ACCENDRA HEALTH INC/VA/ 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis describes results of operations and material changes in the financial condition of Owens & Minor, Inc. and its subsidiaries since December 31, 2020. Trends of a material nature are discussed to the extent known and considered relevant. This discussion should be read in conjunction with the consolidated financial statements, related notes thereto, and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2020. Overview Owens & Minor, Inc., along with its subsidiaries, (we, us, or our) is a leading global healthcare solutions company. On June 18, 2020 (the Divestiture Date), we completed the divestiture of our European logistics business, Movianto (the Divestiture), as well as certain support functions in our Dublin, Ireland office, to Walden Group SAS (the Buyer) and EHDH (as Buyer’s guarantor) for cash consideration of $133 million. The Divestiture provides us with a greater ability to focus on and invest in our di fferentiated products, services and U.S. distribution businesses. As a result of the Divestiture, the results of operations from our Movianto business are reported as “Loss from discontinued operations, net of tax” for the three months ended March 31, 2020. See Note 3, “Discontinued Operations,” of the Notes to Consolidated Financial Statements for further information. Unless otherwise indicated, the following information relates to continuing operations. Income (loss) from continuing operations per diluted share was $0.98 for the three months ended March 31, 2021 as compared to $(0.15) for the three months ended March 31, 2020. Global Solutions segment operating income was $8.9 million for the three months ended March 31, 2021, compared to $7.7 million for the three months ended March 31, 2020. Global Products segment operating income was $164 million for the three months ended March 31, 2021, compared to $18.6 million 18 Table of Contents for the three months ended March 31, 2020. The increase was a result of higher revenues and favorable product mix combined with continued operating efficiencies compared to the prior year. COVID-19 Update We are closely monitoring the impact of the 2019 novel coronavirus (COVID-19) on all aspects of our business, including how it impacts our customers, teammates, suppliers, vendors and distribution channels. We have taken actions to protect our teammates while maintaining business continuity as we respond to the needs from this global pandemic. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our teammates, customers, suppliers and shareholders. Revenue for the three months ended March 31, 2021 of $2.3 billion includes an increase in demand for personal protective equipment (PPE), which was partially offset by a reduction in elective surgical procedures primarily due to the impact of COVID-19. Operating income also benefited from improved productivity and increased manufacturing output related to PPE, favorable product mix and operating efficiencies. We have expanded our PPE production operations and have taken measures to increase and improve our production such as retooling existing equipment, installing and optimizing new production lines and ramping up our new non-woven fabric machinery. We expect that we will continue servicing our customers' needs related to the heightened demand for our PPE as a result of various factors, including the implementation of new regulations and healthcare protocols calling for increased use of PPE, healthcare professional preference for medical grade PPE, stockpile PPE demand and the creation of new channels for PPE demand in healthcare, non-healthcare and international markets. In March 2020, under the Defense Production Act (DPA), we were awarded a contract with the U.S. Department of Health and Human Services to produce N-95 respirator masks in an effort to replenish the Strategic National Stockpile. In April 2020, also under the DPA, the U.S. Department of Defense initiated a technology investment agreement with us involving up to $30.0 million of anticipated funding of assets to expand capacity to supply N-95 respirator masks. Through March 31, 2021, approximately $27.8 million had been expended, substantially all of which had been reimbursed in accordance with this arrangement . We are unable to predict the timing of the pandemic and the full impact that COVID-19 will have on our future financial position and operating results due to numerous variables and continued uncertainties. Although we have experienced growth in sales volumes for certain of our products (such as PPE) during the COVID-19 pandemic, as well as improved productivity and manufacturing output, there can be no assurance that such growth rates, increased sales volumes or other improvements will be maintained during or following the COVID-19 pandemic. Results of Operations Net revenue. Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Global Solutions $ 1,849,509 $ 1,847,593 $ 1,916 0.1 % Global Products 658,750 391,192 267,558 68.4 % Inter-segment (181,725) (116,092) (65,633) (56.5) % Net revenue $ 2,326,534 $ 2,122,693 $ 203,841 9.6 % The change in net revenue for the three months ended March 31, 2021 reflected the impact of revenue growth in Global Products from increased demand for PPE, higher cost pass-through in gloves, along with strong performance in our Byram Patient Direct business. These were partially offset by a reduction in elective surgical procedures, primarily due to the impact of COVID-19, and one less selling day. Foreign currency translation had a favorable impact on net revenue of $9.3 million for the three months ended March 31, 2021 as compared to the prior year. Cost of goods sold. 19 Table of Contents Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Cost of goods sold $ 1,883,783 $ 1,854,134 $ 29,649 1.6 % Cost of goods sold includes the cost of the product (net of supplier incentives and cash discounts) and all costs incurred for shipments of products from manufacturers to our distribution centers for all customer arrangements where we are the primary obligor and bear risk of general and physical inventory loss. These are sometimes referred to as distribution contracts. Cost of goods sold also includes direct and certain indirect labor, material and overhead costs associated with our Global Products business. There is no cost of goods sold associated with our fee-for-service arrangements. Cost of goods sold compared to prior year reflects changes in sales activity, including sales mix. Gross margin. Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Gross margin $ 442,751 $ 268,559 $ 174,192 64.9 % As a % of net revenue 19.03 % 12.65 % Gross margin increase in the three months ended March 31, 2021 was driven by sales growth, market dynamics including timing of cost changes, an overall improved sales mix, operating efficiencies primarily in Global Products and a favorable impact from foreign currency translation of $6.2 million. Operating expenses. Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Distribution, selling and administrative expenses $ 292,701 $ 254,048 $ 38,653 15.2 % As a % of net revenue 12.58 % 11.97 % Acquisition-related and exit and realignment charges $ 5,963 $ 6,064 $ (101) (1.7) % Other operating income, net $ (2,605) $ (2,309) $ (296) 12.8 % Distribution, selling and administrative (DS&A) expenses include labor and warehousing costs associated with our distribution and outsourced logistics services and all costs associated with our fee-for-service arrangements. Shipping and handling costs are primarily included in DS&A expenses and include costs to store, move, and prepare products for shipment, as well as costs to deliver products to customers. Overall DS&A expenses were affected by revenue growth, higher accrued incentive compensation, teammate benefits and charitable contributions, partially offset by operational efficiencies. DS&A expenses also included an unfavorable impact for foreign currency translation of $1.0 million for the three months ended March 31, 2021. There were no acquisition-related charges for the three months ended March 31, 2021 compared to $4.2 million for the same period of 2020, which consisted primarily of transition costs for the Halyard acquisition. Exit and realignment charges were $6.0 million for the three months ended March 31, 2021 and consisted primarily of an increase in reserves associated with certain retained assets of Fusion5, IT restructuring charges and other costs related to the reorganization of the U.S. commercial, operations and executive teams. Exit and realignment charges were $1.8 million for the three months ended March 31, 2020 and consisted primarily of IT restructuring charges and other costs related to the reorganization of the U.S. commercial, operations and executive teams. The change in other operating income, net was attributed primarily to lower foreign currency transaction gains offset by lower losses from the adjustments to fair value on our foreign currency contracts compared to prior year. Interest expense, net . 20 Table of Contents Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Interest expense, net $ 13,672 $ 23,342 $ (9,670) (41.4) % Effective interest rate 5.45 % 7.17 % Interest expense, net and the effective interest rate fo r the three months ended March 31, 2021 decreased primarily due to a reduction of debt and lower interest rates. See Note 6 in Notes to Consolidated Financial Statements. Loss on extinguishment of debt. Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Loss on extinguishment of debt $ 40,433 $ 4,127 $ 36,306 879.7 % Loss on extinguishment of debt for the three months ended March 31, 2021 includes the write-off of deferred financing costs and third party fees associated with the debt financing in March 2021 of $15. 3 million and amounts reclassified from accumulated other comprehensive loss as a result of the termination of our interest rate swaps of $25.1 million. Loss on extinguishment of debt for the three months ended March 31, 2020 primarily includes the write-off of deferred financing costs and third party fees. Other expense, net . Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Other expense, net $ 569 $ 719 $ (150) (20.9) % Other expense, net for the three months ended March 31, 2021 and 2020 represents interest cost and net actuarial losses related to our retirement plans. Income taxes. Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Income tax provision (benefit) $ 22,429 $ (8,523) $ 30,952 363.2 % Effective tax rate 24.4 % 48.9 % The change in the effective tax rate for the three months ended March 31, 2021 compared to the same period in 2020 resulted primarily from an income tax benefit recorded in the first quarter of 2020 associated with the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the mixture of income and losses in jurisdictions in which we operate, and the incremental income tax benefit associated with the vesting of restricted stock recorded in the first quarter of 2021. 21 Table of Contents Financial Condition, Liquidity and Capital Resources Financial condition . We monitor operating working capital through days sales outstanding (DSO) and merchandise inventory days. We estimate a hypothetical increase (decrease) in DSO of one day would result in a decrease (increase) in our cash balances, an increase (decrease) in borrowings against our revolving credit facility or Receivables Securitization Program, or a combination thereof of approximately $25.9 million. The majority of our cash and cash equivalents are held in cash depository accounts with major banks in the United States, Europe, and Asia. Changes in our working capital can vary in the normal course of business based upon the timing of inventory purchases, collections of accounts receivable, and payments to suppliers. March 31, 2021 December 31, 2020 Change (Dollars in thousands) $ % Cash and cash equivalents $ 54,455 $ 83,058 $ (28,603) (34.4) % Accounts receivable, net of allowances $ 736,176 $ 700,792 $ 35,384 5.0 % Consolidated DSO (1) 27.7 26.0 Merchandise inventories $ 1,322,897 $ 1,233,751 $ 89,146 7.2 % Inventory days (2) 63.2 57.8 Accounts payable $ 1,021,761 $ 1,000,186 $ 21,575 2.2 % (1) Based on period end accounts receivable and net revenue for the quarters ended March 31, 2021 and December 31, 2020 (2) Based on period end merchandise inventories and cost of goods sold for the quarters ended March 31, 2021 and December 31, 2020 Liquidity and capital expenditures. The following table summarizes our consolidated statements of cash flows for the three months ended March 31, 2021 and 2020, which relates to continuing operations and discontinued operations: (Dollars in thousands) 2021 2020 Net cash provided by (used for): Operating activities $ 25,423 $ 93,454 Investing activities (6,619) (5,680) Financing activities (80,394) (31,406) Effect of exchange rate changes (2,139) (62) Net (decrease) increase in cash, cash equivalents and restricted cash $ (63,729) $ 56,306 Cash provided by operating activities in the first three months of 2021 and 2020 reflected fluctuations in net income along with changes in working capital. Cash used for investing activities in the first three months of 2021 and 2020 included capital expenditures of $6.6 million and $5.7 million for our strategic and operational efficiency initiatives associated with property and equipment, investments for increased manufacturing capacity in the Americas, and capitalized software. C ash used for financing activities in the first three months of 2021 included dividend payments of $0.2 million and repayments of $96.5 million under our revolving credit facility, compared to $0.2 million and $6.2 million for the same period of 2020. We also had proceeds from borrowings of $575 million related to the 2029 Unsecured Notes and Accounts Receivable Securitization Program for the first three months of 2021, compared to $150 million related to the Accounts Receivable Securitization Program for the first three months of 2020. Financing activities also included repayments of $523 million for the first three months of 2021 compared to $167 million in the same period of 2020 on our term loans and 2021 and 2024 Notes. We used $4.4 million of cash to repurchase $4.6 million aggregate principal amount of the 2021 and 2024 Notes during the first three months of 2020. We also paid $11.7 million in financing costs, as compared to $5.8 million in financing costs for the same period of 2020. In addition, we paid $15.4 million to terminate the remaining $300 million in notional value of interest rate swaps during the first three months of 2021. 22 Table of Contents Capital resources . Our sources of liquidity include cash and cash equivalents, a revolving credit facility under our Credit Agreement with Bank of America, N.A, as an administrative agent and collateral agent, and a syndicate of financial institutions, as lenders (the Credit Agreement), and the Receivables Securitization Program. The Credit Agreement provides a revolving borrowing capacity of $300 million. The interest rate on our revolving credit facility is based on a spread over either the Eurocurrency Rate or the Base Rate (each as defined in the Credit Agreement) . The Credit Agreement matures in March 2026. At March 31, 2021 and December 31, 2020, we had borrowings of $6.7 million and $103 million, and letters of credit of $11.4 million and $13.9 million outstanding under our credit agreements. At March 31, 2021 and December 31, 2020, we had $282 million and $283 million, available for borrowing. We also had letters of credit and bank guarantees outstanding for $1.9 million and $1.6 million as of March 31, 2021 and December 31, 2020, which supports certain leased facilities as well as other normal business activities in the United States and Europe. These letters of credit and guarantees were issued independent of the Credit Agreement . We entered into a Security and Pledge Agreement (the Security Agreement), dated March 10, 2021, pursuant to which we granted collateral on behalf of the holders of the 2024 Notes, and the parties secured under the Credit Agreement (the Secured Parties) including first priority liens and security interests in (a) all present and future shares of capital stock owned by the Credit Parties (as defined) in the Credit Parties’ present and future subsidiaries and (b) all present and future personal property and assets of the Credit Parties, subject to certain exceptions. The Credit Agreement included additional collateral requirements of the Credit Parties, including an obligation to pledge our owned U.S. real estate and the remaining equity interests in foreign subsidiaries. On March 10, 2021, we entered into an amendment to our accounts receivable securitization program (the Receivables Securitization Program). Pursuant to the amended Receivables Securitization Program, the aggregate principal amount of the loans made by the Lenders (as defined) will not exceed $450 million outstanding at any time. The interest rate under the Receivables Securitization Program is based on a spread over the London Interbank Offered Rate (LIBOR) or successor rate. Under the Receivables Securitization Program, certain of our subsidiaries sell substantially all of their accounts receivable balances to our wholly owned special purpose entity, O&M Funding LLC. The Receivables Securitization Program matures in March 2024. The Credit Agreement, Receivables Securitization Program, 2024 Notes and 2029 Unsecured Notes contain cross-default provisions which could result in the acceleration of payments due in the event of default of either agreement. The terms of the Credit Agreement also require us to maintain ratios for leverage and interest coverage, including on a pro forma basis in the event of an acquisition or divestiture. We were in compliance with our debt covenants at March 31, 2021. In May 2020, we entered into an equity distribution agreement, pursuant to which we may offer and sell, from time to time, shares of our common stock having an aggregate offering price of up to $50.0 million. We intend to use the net proceeds from the sale of our securities offered by this program for the repayment of indebtedness and/or for general corporate and working capital purposes. As of March 31, 2021 no shares were issued and $50.0 million of common stock remained available under the at-the-market equity financing program. We regularly evaluate market conditions, our liquidity profile and various financing alternatives to enhance our capital structure. From time to time, we may enter into transactions to repay, repurchase or redeem our outstanding indebtedness (including by means of open market purchases, privately negotiated repurchases, tender or exchange offers and/or repayments or redemptions pursuant to the debt’s terms). Our ability to consummate any such transaction will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. We cannot provide any assurance as to if or when we will consummate any such transactions or the terms of any such transaction. The first quarter dividend of $0.0025 per share was paid in March 2021. The payment of future dividends remains within the discretion of the Board of Directors and will depend upon our results of operations, financial condition, capital requirements, current and future limitations under our Credit Agreement and other factors. We believe available financing sources, including cash generated by operating activities and borrowings under the Credit Agreement and Receivables Securitization Program, will be sufficient to fund our working capital needs, capital expenditures, long-term strategic growth, payments under long-term debt and lease arrangements, payments of quarterly cash dividends, debt repurchases and other cash requirements. While we believe that we will have the ability to meet our financing needs in the foreseeable future, changes in economic conditions may impact (i) the ability of financial institutions to meet their contractual commitments to us, (ii) the ability of our customers and suppliers to meet their obligations to us or (iii) our cost of borrowing. We earn a portion of our operating income in foreign jurisdictions outside the United States. Our cash and cash equivalents held by our foreign subsidiaries totaled $37.7 million and $72.0 million at March 31, 2021 and December 31, 2020. We continue to remain permanently reinvested in our foreign subsidiaries, with the exception of a subsidiary in Thailand. We 23 Table of Contents have no specific plans to indefinitely reinvest the unremitted earnings of our foreign subsidiary located in Thailand as of March 31, 2021. As such, we have recorded withholding tax liabilities that would be incurred upon future distribution to the U.S. There are no unrecognized deferred taxes as there is no outside basis difference unrelated to unremitted earnings for Thailand. We will continue to evaluate our foreign earnings repatriation policy in 2021 for all our foreign subsidiaries. Guarantor and Collateral Group Summarized Financial Information We are providing the following information in compliance with Rule 13-01, “Financial Disclosures about Guarantors and Issuers of Guaranteed Securities” and Rule 13-02 of Regulation S-X, of with respect to our 2024 Notes. See Note 6 of the accompanying consolidated financial statements for additional information regarding the terms of the 2024 Notes. The following tables present summarized financial information for Owens & Minor, Inc. and the guarantors of Owens & Minor, Inc.’s 2024 Notes (together, "the Guarantor Group"), on a combined basis with intercompany balances and transactions between entities in the Guarantor Group eliminated. The guarantor subsidiaries are 100% owned by Owens & Minor, Inc. Separate financial statements of the guarantor subsidiaries are not presented because the guarantees by our guarantor subsidiaries are full and unconditional, as well as joint and several. Summarized financial information of the Guarantor Group is as follows: Summarized Consolidated Statement of Operations - Guarantor Group Three months ended March 31, 2021 (Dollars in thousands) Net revenue (1) $ 2,260,930 Gross margin 386,153 Operating income 105,032 Income from continuing operations, net of tax 42,145 Net income 42,145 (1) Includes $78.2 million in sales to non-guarantor subsidiaries for the three months ended March 31, 2021. Summarized Consolidated Balance Sheet - Guarantor Group March 31, 2021 December 31, 2020 (Dollars in thousands) Total current assets $ 1,286,114 $ 1,559,248 Intercompany receivable 370,103 399,484 Total assets 2,664,388 2,943,125 Current liabilities 1,379,941 1,374,800 Intercompany payable 106,238 89,040 Total liabilities 2,388,724 2,465,894 The following tables present summarized financial information for Owens & Minor, Inc. and the subsidiaries of Owens & Minor, Inc.’s 2024 Notes pledged that constitute a substantial portion of collateral (together, "the Collateral Group"), on a combined basis with intercompany balances and transactions between entities in the Collateral Group eliminated. The pledged subsidiaries are 100% owned by Owens & Minor, Inc. No trading market for the subsidiaries included in the Collateral Group exists. Summarized financial information of the Collateral Group is as follows: Summarized Consolidated Balance Sheet - Collateral Group March 31, 2021 December 31, 2020 (Dollars in thousands) Total current assets $ 1,377,069 $ 1,651,460 Intercompany receivable 248,974 158,651 Total assets 2,561,146 2,851,226 Current liabilities 1,335,156 1,356,024 Intercompany payable 504,299 486,491 Total liabilities 2,376,416 2,480,953 24 Table of Contents The results of operations of the Collateral Group are not materially different from the corresponding amounts presented in our Consolidated Statements of Operations. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, see our Annual Report on Form 10-K for the year ended December 31, 2020 and Note 14 in the Notes to Consolidated Financial Statements, included in this Quarterly Report on Form 10-Q for the quarterly period ended on March 31, 2021. Forward-looking Statements Certain statements in this discussion constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Although we believe our expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of our knowledge of our business and operations, all forward-looking statements involve risks and uncertainties and, as a result, actual results could differ materially from those projected, anticipated or implied by these statements. Such forward-looking statements involve known and unknown risks, including, but not limited to: • our ability to achieve revenue and operating income goals may be affected by: COVID-19 related factors, risks and challenges, including among others, the length of time that the pandemic continues, and any worsening of the pandemic or future pandemics, related governmental responses, a decrease in revenue ultimately resulting in less cash flow, longer duration in receivables collection, the need to expedite payments to important suppliers may grow, shifts in demand away from certain products we manufacture and distribute, reduced workforces which may be caused by, but not limited to, the temporary inability of the workforce to work due to illness, quarantine, or government mandates, temporary production and distribution center and office closures due to reduced workforces or government mandates, availability of raw materials, potential resulting labor negotiations or disputes, changes in the types and numbers of businesses that compete with us, including non-traditional competitors, and the aggressiveness of that competition, impacts of the pandemic or future pandemics on other third parties with whom we conduct business, the healthcare industry, and the broader business environment, and trends in elective surgeries and other healthcare spending not directly associated with COVID-19; • competitive pressures in the marketplace, including intense pricing pressure; • our ability to retain existing and attract new customers in a market characterized by significant customer consolidation and intense cost-containment initiatives; • our dependence on sales to certain customers or the loss or material reduction in purchases by key customers; • our dependence on distribution of product of certain suppliers; • our ability to successfully identify, manage or integrate acquisitions; • our ability to successfully manage our international operations, including risks associated with changes in international trade regulations, foreign currency volatility, changes in regulatory conditions, deteriorating economic conditions, adverse tax consequences, and other risks of operating in international markets; • uncertainties related to and our ability to adapt to changes in government regulations, including healthcare laws and regulations; • risks arising from possible violations of legal, regulatory or licensing requirements of the markets in which we operate; • uncertainties related to general economic, regulatory and business conditions; • our ability to successfully implement our strategic initiatives; • the availability of and modifications to existing supplier funding programs and our ability to meet the terms to qualify for certain of these programs; • the effect of price volatility in the commodities markets, including fuel price fluctuations, on our operating costs and supplier product prices; • our ability to adapt to changes in product pricing and other terms of purchase by suppliers of product; • the ability of customers and suppliers to meet financial commitments due to us; 25 Table of Contents • changes in manufacturer preferences between direct sales and wholesale distribution; • changing trends in customer profiles and ordering patterns and our ability to meet customer demand for additional value-added services; • our ability to manage operating expenses and improve operational efficiencies in response to changing customer profiles; • our ability to meet performance targets specified by customer contracts under contractual commitments; • availability of and our ability to access special inventory buying opportunities; • the ability of business partners and financial institutions to perform their contractual responsibilities; • our ability to continue to obtain financing, obtain financing at reasonable rates and to manage financing costs and interest rate risk, and our ability to refinance, extend or repay our substantial indebtedness; • the risk that information systems are interrupted or damaged or fail for any extended period of time, that new information systems are not successfully implemented or integrated, or that there is a data security breach in our information systems; • the risk that a decline in business volume or profitability could result in an impairment of goodwill or other long-lived assets; • our ability to timely or adequately respond to technological advances in the medical supply industry; • the costs associated with and outcome of outstanding and any future litigation, including product and professional liability claims; • adverse changes in U.S. and foreign tax laws and the outcome of outstanding tax contingencies and legislative and tax proposals; • our ability to successfully implement the expense reduction and productivity and efficiency initiatives; • our ability to continue to comply with the terms and conditions of Byram Healthcare’s Corporate Integrity Agreement; and • other factors detailed from time to time in the reports we file with the SEC, including those described in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2020. We undertake no obligation to update or revise any forward-looking statements, except as required by applicable law.