMF) and Owens & Minor Trust I. Under these guarantees, the guarantor subsidiaries would be required to pay up to the full balance of the debt in the event of default of Owens & Minor, Inc. The net proceeds from the 2011 Notes were used to retire the 10.875% Senior Sub- ordinated 10-year Notes due in 2006 (2006 Notes) and to reduce the amount of outstanding financing under the company’s off balance sheet receivables financing facility. The early retirement of the 2006 Notes resulted in an extraordinary loss of $7.1 million, consisting of $8.4 million of retirement premiums, a $3.2 million write-off of debt issuance costs, $0.2 million of fees, and an income tax benefit of $4.7 million. In April 2002, the company replaced its revolving credit facility with a new agreement expiring in April 2005. The credit limit of the new facility is $150.0 million, and the interest rate is based on, at the company’s discretion, LIBOR, the Federal Funds Rate or the Prime Rate. Under the new facility, the company is charged a commitment fee of between 0.30% and 0.40% on the unused portion of the facility, and a utilization fee of 0.25% if borrowings exceed $75.0 million. The terms of the new agreement limit the amount of indebtedness that the company may incur, require the company to maintain certain levels of net worth, current ratio, leverage ratio and fixed charge coverage ratio, and restrict the ability of the company to materially alter the character of the business through con- solidation, merger, or purchase or sale of assets. 42 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Net interest expense includes finance charge income of $4.2 million, $4.5 million and $5.3 million in 2002, 2001 and 2000. Finance charge income represents payments from customers for past due balances on their accounts. Cash payments for interest dur- ing 2002, 2001 and 2000 were $14.9 million, $10.8 million and $16.5 million. The estimated fair value of long term debt is based on the borrowing rates currently available to the company for loans with sim- ilar terms and average maturities. The annual maturities of long-term debt for the five years subsequent to December 31, 2002 are: $0 in 2003 and 2004, $27.9 million in 2005, and $0 in 2006 and 2007. Note 9—Off Balance Sheet Receivables Financing Facility In April 2002, the company replaced its off balance sheet receivables financing facility (Receivables Financing Facility) with a new agreement expiring in April 2005. Under the terms of the new facility, O&M Funding is entitled to sell, without recourse, up to $225.0 million of its trade receivables to a group of unrelated third party purchasers at a cost of funds based on either commercial paper rates, the Prime Rate, or LIBOR. The terms of the new agreement require the company to maintain certain levels of net worth, cur- rent ratio, leverage ratio and fixed charge coverage ratio, and restrict the company’s ability to materially alter the character of the business through consolidation, merger, or purchase or sale of assets. The company continues to service the receivables that are trans- ferred under the facility on behalf of the purchasers at estimated market rates. Accordingly, the company has not recognized a servicing asset or liability. In the second quarter of 2001, the company adopted the provisions of SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS 125 of the same title. SFAS 140 revised the standards for securitizations and other transfers of financial assets and expanded the disclosure requirements for such transactions, while carrying over many of the provisions of SFAS 125 without change. The provisions of SFAS 140 are effective for transfers of financial assets and extinguishments of liabilities occurring after March 31, 2001, and are to be applied prospectively. The adoption of this standard did not require a change in the company’s accounting treatment of sales of accounts receivable under its Receivables Financing Facility, or have any material effect on the company’s consolidated financial position, results of operations, or cash flows. The company adopted the dis- closure requirements of SFAS 140 in 2000. At December 31, 2002, there were no receivables sold under the Receivables Financing Facility. At December 31, 2001, net accounts receivable of $70.0 million had been sold under the previous agreement and, as a result, were excluded from the con- solidated balance sheet. Note 10—Derivative Financial Instruments The company 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 in order to manage interest rate risk. In July 2001, the company entered into interest rate swap agreements of $100.0 million notional amounts that effectively converted a portion of the company’s fixed rate financing instruments to variable rates. These swaps were designated as fair value hedges of a portion of the company’s 2011 Notes and, as the terms of the swaps are identical to the terms of the Notes, qualify for an assumption of no ineffectiveness under the provisions of SFAS 133. Under these agreements, expiring in July 2011, the company pays the counterparties a variable rate based on LIBOR and the counterparties pay the company a fixed interest rate of 8.50%. Previously, the company had similar interest rate swap agreements of $100.0 million notional amounts that were designated as fair value hedges of a portion of the company’s 2006 Notes, which were cancelled by their respective counterparties on May 28, 2001. Under these agreements, the company paid the counter- parties a variable rate based on LIBOR and the counterparties paid the company a fixed interest rate ranging from 7.35% to 7.38%. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 43 The payments received or disbursed in connection with the interest rate swaps are included in interest expense, net. Based on estimates of the prices obtained from a dealer, the fair value of the company’s interest rate swaps at December 31, 2002 and 2001 was $11.6 million and $3.4 million. The fair value of the swaps are recorded in other assets on the consolidated balance sheet. The company is exposed to certain losses in the event of nonperformance by the counterparties to these swap agreements. However, the company’s exposure is not material and, since the counterparties are investment grade financial institutions, nonperformance is not anticipated. Note 11—Mandatorily Redeemable Preferred Securities In May 1998, Owens & Minor Trust I (Trust), a statutory business trust sponsored and wholly owned by Owens & Minor, Inc. (O&M), issued 2,640,000 shares of $2.6875 Term Convertible Securities, Series A (Securities), for aggregate proceeds of $132.0 million. Each Security has a liquidation value of $50. The net proceeds were invested by the Trust in 5.375% Junior Subordinated Convertible Debentures of O&M (Debentures). The Debentures are the sole assets of the Trust. O&M applied substantially all of the net proceeds of the Debentures to repurchase 1,150,000 shares of its Series B Cumulative Preferred Stock at its par value. The Securities accrue and pay quarterly cash distributions at an annual rate of 5.375% of the liquidation value. Each Security is convertible into 2.4242 shares of the common stock of O&M at the holder’s option prior to May 1, 2013. The Securities are manda- torily redeemable upon the maturity of the Debentures on April 30, 2013, and may be redeemed by the company in whole or in part after May 1, 2001. The obligations of the Trust, as provided under the term of the Securities, are fully and unconditionally guaranteed by O&M. In 2002, the company announced a repurchase plan for a combination of its common stock and its Securities. Under the plan, the company repurchased 137,000 shares of Securities resulting in an extraordinary gain of $50 thousand, net of tax. The estimated fair value, based on quoted market prices, and carrying amount of the Securities were $123.3 million and $125.2 million at December 31, 2002 and $130.0 million and $132.0 million at December 31, 2001. As of December 31, 2002 and 2001, the company had accrued $1.1 million and $1.2 million of distributions related to the Securities. Note 12—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 December 31, 2002, approximately 1.1 million common shares were available for issuance under the Plans. Stock options awarded under the Plans generally vest 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. At December 31, 2002, there were no SARs outstanding. 44 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 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 who meet specified ownership goals in a given year are awarded restricted stock under the provisions of the program. The company also has an Annual Incentive Plan. Under the plan, certain employees may be awarded restricted stock based on achievement of pre-established objectives. Upon issuance of restricted shares, unearned compensation is charged to shareholders’ equity for the market value of restricted stock and recognized as compensation expense ratably over the vesting period. In 2002, 2001 and 2000, the company issued 53 thousand, 72 thousand and 117 thousand shares of restricted stock, at weighted-average market values of $19.21, $15.79 and $8.63. Amortization of unearned compen- sation for restricted stock awards was approximately $953 thousand, $774 thousand and $693 thousand for 2002, 2001 and 2000. The following table summarizes the activity and terms of outstanding options at December 31, 2002, and for each of the years in the three-year period then ended: (in thousands, except per share data) 2002 2001 2000 Average Exercise Price Options Options outstanding at beginning of year 2,219 $13.46 Granted Exercised Expired/cancelled Outstanding at end of year Exercisable options at end of year 378 (219) (7) 2,371 1,642 15.26 12.51 14.64 $13.83 $13.68 Average Exercise Price $12.82 16.03 13.01 11.56 $13.46 $13.56 Options 2,448 500 (358) (87) 2,503 1,655 Average Exercise Price $13.75 8.73 13.57 12.38 $12.82 $13.75 Options 2,503 480 (696) (68) 2,219 1,413 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 45 At December 31, 2002, the following option groups were outstanding: (in thousands, except per share data) Outstanding Exercisable Number of Options (000’s) Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Number of Options (000’s) Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) 393 853 1,125 $ 8.86 $13.73 $15.65 2,371 $13.83 6.73 4.87 4.76 5.13 275 853 514 $ 9.10 $13.73 $16.06 1,642 $13.68 6.57 4.87 3.66 4.78 Range of Exercise Prices $ 8.31—11.94 $ 12.69—14.69 $ 14.90—19.95 Note 13—Retirement Plans Savings and Retirement Plan. The company maintains a voluntary 401(k) Savings and Retirement Plan covering substantially all full-time employees who have completed one month of service and have attained age 18. The company matches a certain percentage of each employee’s contribution. The plan provides for a minimum contribution by the company to the plan for all eligible employees of 1% of their salary. This contribution can be increased at the company’s discretion. The company incurred approximately $3.1 million, $3.0 million and $2.7 million of expenses related to this plan in 2002, 2001 and 2000. Pension Plan. The company has a noncontributory pension plan covering substantially all employees who had earned benefits as of December 31, 1996. On that date, substantially all of the benefits of employees under this plan were frozen, with all participants becoming fully vested. The company expects to continue to fund the plan based on federal requirements, amounts deductible for income tax purposes and as needed to ensure that plan assets are sufficient to satisfy plan liabilities. As of December 31, 2002, plan assets consist primarily of equity securities, including 34 thousand shares of the company’s common stock, and U.S. Government securities. Retirement Plan. The company also has a noncontributory, unfunded retirement plan for certain officers and other key employees. Benefits are based on a percentage of the employees’ compensation. 46 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T The following table sets forth the plans’ financial status and the amounts recognized in the company’s consolidated balance sheets: (in thousands) December 31, Change in benefit obligation Benefit obligation, beginning of year Service cost Interest cost Actuarial loss (gain) Benefits paid Benefit obligation, end of year Change in plan assets Fair value of plan assets, beginning of year Actual return on plan assets Employer contribution Benefits paid Fair value of plan assets, end of year Funded status Funded status at December 31 Unrecognized net actuarial loss Unrecognized prior service cost Unrecognized net transition obligation Net amount recognized Amounts recognized in the consolidated balance sheets Accrued benefit cost Intangible asset Accumulated other comprehensive loss Net amount recognized Pension Plan Retirement Plan 2002 2001 2002 2001 $22,668 $23,053 $ 14,717 $ 11,519 – 1,599 1,890 (1,080) 193 1,518 (965) (1,131) 599 1,055 2,340 (243) 567 878 1,994 (241) $25,077 $22,668 $ 18,468 $ 14,717 $21,454 $24,764 $ (3,177) (2,179) – – (1,080) (1,131) $ – – 243 (243) – – 241 (241) $17,197 $21,454 $ – $ – $ (7,880) $(1,214) $(18,468) $(14,717) 9,876 3,050 – – – – 5,898 2,691 – 3,767 2,972 41 $ 1,996 $ 1,836 $ (9,879) $ (7,937) $ (7,880) $(1,214) $(13,416) $(10,981) – 9,876 – 3,050 2,691 846 3,013 31 $ 1,996 $ 1,836 $ (9,879) $ (7,937) The components of net periodic pension cost for the Pension and Retirement Plans are as follows: (in thousands) Year ended December 31, Service cost Interest cost Expected return on plan assets Amortization of prior service cost Amortization of transition obligation Recognized net actuarial loss Net periodic pension cost 2002 2001 2000 $ 599 $ 760 $ 690 2,654 (1,759) 2,396 2,144 (2,130) (2,026) 281 41 209 282 41 56 133 41 2 $ 2,025 $ 1,405 $ 984 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 47 The weighted average discount rate, rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations and the expected long-term rate of return on plan assets were assumed to be 6.75%, 5.5% and 7.0% in 2002 and 7.25%, 5.5% and 8.5% in 2001. Note 14—Income Taxes The income tax provision consists of the following: (in thousands) Year ended December 31, Current tax provision: Federal State Total current provision Deferred tax provision (benefit): Federal State Total deferred provision (benefit) Total income tax provision 2002 2001 2000 $33,610 5,372 $18,974 $23,604 4,232 4,761 38,982 23,206 28,365 (7,181) (821) (8,002) 9,859 1,409 (1,131) (162) 11,268 (1,293) $30,980 $34,474 $27,072 A reconciliation of the federal statutory rate to the company’s effective income tax rate is shown below: Year ended December 31, Federal statutory rate Increases in the rate resulting from: State income taxes, net of federal income tax impact Provision for tax contingencies Nondeductible goodwill amortization Other, net Effective income tax rate 2002 2001 2000 35.0% 35.0% 35.0% 3.7 – – 0.9 4.8 11.1 2.4 0.1 5.5 – 2.5 2.0 39.6% 53.4% 45.0% 48 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below: (in thousands) Year ended December 31, Deferred tax assets: Allowances for losses on accounts and notes receivable Accrued liabilities not currently deductible Employee benefit plans Restructuring expenses Property and equipment Other Total deferred tax assets Deferred tax liabilities: Merchandise inventories Goodwill Computer software Other Total deferred tax liabilities Net deferred tax liability 2002 2001 $ 1,844 $ 2,118 6,518 10,952 356 1,113 1,543 3,919 6,051 708 970 1,152 22,326 14,918 28,540 4,322 3,741 2,142 38,745 34,218 2,839 3,653 1,726 42,436 $(16,419) $(27,518) Cash payments for income taxes for 2002, 2001, and 2000 were $34.4 million, $23.5 million, and $23.8 million. In August 2000, the company received notice from the Internal Revenue Service (IRS) that it has disallowed certain prior year deductions for interest on loans associated with the company’s corporate-owned life insurance (COLI) program for the years 1995 to 1998. Management believes that the company has complied with the tax law as it relates to its COLI program, and has filed an appeal with the Internal Revenue Service. However, several cases involving other corporations’ COLI programs have been decided in favor of the IRS, and consequently, the climate has become less favorable to taxpayers with respect to these programs. As a result, an income tax provision for the estimated liability of $7.2 million for taxes and interest was recorded in 2001 as management had concluded that it is probable that the company will not achieve a favorable resolution of this matter. Management is continuing negotiations with the IRS to settle liabilities related to its COLI program. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 49 Note 15—Income Per Common Share Before Extraordinary Item The following sets forth the computation of income per basic and diluted common share before extraordinary item: (in thousands, except per share data) Year ended December 31, Numerator: Numerator for income per basic common share before extraordinary item—income before extraordinary item Distributions on convertible mandatorily redeemable preferred securities, net of taxes Numerator for income per diluted common share before extraordinary item—income before 2002 2001 2000 $47,217 4,220 $30,103 $33,088 4,257 3,902 extraordinary item after assumed conversions $51,437 $34,360 $36,990 Denominator: Denominator for income per basic common share before extraordinary item—weighted average shares Effect of dilutive securities: Conversion of mandatorily redeemable preferred securities Stock options and restricted stock Denominator for income per diluted common share before extraordinary item—adjusted weighted average shares and assumed conversions Income per basic common share before extraordinary item Income per diluted common share before extraordinary item 33,799 33,368 32,712 6,383 516 6,400 619 6,400 341 40,698 40,387 39,453 $ $ 1.40 1.26 $ $ 0.90 0.85 $ $ 1.01 0.94 During the years ended December 31, 2002, 2001 and 2000, outstanding options to purchase approximately 65 thousand, 27 thousand and 1.6 million common shares were excluded from the calculation of income per diluted common share before extra- ordinary items because their exercise price exceeded the average market price of the common stock for the year. Subsequent to December 31, 2002, the company repurchased common stock and mandatorily redeemable preferred securities under a previously announced repurchase plan. See Note 20. 50 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Note 16—Accumulated Other Comprehensive Loss Components of accumulated other comprehensive loss consist of the following: (in thousands) Balance December 31, 2000 2001 change, gross Income tax benefit (expense) Balance December 31, 2001 2002 change, gross Income tax benefit Balance December 31, 2002 Note 17—Shareholders’ Equity Unrealized Gain/(Loss) on Investment $ (628) 1,523 (609) 286 (370) 148 Minimum Pension Liability Adjustment $ – (3,081) 1,233 (1,848) (7,641) 2,948 Accumulated Other Comprehensive Loss $ (628) (1,558) 624 (1,562) (8,011) 3,096 $ 64 $(6,541) $(6,477) The company has a shareholder rights agreement under which 8/27ths of a Right is attendant to each outstanding share of common stock of the company. Each full Right entitles the registered holder to purchase from the company one one-hundredth of a share of Series A Participating Cumulative Preferred Stock (the Series A Preferred Stock), at an exercise price of $75 (the Purchase Price). The Rights will become exercisable, if not earlier redeemed, only if a person or group acquires 20% or more of the outstanding shares of the company’s common stock or announces a tender offer, the consummation of which would result in ownership by a person or group of 20% or more of such outstanding shares. Each holder of a Right, upon the occurrence of certain events, will become entitled to receive, upon exercise and payment of the Purchase Price, Series A Preferred Stock (or in certain circumstances, cash, property or other securities of the company or a potential acquirer) having a value equal to twice the amount of the Purchase Price. The Rights will expire on April 30, 2004, if not earlier redeemed. Note 18—Commitments and Contingencies The company has a commitment through July 31, 2009 to outsource its information technology operations, including the manage- ment and operation of its mainframe computer and distributed services processing, as well as application support, development and enhancement services. The commitment is cancelable for convenience after August 1, 2005 with 180 days notice and payment of a termination fee. The termination fee is based upon certain costs which would be incurred by the vendor as a direct result of the early termination of the agreement. The maximum termination fee payable is $9.1 million after the third contract year, which ends July 31, 2005. The termination fee declines each year to $2.3 million at the end of the sixth contract year, which ends July 31, 2008. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 51 Assuming no early termination of the contract, the fixed and determinable portion of the obligations under this agreement is $29.7 million per year from 2003 through 2007, and $47.0 million for the period thereafter, totaling $195.4 million. These obligations can vary annually up to a certain level for changes in the Consumer Price Index or for a significant increase in the company’s medical/ surgical distribution business. Additionally, the service fees under this contract can vary to the extent additional services are provided by the vendor which are not covered by the negotiated base fees, or as a result of reduction in services provided by the vendor that were included in these base fees. In 2002, the company gave notice of cancellation to its previous vendor for mainframe computer services. The company is obli- gated under this previous contract to pay for termination fees and mainframe computer services through February 2003. As of December 31, 2002, the company is obligated to pay $2.9 million in 2003 for termination fees. The termination fees were included in selling, general and administrative expense in 2002. At December 31, 2002, the company is also obligated to pay $1.3 million to this vendor for mainframe computer services in 2003. The company has a non-cancelable agreement through September 2004 to receive support and upgrades for certain computer software. Future minimum annual payments under this agreement for 2003 and 2004 are $0.5 million and $0.4 million. The company has entered into non-cancelable agreements to lease most of its office and warehouse facilities with remaining terms generally ranging from one to five years. Certain leases include renewal options, generally for five-year increments. The com- pany also leases most of its trucks and material handling equipment for terms generally ranging from four to six years. At December 31, 2002, future minimum annual payments under non-cancelable operating lease agreements with original terms in excess of one year are as follows: (in thousands) 2003 2004 2005 2006 2007 Later years Total minimum payments Total $24,021 18,928 13,909 8,535 4,266 2,554 $72,213 Rent expense for all operating leases for the years ended December 31, 2002, 2001, and 2000 was $32.9 million, $31.1 million, and $28.1 million. The company has limited concentrations of credit risk with respect to financial instruments. Temporary cash investments are placed with high credit quality institutions and concentrations within accounts and notes receivable are limited due to their geo- graphic dispersion. 52 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Net sales to member hospitals under contract with Novation totaled $2.0 billion in 2002, $1.9 billion in 2001 and $1.8 billion in 2000, approximately 50%, 51% and 51% of the company’s net sales. As members of a group purchasing organization, Novation members have an incentive to purchase from their primary selected distributor; however, they operate independently and are free to negotiate directly with distributors and manufacturers. Net sales to member hospitals under contract with Broadlane totaled $0.5 bil- lion in 2002 and $0.4 billion in 2001, approximately 14% and 11% of the company’s net sales. Note 19—Legal Proceedings As of December 31, 2002, approximately 191 lawsuits (the Lawsuits), seeking compensatory and punitive damages, in most cases of an unspecified amount, have been filed in various federal and state courts against the company, product manufacturers, and other distributors and sellers of natural rubber latex products. The company has obtained dismissal or summary judgment in 109 cases, including 38 dismissals in 2002. The existing Lawsuits allege injuries arising from the use of latex products, principally medical gloves. The company may be named as a defendant in additional, similar lawsuits in the future although only two new Lawsuits of this type were served on the company in the past twelve months. In the course of its medical supply business, the company has distributed latex products, including medical gloves, but it does not, nor has it ever manufactured any latex products. The company has tendered the defense of the Lawsuits to manufacturer defendants whose gloves were distributed by the company. Manufacturers or their insurers have agreed to indemnify and assume the defense of the company in a total of eleven (11) Lawsuits. The company will continue to vigorously pursue indemnification from latex product manufacturers. The company’s insurers are paying all costs of defense in the Lawsuits, and the company believes that future defense costs and any potential liability should be adequately covered by the insurance, subject to policy limits and insurer solvency. Most of the Lawsuits that were scheduled for trial have been dismissed on summary judg- ment. The company believes that the likelihood of a material loss to the company with respect to the Lawsuits is remote. The company is party to various other legal actions that are ordinary and incidental to its business. While the outcome of legal actions cannot be predicted with certainty, management believes the outcome of these proceedings will not have a material adverse effect on the company’s financial condition or results of operations. Note 20—Subsequent Event In November 2002, the company announced a repurchase plan for a combination of its common stock and its $2.6875 Term Con- vertible Securities, Series A (Securities). Between January 1 and February 24, 2003, the company repurchased 661,500 shares of common stock and 250,000 shares of Securities under this plan. Each share of the Securities is convertible to 2.4242 shares of common stock. Note 21—Condensed Consolidating Financial Information The following tables present condensed consolidating financial information for: Owens & Minor, Inc.; on a combined basis, the guar- antors of Owens & Minor, Inc.’s 2011 Notes; and the non-guarantor subsidiaries of the 2011 Notes. Separate financial statements of the guarantor subsidiaries are not presented because the guarantors are jointly, severally and unconditionally liable under the guaran- tees and the company believes the condensed consolidating financial information is more meaningful in understanding the financial position, results of operations and cash flows of the guarantor subsidiaries. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 53 Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2002 Statements of Operations Net sales Cost of goods sold Gross margin Selling, general and administrative expenses Depreciation and amortization Interest expense (income), net Intercompany dividend income Discount on accounts receivable securitization Distributions on mandatorily redeemable preferred securities Restructuring credit Total expenses Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ – – – 3 – (14,651) (44,999) – – – $3,959,781 $ 3,539,911 419,870 303,916 15,926 37,627 – 13 – (487) $ – – – 3,096 – (12,573) – 1,769 7,034 – – – – – – – 44,999 – – – $3,959,781 3,539,911 419,870 307,015 15,926 10,403 – 1,782 7,034 (487) (59,647) 356,995 (674) 44,999 341,673 Income before income taxes and extraordinary item Income tax provision Income before extraordinary item Extraordinary item, net of tax 59,647 5,730 53,917 50 62,875 24,595 38,280 – Net income $ 53,967 $ 38,280 $ 674 655 19 – 19 (44,999) – (44,999) – 78,197 30,980 47,217 50 $(44,999) $ 47,267 54 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2001 Statements of Operations Net sales Cost of goods sold Gross margin Selling, general and administrative expenses Depreciation and amortization Amortization of goodwill Interest expense (income), net Intercompany dividend income Discount on accounts receivable securitization Impairment loss on investment Distributions on mandatorily redeemable preferred securities Restructuring credit Total expenses Income before income taxes and extraordinary item Income tax provision (benefit) Income before extraordinary item Extraordinary item, net of tax benefit Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $3,814,994 $ 3,406,758 $ – – – – – – 1,849 (127,857) – 1,071 – – 408,236 296,072 16,495 5,974 29,998 – 13 – – (1,476) $ – – – 735 – – (18,484) – 4,317 – 7,095 – – – – – – – – 127,857 – – – – $3,814,994 3,406,758 408,236 296,807 16,495 5,974 13,363 – 4,330 1,071 7,095 (1,476) (124,937) 347,076 (6,337) 127,857 343,659 124,937 (1,005) 125,942 (7,068) 61,160 32,677 28,483 – 6,337 2,802 3,535 – (127,857) – (127,857) – 64,577 34,474 30,103 (7,068) Net income $ 118,874 $ 28,483 $ 3,535 $(127,857) $ 23,035 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 55 Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2000 Statements of Operations Net sales Cost of goods sold Gross margin Selling, general and administrative expenses Depreciation and amortization Amortization of goodwill Interest expense (income), net Discount on accounts receivable securitization Distributions on mandatorily redeemable preferred securities Restructuring credit Total expenses Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ – – – 137 – – 9,965 – – – $3,503,583 3,127,911 $ 375,672 266,684 15,527 5,988 25,217 15 – (750) – – – 1,384 – – (22,616) 6,866 7,095 – 10,102 312,681 (7,271) $ – – – – – – – – – – – – – $3,503,583 3,127,911 375,672 268,205 15,527 5,988 12,566 6,881 7,095 (750) 315,512 60,160 27,072 Income (loss) before income taxes Income tax provision (benefit) (10,102) (4,445) 62,991 27,841 7,271 3,676 Net income (loss) $ (5,657) $ 35,150 $ 3,595 $ – $ 33,088 56 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Condensed Consolidating Financial Information (in thousands) December 31, 2002 Balance Sheets Assets Current assets Cash and cash equivalents Accounts and notes receivable, net Merchandise inventories Intercompany advances, net Other current assets Total current assets Property and equipment, net Goodwill, net Intercompany investments Deferred income taxes Other assets, net Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable Accrued payroll and related liabilities Deferred income taxes Other accrued liabilities Total current liabilities Long-term debt Intercompany long-term debt Other liabilities Total liabilities Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ 1,244 $ 2,116 $ 1 $ 351,264 – (316,057) – 35,208 – – – – 196,804 21 198,069 – – 387,498 – 20,835 3,592 351,835 119,253 19,680 496,476 21,808 198,139 22,773 3,950 34,992 129,233 (539,504) – – – – – – – – – – – – $ 3,361 354,856 351,835 – 19,701 729,753 21,808 198,139 – 3,950 55,827 $606,402 $778,138 $ 164,441 $(539,504) $1,009,477 $ – – – 5,880 5,880 240,185 129,233 – $259,597 $ 12,985 20,369 44,717 337,668 – 188,890 27,975 – – – 1,182 1,182 – – – $ – – – – – – (318,123) $ 259,597 12,985 20,369 51,779 344,730 240,185 – – 27,975 375,298 554,533 1,182 (318,123) 612,890 Company-obligated mandatorily redeemable preferred securities of subsidiary trust, holding solely convertible debentures of Owens & Minor, Inc. Shareholders’ equity Common stock Paid-in capital Retained earnings Accumulated other comprehensive income (loss) – 68,226 30,134 132,680 64 – – 199,797 30,349 (6,541) 125,150 – 125,150 5,583 16,001 16,525 – (5,583) (215,798) – – 68,226 30,134 179,554 (6,477) Total shareholders’ equity 231,104 223,605 38,109 (221,381) 271,437 Total liabilities and shareholders’ equity $606,402 $778,138 $ 164,441 $(539,504) $1,009,477 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 57 Condensed Consolidating Financial Information (in thousands) December 31, 2001 Balance Sheets Assets Current assets Cash and cash equivalents Accounts and notes receivable, net Merchandise inventories Intercompany advances, net Other current assets Total current assets Property and equipment, net Goodwill, net Intercompany investments Other assets, net Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable Accrued payroll and related liabilities Deferred income taxes Other accrued liabilities Total current liabilities Long-term debt Intercompany long-term debt Deferred income taxes Other liabilities Total liabilities Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ 507 $ 445 $ 1 $ – – 173,802 17 174,326 – – 342,497 13,708 – 264,235 389,504 58,161 24,743 472,853 25,257 198,324 15,001 36,110 – (231,963) – 32,273 – – 136,083 1,002 – – – – – – – – (493,581) $ 953 264,235 389,504 – 24,760 679,452 25,257 198,324 – – 50,820 $530,531 $747,545 $ 169,358 $(493,581) $953,853 $ – – (4) 7,242 7,238 203,449 136,083 (755) – $286,656 $ 12,669 29,178 32,622 361,125 – 143,890 1,147 14,123 $ – – (2,020) 1,331 (689) – – (28) – – – – – – – (279,973) – – $286,656 12,669 27,154 41,195 367,674 203,449 – 364 14,123 346,015 520,285 (717) (279,973) 585,610 Company-obligated mandatorily redeemable preferred securities of subsidiary trust, holding solely convertible debentures of Owens & Minor, Inc. – – 132,000 – 132,000 Shareholders’ equity Common stock Paid-in capital Retained earnings Accumulated other comprehensive income (loss) 67,770 27,181 89,279 286 40,879 151,145 37,084 (1,848) 5,583 16,001 16,491 – (46,462) (167,146) – – 67,770 27,181 142,854 (1,562) Total shareholders’ equity 184,516 227,260 38,075 (213,608) 236,243 Total liabilities and shareholders’ equity $530,531 $747,545 $ 169,358 $(493,581) $953,853 58 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2002 Statements of Cash Flows Operating Activities Income before extraordinary item Adjustments to reconcile income before extraordinary item to cash provided by (used for) operating activities: Depreciation and amortization Restructuring credit Deferred income taxes Provision for LIFO reserve Provision for losses on accounts and notes receivable Changes in operating assets and liabilities: Net decrease in receivables sold Accounts and notes receivable, excluding sales of receivables Merchandise inventories Accounts payable Net change in other current assets and current liabilities Other liabilities Other, net Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ 53,917 $ 38,280 $ 19 $(44,999) $ 47,217 – – 759 – – – 15,926 (487) (10,809) 4,131 600 – – 2,048 – 2,073 – (70,000) – – – (1,399) – 2,045 (4,192) 33,538 (40,059) 16,201 6,534 (154) (19,102) – – (134) – 1,002 – – – – – – – – – – – – 15,926 (487) (8,002) 4,131 2,673 (70,000) (23,294) 33,538 (40,059) 14,668 6,534 2,893 Cash provided by (used for) operating activities 55,322 59,509 (84,094) (44,999) (14,262) Investing Activities Additions to property and equipment Additions to computer software Investment in intercompany debt Increase in intercompany investments, net Other, net – – (45,000) (1) – (4,815) (4,942) – – 9 Cash used for investing activities (45,001) (9,748) Financing Activities Payments to repurchase mandatorily redeemable preferred securities Net proceeds from revolving credit facility Net proceeds from issuance of intercompany debt Change in intercompany advances Increase in intercompany investments, net Cash dividends paid Intercompany dividends paid Proceeds from exercise of stock options Increase in drafts payable Other, net (6,594) 27,900 – (23,002) – (10,567) – 1,992 – 687 – – 45,000 (61,092) 1 – (44,999) – 13,000 – Cash provided by (used for) financing activities (9,584) (48,090) Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year 737 507 1,671 445 Cash and cash equivalents at end of period $ 1,244 $ 2,116 $ – – – – – – – – – 84,094 – – – – – – 84,094 – 1 1 – – 45,000 1 – 45,001 – – (45,000) – (1) – 44,999 – – – (4,815) (4,942) – – 9 (9,748) (6,594) 27,900 – – – (10,567) – 1,992 13,000 687 (2) 26,418 – – – 2,408 953 $ 3,361 $ O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 59 Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2001 Statements of Cash Flows Operating Activities Income before extraordinary item Adjustments to reconcile income before extraordinary item to cash provided by (used for) operating activities: Depreciation and amortization Restructuring credit Impairment loss on investment Deferred income taxes Provision for LIFO reserve Provision for losses on accounts and notes receivable Changes in operating assets and liabilities: Net decrease in receivables sold Accounts and notes receivable, excluding sales of receivables Merchandise inventories Accounts payable Net change in other current assets and current liabilities Other liabilities Other, net Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ 125,942 $ 28,483 $ 3,535 $(127,857) $ 30,103 – – 1,071 256 – – 22,469 (1,476) – 10,816 4,264 2,865 – – – 196 – (518) – – (10,000) – – – 10,236 – 3,100 21,359 (78,198) 10,049 (10,112) 1,053 195 (16,036) – – (76) – 25 – – – – – – – – – – – – – 22,469 (1,476) 1,071 11,268 4,264 2,347 (10,000) 5,323 (78,198) 10,049 48 1,053 3,320 Cash provided by (used for) operating activities 140,605 11,767 (22,874) (127,857) 1,641 Investing Activities Additions to property and equipment Additions to computer software Investment in intercompany debt Decrease in intercompany investment Other, net Cash used for investing activities Financing Activities Net proceeds from issuance of long-term debt Payments to retire long-term debt Net payments on revolving credit facility Net proceeds from issuance of intercompany debt Change in intercompany advances Increase (decrease) in intercompany investments, net Cash dividends paid Intercompany dividends paid Proceeds from exercise of stock options Decrease in drafts payable Other, net – – (143,890) 15,030 – (10,147) (6,686) – – 139 (128,860) (16,694) 194,331 (158,594) (2,200) – (44,355) – (9,182) – 8,255 – – – – – 143,890 21,484 (16,030) – (127,857) – (14,900) (1,333) Cash provided by (used for) financing activities (11,745) 5,254 – – – – (997) (997) – – – – 22,871 1,000 – – – – – 23,871 – – 143,890 (15,030) – (10,147) (6,686) – – (858) 128,860 (17,691) – – – (143,890) – 15,030 – 127,857 – – – 194,331 (158,594) (2,200) – – – (9,182) – 8,255 (14,900) (1,333) (1,003) 16,377 Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of period $ – 507 507 $ 327 118 445 $ – 1 1 $ – – – $ 327 626 953 60 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Owens & Minor, Inc. Guarantor Subsidiaries Non-guarantor Subsidiaries Eliminations Consolidated $ (5,657) $ 35,150 $ 3,595 $ – $ 33,088 Condensed Consolidating Financial Information (in thousands) Year ended December 31, 2000 Statements of Cash Flows Operating Activities Net income (loss) Adjustments to reconcile net income (loss) to cash provided by (used for) operating activities: Depreciation and amortization Restructuring credit Deferred income taxes Provision for LIFO reserve Provision for losses on accounts and notes receivable Changes in operating assets and liabilities: Net decrease in receivables sold Accounts and notes receivable, excluding sales of receivables Merchandise inventories Accounts payable Net change in other current assets and current liabilities Other liabilities Other, net – – (619) – – – – – – 346 – 3,191 21,515 (750) (205) 2,973 2,090 – – (469) – (170) – (25,612) 85,774 23,935 (14,783) 8,876 708 (564) (97,060) – – (296) – 1,187 Cash provided by (used for) operating activities (2,739) 164,719 (118,825) Investing Activities Additions to property and equipment Additions to computer software Other, net Cash used for investing activities Financing Activities Net payments on revolving credit facility Change in intercompany advances Cash dividends paid Proceeds from exercise of stock options Increase in drafts payable Other financing, net – – (155) (155) (20,400) 27,868 (8,156) 4,837 – (1,255) (8,002) (11,622) 3 (19,621) – (3) – – (3) – (146,693) 118,825 – – 2,800 (1,245) – – – – Cash provided by (used for) financing activities 2,894 (145,138) 118,825 Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of period $ – 507 507 $ (40) 158 118 (3) 4 1 $ – – – – – – – – – – – – – – – – – – – – – – – – – – $ – $ 21,515 (750) (1,293) 2,973 1,920 (25,612) (11,286) 23,935 (14,783) 8,926 708 3,814 43,155 (8,005) (11,622) (152) (19,779) (20,400) – (8,156) 4,837 2,800 (2,500) (23,419) (43) 669 626 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 61 Independent Auditors’ Report The Board of Directors and Shareholders Owens & Minor, Inc.: We have audited the accompanying consolidated balance sheets of Owens & Minor, Inc. and subsidiaries (the company) as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those stand- ards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Owens & Minor, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, the company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Richmond, Virginia January 29, 2003, except as to Note 20, which is as of February 24, 2003 Report of Management The management of Owens & Minor, Inc. is responsible for the preparation, integrity and objectivity of the consolidated financial statements and related information presented in this annual report. The consolidated financial statements were prepared in conformity with generally accepted accounting principles and include, when necessary, the best estimates and judgments of management. The company maintains a system of internal controls that provides reasonable assurance that its assets are safeguarded against loss or unauthorized use, that transactions are properly recorded and that financial records provide a reliable basis for the preparation of the consolidated financial statements. The Audit Committee of the Board of Directors, composed entirely of directors who are not current employees of Owens & Minor, Inc., meets periodically and privately with the company’s independent auditors and internal auditors, as well as with company manage- ment, to review accounting, auditing, internal control and financial reporting matters. The independent auditors and internal auditors have direct access to the Audit Committee with and without management present to discuss the results of their activities. G. Gilmer Minor, III Chairman & Chief Executive Officer Jeffrey Kaczka Senior Vice President & Chief Financial Officer 62 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Quarterly Financial Information (in thousands, except per share data) Quarters Net sales Gross margin Income before extraordinary item Net income Per common share: Income before extraordinary item Basic Diluted Net income Basic Diluted Dividends Market price High Low Quarters Net sales Gross margin Income before extraordinary item Net income (loss) Per common share: Income before extraordinary item Basic Diluted Net income (loss) Basic Diluted Dividends Market price High Low 2002 1st 2nd(1) 3rd(2) 4th(3) $966,683 $979,557 $992,453 $1,021,088 103,031 103,417 105,127 108,295 10,820 11,479 10,737 10,820 11,479 10,737 14,181 14,231 $ $ 0.32 0.29 0.32 0.29 0.07 $ $ 0.34 0.31 0.34 0.31 0.08 $ $ 0.32 0.29 0.32 0.29 0.08 $ $ $ 20.30 $ 20.90 $ 19.74 $ 17.90 18.05 13.27 0.42 0.37 0.42 0.38 0.08 17.35 13.00 2001 1st 2nd(4) 3rd(5) 4th $ 924,508 $ 953,531 $ 968,230 $ 968,725 98,883 100,721 103,068 105,564 7,711 7,711 0.23 0.22 0.23 0.22 0.0625 17.75 13.92 $ $ $ 9,423 9,423 0.28 0.26 0.28 0.26 0.07 21.00 15.97 $ $ $ 1,697 (5,371) 11,272 11,272 $ $ $ 0.05 0.05 (0.16) (0.16) 0.07 21.69 16.24 $ $ $ 0.34 0.30 0.34 0.30 0.07 20.90 17.01 (1) (2) (3) (4) (5) In the second quarter of 2002, the company reduced the restructuring accrual by $0.2 million, or $0.1 million net of tax. See Note 3 to the Consolidated Financial Statements. In the third quarter of 2002, the company recorded a charge of $3.0 million, or $1.8 million net of tax, due to the cancellation of the company’s contract for mainframe computer services. In the fourth quarter of 2002, the company reduced the restructuring accrual by $0.3 million, or $0.2 million net of tax, and recorded an extraordinary gain on the repurchase of mandatorily redeemable preferred securities of $50 thousand, net of tax. See Notes 3 and 11 to the Consolidated Financial Statements. In the second quarter of 2001, the company reduced the restructuring accrual by $1.5 million, or $0.8 million net of tax. See Note 3 to the Consolidated Financial Statements. In the third quarter of 2001, the company recorded an impairment loss of $1.1 million on an investment in marketable equity securities, a contingency provision for income tax assessments of $7.2 million, and an extraordinary loss on early retirement of debt of $7.1 million, net of tax benefit. See Notes 6, 8 and 14 to the Consolidated Financial Statements. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 63 Form 10-K Annual Report UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the year ended December 31, 2002 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number 1-9810 OWENS & MINOR, INC. (Exact name of registrant as specified in its charter) Virginia (State or other jurisdiction of incorporation or organization) 4800 Cox Road, Glen Allen, Virginia (Address of principal executive offices) 54-1701843 (I.R.S. Employer Identification No.) 23060 (Zip Code) Registrant’s telephone number, including area code (804) 747-9794 Securities registered pursuant to Section 12(b) of the Act: Indicate by check mark if disclosure of delinquent filers Name of each exchange on which registered pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, Title of each class Common Stock, $2 par value Preferred Stock Purchase Rights 8 1⁄ 2% Senior Subordinated Notes due 2011 New York Stock Exchange New York Stock Exchange Not Listed $2.6875 Term Convertible Not Listed Securities, Series A in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of Common Stock held by non-affiliates (based upon the closing sales price) was approx- imately $556,240,754 as of February 19, 2003. The number of shares of the Company’s Common Stock outstanding as of February 19, 2003 was 33,691,142 shares. Securities registered pursuant to Section 12(g) of the Act: Documents Incorporated by Reference None 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 The proxy statement for the annual meeting of security hold- ers on April 24, 2003 is incorporated by reference for Part III. 64 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Item Captions and Index – Form 10-K Annual Report Item No. Page Part I 1. 2. 3. 4. Part II 5. 6. 7. 7A. 8. 9. Part III 10. 11. 12. 13. 14. Part IV 15. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal Proceedings . . . . . . . . . . . . . . . . . . . . Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . Market for Registrant’s Common Equity . . . . . . . and Related Stockholder Matters Selected Financial Data . . . . . . . . . . . . . . . . Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . Quantitative and Qualitative Disclosures about Market Risk . . . . . . . . . . . . . . . . . . . . Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . 18-23 23 53 N/A 63, 68 17 24-31 31, 43 See Item 15 N/A Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . .(a), 14, 15 Executive Compensation . . . . . . . . . . . . . . . (a) Security Ownership of Certain Beneficial Owners and Management . . . . . Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . Controls and Procedures . . . . . . . . . . . . . . . (a) 65 (a) Exhibits, Financial Statement Schedules, and Reports on Form 8-K a. Consolidated Statements of Income for the Years Ended Dec. 31, 2002, Dec. 31, 2001 and Dec. 31, 2000 . . . . . . . . . Consolidated Balance Sheets at Dec. 31, 2002 and Dec. 31, 2001 . . . . . . . . . Consolidated Statements of Cash Flows for the Years Ended Dec. 31, 2002, Dec. 31, 2001 and Dec. 31, 2000 . . . . . . . . . . . . . . . . Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended Dec. 31, 2002, Dec. 31, 2001 and Dec. 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements for the Years Ended Dec. 31, 2002, Dec. 31, 2001 and Dec. 31, 2000 . . . . Report of Independent Auditors . . . . . . . . b. Reports on Form 8-K: The company filed a Curent Report on Form 8-K dated November 20, 2002, under Items 7 and 9, announcing new strategic initiatives and a plan to repurchase common stock and Trust Preferred Securities. 32 33 34 35 36-61 62 c. The index to exhibits has been filed as separate pages of 2002 Form 10-K and is available to shareholders on request from the Secretary of the company at the principal executive offices. (a) Part III will be incorporated by reference from the registrant’s 2003 Proxy Statement pursuant to instructions (1) and G(3) of the General Instructions to Form 10-K. Controls and Procedures Within the 90 days prior to the filing date of this report, under the supervision and with the participation of the company’s management (including its Chief Executive Officer and Chief Financial Officer), the company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. 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. Since the date of the evaluation, there have been no significant changes in the company’s internal controls or factors that could significantly affect them. Pursuant to the requirements of Section 13 or 15(d) 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, on the 11th day of March, 2003. OWENS & MINOR, INC. /s/ G. Gilmer Minor, III G. Gilmer Minor, III Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant on the 11th day of March 2003 and in the capacities indicated. /s/ G. Gilmer Minor, III G. Gilmer Minor, III /s/ Jeffrey Kaczka Jeffrey Kaczka Chairman and Chief Executive Officer and Director (Principal Executive Officer) Senior Vice President and Chief Financial Officer (Principal Financial Officer) /s/ Olwen B. Cape Olwen B. Cape Vice President and Controller (Principal Accounting Officer) /s/ A. Marshall Acuff, Jr. A. Marshall Acuff, Jr. /s/ Henry A. Berling Henry A. Berling /s/ Josiah Bunting, III Josiah Bunting, III /s/ John T. Crotty John T. Crotty /s/ James B. Farinholt, Jr. James B. Farinholt, Jr. /s/ Vernard W. Henley Vernard W. Henley /s/ Peter S. Redding Peter S. Redding /s/ James E. Rogers James E. Rogers /s/ James E. Ukrop James E. Ukrop /s/ Anne Marie Whittemore Anne Marie Whittemore Director Director Director Director Director Director Director Director Director Director O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 65 I, G. Gilmer Minor III, certify that: 1. I have reviewed this annual report on Form 10-K of Owens & Minor, Inc; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) b) c) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): a) b) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and 6. The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 11, 2003 G. Gilmer Minor III Chief Executive Officer 66 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T I, Jeffrey Kaczka, certify that: 1. I have reviewed this annual report on Form 10-K of Owens & Minor, Inc; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) b) c) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): a) b) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and 6. The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 11, 2003 Jeffrey Kaczka Chief Financial Officer O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T 67 Corporate Information Annual Meeting address, they may receive multiple copies of annual reports. To The annual meeting of Owens & Minor, Inc.’s shareholders eliminate multiple mailings, please write to the transfer agent. will be held on Thursday, April 24, 2003, at The Virginia Historical Society, 428 North Boulevard, Richmond, Virginia. Transfer Agent, Registrar and Dividend Disbursing Agent The Bank of New York Shareholder Relations Department P.O. Box 11258 Church Street Station New York, NY 10286 800-524-4458 shareowner-svcs@bankofny.com Dividend Reinvestment and Stock Purchase Plan The Dividend Reinvestment and Stock Purchase Plan offers holders of Owens & Minor, Inc. common stock an oppor- tunity to buy additional shares automatically with cash dividends and to buy additional shares with voluntary cash payouts. Under the plan, the company pays all brokerage commissions and service charges for the acquisition of shares. Information regarding the plan may be obtained by writing the transfer agent at the following address: The Bank of New York Dividend Reinvestment Department P.O. Box 1958 Newark, NJ 07101-9774 Shareholder Records Direct correspondence concerning Owens & Minor, Inc. stock holdings or change of address to The Bank of New York’s Shareholder Services Department (listed above). Direct correspondence concerning lost or missing dividend checks to: Receive and Deliver Department P.O. Box 11002 Church Street Station New York, NY 10286 Duplicate Mailings Counsel Hunton & Williams Richmond, Virginia Independent Auditors KPMG LLP Richmond, Virginia Market for the Registrant’s Common Equity and Related Stockholder Matters Owens & Minor, Inc.’s common stock trades on the New York Stock Exchange under the symbol OMI. As of December 31, 2002, there were approximately 13,100 common shareholders. Press Releases Owens & Minor, Inc.’s press releases are available at www.prnewswire.com or at www.owens-minor.com. Communications and Investor Relations 804-747-9794 Information for Investors The company files annual, quarterly and current reports, information statements and other information with the SEC. The public may read and copy any materials that the company files with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov. The address of the company’s Internet website is www.owens-minor.com. Through a link to the SEC’s Internet site on the Investor Relations portion of our Internet website we make available all of our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as well as beneficial ownership reports filed with the SEC by directors, officers and other reporting persons relating to holdings in Owens & Minor, Inc. When a shareholder owns shares in more than one account securities. This information is available as soon as the filing is or when several shareholders live at the same accepted by the SEC. 68 O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T Statement Mission Statement Mission To create consistent value for our customers and supply chain partners that will maximize shareholder value and long-term earnings growth; we will do this by managing our business with integrity and the highest ethical standards, while acting in a socially responsible manner with particular emphasis on the well-being of our teammates and the communities we serve. Vision To be a world class provider of supply chain management solutions to the selected segments of the healthcare industry we serve. Values We believe in high integrity as the guiding principle of doing business. We believe in our teammates and their well-being. We believe in providing superior customer service. We believe in supporting the communities we serve. We believe in delivering long-term value to our shareholders. OWENS & MINOR, INC., A FORTUNE 500 COMPANY, IS THE NATION’S LEADING DISTRIBUTOR OF NATIONAL NAME-BRAND MEDICAL AND SURGICAL PRODUCTS. THE COMPANY, WHICH SERVES HEALTHCARE PROVIDER CUSTOMERS FROM FACILITIES AROUND THE NATION, IS KNOWN FOR ITS ABSOLUTE FOCUS ON CUSTOMER SERVICE. FOUNDED IN 1882, THE COMPANY WAS BUILT ON A FOUNDATION OF TRUST, INTEGRITY, ETHICS, CHARACTER AND VALUE. THESE CORE VALUES ARE THE BUILDING BLOCKS FOR OWENS & MINOR’S FUTURE. O W E N S & M I N O R 2 0 0 2 A N N U A L R E P O R T & F O R M 1 0 - K O W E N S & M I N O R , I N C . C O R P O R A T E O F F I C E Street Address 4800 Cox Road Glen Allen, Virginia 23060 Mailing Address Post Office Box 27626 Richmond, Virginia 23261-7626 804-747-9794